One of the most significant decisions regarding the implementation of IFRS 17 is the transition to the latest standard. The decisions made regarding transition approaches will have an impact on the opening balance sheet, future profit release, reporting comparability and additional disclosure. Insurers will have to decide how best to meet their compliance requirements whilst managing the issues of increased complexity and operational constraints.
Earlier this year, the International Accounting Standards Board (IASB) deferred the effective date for IFRS 17 to the 1st of January 2023. This means that the requirement for comparative reporting of the period immediately prior may need to be completed by insurers as early as 2022, depending on each insurer’s financial year end and solution reporting frequency. Therefore, the assessment and calculation of the transitional opening balances are becoming increasingly important.
The standard provides for three different approaches that should be applied to each annual cohort of contracts recognised at the transition date:
Ideally, insurers are required to implement the full retrospective approach, which aims to measure in-force insurance contracts as if IFRS 17 had always been applied. However, if this approach is impracticable – if it cannot be applied after an entity makes every reasonable effort to do so as defined in IAS 8: Accounting Policies, Changes in Accounting Estimates and Errors – the IASB has provided transitional relief in the form of the other two approaches.
The default, and most comprehensive, approach is the full retrospective approach. This approach requires current data to measure fulfilment cash flows and historic data to measure the contractual service margins (CSM) from inception until transition and initial assessments. This will provide insurers with the measurements of contracts as if IFRS 17 had always been applied.
The scale and granularity of the required historical data, as well as modelling complexity – especially for companies with longer coverage periods – can, however, become prohibitively expensive and arduous to the point of being impracticable. Many insurers will discover they have not retained the necessary data or retained data at the level of granularity required for such an approach. In this case, the organisation may choose, at their own discretion, to employ either the modified retrospective or fair value approach.
The aim of the modified retrospective approach is to achieve the closest possible outcome to the full approach using modifications and simplified assumptions, whilst using reasonable and supportable information. Importantly, the full retrospective approach should be adhered to first, as far as the information required is available without undue cost or effort.
Provided reasonable and supportable information is unavailable, key modifications include the simplification of future cash flows, discount rates, and risk adjustments; the calculation of the CSM or loss component; and the absence of the requirement to group insurance contracts by annual cohorts. It is important to remember that any modifications will need to be justified and supported in future annual disclosure.
The fair value approach is the second transitional relief approach and is considered the least operationally arduous of all the approaches. This approach, however, must only be applied if there is insufficient reasonable and supportable information to apply the modified retrospective approach. The measurement of the insurance contracts applies the principles of IFRS 13: Fair Value Management, where fair value is defined as the price that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date. This can make the approach tricky as insurers will need to apply their own judgement to their fair value methodology.
As part of the fair value approach, the calculation of CSM or loss component is simply calculated as the difference between the fair value price and the fulfilment cash flows at the date of transition. Additionally, insurers have a choice to group contracts either into annual cohorts or into groups more than one year apart. Annual cohort divisions must be adopted using reasonable and supportable information.
With the complexity of these transition decisions in mind, Celest Meyer, Director for the United Kingdom and Europe at Monocle, reaffirmed in our Monocle podcast: “The key point for any IFRS 17 implementation is that you have a technical understanding of the requirements of the standard…and you need to ensure that your system and data architecture can support the requirements for measurement under IFRS 17”.
As insurers continue with their transition assessments throughout 2020 and 2021, they will most likely apply a combination of the approaches across their generational contract groups, taking into consideration the data and model requirements and the cost associated with each approach. Insurers will therefore be forced to balance their technical accounting requirements with the practical considerations of implementation and operationalisation.
Insurers should therefore aim to complete the following tasks in their transition initiatives:
Assess availability, quality, and granularity of data to make informed decisions on the approaches that can be applied
Assess and understand the financial and reporting impact of using the various approaches
Engage with auditors around key judgements and decisions to ensure they are permissible and supportable
Clearly define and document accounting policies and judgements with input from the actuarial and technology functions
For further information on implementing IFRS 17 with a focus on the operational impact of the standard on data, processes and systems, please download and read our insights paper IFRS 17: More Than Technical Accounting from our website.
Monocle is a management consulting firm specialising in banking and insurance. Since our establishment in 2002, we have worked with industry-leading banks and insurance companies around the world, including institutions in the United Kingdom, Europe, Scandinavia, Asia, South Africa and throughout sub-Saharan Africa.
We design and execute bespoke change projects from start to finish, bridging the divide between business stakeholders’ needs and the complex systems, processes and data that sit under the hood. We offer several unique capabilities to our clients, which have been forged over time through the combination of a highly specialised skillset and extensive experience working with the systems, processes and people that are at the heart of the financial services industry.
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