IFRS 17: Starting from scratch

You are not alone.

IFRS 17 implementation is a challenge for everyone.

So far, we didn't have a consistent approach to account for insurance contracts. But that's okay. Even physicists could not reconcile general relativity and quantum mechanics for over 100 years. Some things take time.

You see, accounting is like Newtonian mechanics. 100% deterministic. But insurance contracts are fuzzy and probabilistic. Just like quantum mechanics. How do you reconcile the two?

Fear not. Today is not the day for scary questions.

This article will address some fundamental frequently asked questions.

What is #IFRS17 ?

IFRS 17 is the International Financial Reporting Standard for insurance contracts. It replaces IFRS 4 and provides a comprehensive framework for the recognition, measurement, and presentation of insurance contracts.

What is the scope of IFRS 17?

The scope of IFRS 17 is defined in terms of the type of a contract and not in terms of the type of entity. This means contracts issued by an insurance company may not be covered under IFRS 17. Similarly, Contracts issued by non-insurance companies may be covered under IFRS 17

Which transactions and contracts are covered under IFRS 17?

IFRS 17 applies to insurance and reinsurance contracts issued by an entity, as well as reinsurance contracts it holds. However, there are some exceptions to this general rule:

1- Contracts that are not insurance contracts but are covered under IFRS 17

Investment contracts issued with discretionary participation features do not meet the definition of an insurance contract but are accounted for under IFRS 17 if the entity also issues insurance contracts.

2- Contracts that meet the definition of insurance contracts but are excluded from the scope of IFRS 17 unconditionally

1. Contractual rights or contractual obligations contingent on the future use of, or the right to use, a non-financial item (for example, some license fees, royalties, variable and other contingent lease payments, and similar items under IFRS 15, IAS 38 IFRS 16).
2. Warranties provided by a manufacturer, dealer, or retailer in connection with the sale of its goods or services to a customer (IFRS 15 applies)
3. Residual value guarantees are provided by a manufacturer, dealer, or retailer, and a lessee’s residual value guarantees when they are embedded in a lease (see IFRS 15 and IFRS 16).
4. Employers’ assets and liabilities that arise from employee benefit plans and retirement benefit obligations reported by defined benefit retirement plans (IAS 26 applies)
5. Contingent consideration payable or receivable in a business combination

3- Contracts that meet the definition of insurance contracts but are excluded from the scope of IFRS 17 on meeting certain conditions.

1. Credit card contracts, or similar contracts that provide credit or payment arrangements, that meet the definition of an insurance contract if, (a) the entity does not reflect an assessment of the insurance risk associated with an individual customer in setting the price of the contract with that customer and (b) IFRS 9 does not require the entity to separate the insurance coverage component
2. Financial guarantee contracts, unless the issuer has previously asserted explicitly that it regards such contracts as insurance contracts and has used accounting applicable to insurance contracts. In this case irrevocable choice is available on contract by contract basis)
3. Fixed-fee service contracts meet the definition of an insurance contract but may be accounted for under IFRS 15 in certain circumstances

We already had IFRS 4, why did we need a new standard?

The standard was developed to address the shortcomings of its predecessor, IFRS 4, and to improve the consistency, comparability, and transparency of financial reporting by insurance companies.

What kind of inconsistencies exist before IFRS 17?

Following is a helpful snapshot of a variety of accounting practices that made the financial statements of Insurance Companies less comparable, less relevant, and less transparent.

Lack of Comparability

IFRS 4 allowed insurance companies to use a variety of accounting policies to account for similar contracts, resulting in a lack of comparability between companies. For instance, companies operating in different jurisdictions could:

1. Recognize premiums received as revenue in different ways. Some companies may report all premiums as revenue, while others may exclude saving components received through premiums from their reported revenue.
2. Capitalize and amortize the costs incurred in issuing new insurance contracts over several years, while others may expense these costs when incurred.
3. Use varying methods to measure their insurance contracts. Some companies may use updated discount rates, while others may use historical discount rates.
4. Consolidate subsidiaries using non-uniform accounting policies. However, this approach leads to a lack of comparability between insurance contracts issued by the same group in different jurisdictions.
5. Report cash or deposits received as revenue contrary to accounting practices in other industries, such as banking and investment management.

Lack of Relevance

The following practices while adding inconsistency, had the potential to produce information that is less relevant for investors:

1. Some companies measured insurance contracts using assumptions made at the time the contracts were issued, and these assumptions were not subsequently updated to reflect changes in the economic environment.
2. Some companies used the "expected return on assets held" as the discount rate to measure insurance contract liabilities. This approach distorted the value of insurance contract liabilities, as these liabilities were not necessarily linked to assets and may have had a different duration.
3. Some companies did not consider the time value of money when measuring liabilities for claims incurred. This resulted in misleading results for insurance contracts for which the settlement of a claim may take several years.

Lack of Transparency

Before the introduction of IFRS 17, the financial statements of insurance companies were less transparent and relevant for the following reasons:

1. Some companies included an "implicit allowance for risk" when measuring their insurance contract liabilities. However, the extent of this implicit margin was usually not disclosed in the notes to the financial statements, resulting in a lack of transparency.
2. There was a lack of transparency about the sources of profit recognized from insurance contracts, especially when revenue was reported on a cash basis.

These differences in accounting policies among companies make it difficult to compare their financial performance in a meaningful way. The lack of comparability makes it challenging for stakeholders to evaluate the financial performance of insurance companies and assess the risks and uncertainties associated with their insurance contracts.

How IFRS 17 aims to resolve these issues?

IFRS 17 aims to achieve several objectives, including:

1. Providing more relevant information: Under IFRS 17, insurance companies are required to provide consistent information about the components of current and future profits from insurance contracts. This means that the financial statements of insurance companies will provide more detailed and comprehensive information on the revenue, expenses, and profits associated with their insurance contracts.
2. Improving comparability: IFRS 17 requires all insurers to use a consistent approach called the Premium Allocation Approach and General Measurement Model and Variable Fee Approach to accounting for insurance contracts, which will improve the comparability of financial statements across different insurers.
3. Enhancing transparency: The standard requires insurers to provide more disclosure about their insurance contracts, which will help investors and other stakeholders better understand the risks and uncertainties associated with these contracts.

I hope this helped. If your team needs help in understanding IFRS 17, feel free to DM me.