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what to do now
Implications for European insurers
Executive summary
The International Accounting Standard Board (IASB ►► Increase the frequency of loss recognition
or Board) issued the new Insurance Accounting ►► Add complexity to valuation processes, data requirements,
Standard, IFRS 17 Insurance Contracts (the assumption setting. The requirements for forecasting
results of the new metric is even more challenging than
Standard) on 18 May 2017. The Standard will have
analyzing current results
to be applied for reporting periods starting on or
The IASB decided on a mandatory effective date
after 1 January 2021. of 1 January 2021 for the new standard. In the coming years,
insurers will need to interpret and apply the requirements to
This standard will represent the most significant change to
their insurance contracts — a process involving significant time
European insurance accounting requirements in 20 years,
and effort. The major change program required will extend
requiring insurers to entirely overhaul their financial statements.
beyond finance and actuarial teams and its impacts will need
Given the scale of this change, investors and other stakeholders
to be communicated to a broad range of internal and external
will want to understand the likely impact as early as possible (see
stakeholders.
Exhibit 1).
In addition to the Standard, insurers will need to adapt to a wave of
The Standard uses three measurement approaches:
other accounting changes over the next five years, including:
1. General model or Building Block Approach (BBA) — for most
►► IFRS 9 Financial Instruments — effective 1 Jan 2018
long-term contracts
(although most insurers will be able to defer this to
2. Premium Allocation Approach (PAA) — for most short-term 1 January 2021)
contracts (optional)
►► IFRS 15 Revenue from Contracts with Customers —
3. Variable Fee Approach (VFA) — for contracts with direct effective 1 January 2018
participation features
►► IFRS 16 Leases — effective 1 January 2019
The principles underlying these measurement approaches result in
Given the scale of the Standard’s impact, and the complexity of
a fundamental change to current practice, particularly for long-
the implementation task, insurers should start formally assessing
duration contracts. The requirements are markedly different to
impacts and mobilize their organizations now — starting with these
existing accounting in a number of critical aspects that will:
six actions.
►► Change profit emergence patterns
1 2 3 4 5 6
Educate the Identify the key Analyze the Draft budget and Assess Assess strategic
executives methodology and financial, plan resourcing implications for and product
on the new design decisions operational requirements. other current implications.
requirements and assumptions and system or planned
and implications. driving implications. programs of
implementation. activity in the
next 3–4 years.
Disclosure of expected impacts of Revised IFRS 9 classification from First IFRS 17–
the issued but not effective Standard IFRS 17 implementation* compliant financial
statements
►►Communicate early to key stakeholders, including market analysts ►►Allocate time and resources to projects to design, build and test new
and shareholders, providing clarity around the expected impacts to data, modelling and systems capability
the financial statements and profit profiles
►►Update methodology guidance for risk adjustment, discount curve
►►Analyze current management reporting, key performance and assumption setting
indicators and incentive frameworks for ongoing applicability, and
►►Create a new calculation engine for amortizing and adjusting the
incorporate necessary changes for analysing margins and volatility
contractual service margin (CSM)
►►Update volatility and asset-liability management frameworks for
►►Work with the finance team to estimate impacts on transition and
measurement changes under IFRS 17 and assets under IFRS 9
design optimal approaches
►►Evaluate any tax, capital or distributable profit implications
►►Assist in making sure the reported figures are auditable
►►Analyse of earnings volatility and how to mitigate
Controllership ►►Perform in-depth analysis on impacts on ALM strategies
Taxation
Investing
►►Determine impacts of IFRS 17 on current tax and deferred tax
►►Engage with local tax authorities to discuss treatment if tax follows ►►Review investment policies and asset liability management strategy
IFRS financials based on the impacts of the new measurement models for both
insurance contracts and financial instruments
►►Consider other impacts such as data requests for tax compliance,
tax impacts of new KPI’s and changes to reward plans.
Investing
Phase 2 Phase 4
Design smart-tailored solution Dry-run/restatement and
comparatives
►► Detailed financial impact analysis
►► Prepare transition data
►► Design Target Operating Model
(TOM) and develop new key ►► Implement TOM
performance indicators (KPIs)
►► Redesign of control frameworks
►► Run system assessment and processes
►► Prepare data analysis for transition
►► Identify options for optimizing
implementation — mitigating
profit impacts, reducing costs of
implementation
? ? ? ? ? ?
See pages See pages 18, See pages 13,
See page 9 See page 11 See page 20
13, 15, 17, 19 22 15, 17, 19
►►Is this an ►►Do we have ►►Which ►►What additional ►►What are the ►►Which
insurance non-insurance measurement data do we implications for transition
contract? If components model should need for our asset liability approach
so, what is its that must be we apply? disclosures and management should we use?
duration? separated? ►►What changes do presentation? (ALM), product
►►To what extent we need to make strategy, pricing
can we group to our valuation and profit release
individual systems and patterns?
contracts? processes?
Are any of
the contracts
onerous?
Building block approach (BBA) Premium allocation approach (PAA) Variable fee approach (VFA)
►► Default valuation approach. ►► Optional simplified approach for ►► Applies to direct participating
contracts with a coverage period of contracts, as defined by three
►► Insurance contract valued using
one year or less, or criteria, based on policyholders
fulfilment cash flows — the present
where it is a reasonable being entitled to a significant
expected future cash flows, plus a
approximation to BBA. share in the profit from a clearly
risk adjustment.
identified pool of underlying items.
►► Many non-life, and some life,
►► Any day one gain is offset by
insurance contracts are expected ►► Insurance contract liability based
the contractual service margin
to meet these criteria. on the obligation for the entity to
(CSM), which represents unearned
pay the policyholder an amount
profit the insurer recognizes as ►► Insurance contract represented by
equal to the value of the underlying
it provides services under the a pre-claims coverage liability and
items, net of a consideration
contract. The CSM is unlocked for an incurred claims liability.
charged for the contract —
the impact of changes in fulfilment
►► Similar to existing non-life a “variable fee”.
cash flows and risk adjustment
insurance contract approaches
relating to future coverage. ►► Changes in financial assumptions
for pre-claims coverage liability
offset against contractual
(unearned premium). Incurred
service margin if they relate to
claims liability valued using
future service. Insurance finance
fulfilment cash flows similar to
expenses expense matches the
Solvency II best estimate claim
investment income recognized
reserving.
on underlying items if underlying
items are held “current period book
yield approach”.
Separation of
Premium allocation
Risk adjustment
components
(see page 11) Liability for
remaining Discount rate
coverage Transition
(see page 20)
Cash flows of
claim liability
Risk adjustment
Presentation/
Level of aggregation (unit of account)
Disaggregation
Building block
approach
approach
Definition
and scope Expected value concept. It determines the level at which insurers apply the
of future cash flows
Reinsurance Disclosure
recognition and measurement requirements of the standard
Premium allocation
Separation of
components Liability for
Risk adjustment and directly affects insurers’ ability to aggregate contracts for
remaining Discount rate
Transition valuation purposes and the onerous contract test.
approach
coverage
Cash flows of
claim liability
The level of aggregation is determined by the following hierarchy
Financial instruments and other accounting changes
of groupings:
►► Portfolio: a portfolio is a group of contracts which are subject
Implications to similar risks and are managed together. IFRS 17 provides
guidance that contracts in different product lines, for example
►► More granularity in contract groupings for valuation annuities compared with term life assurance, would not have
purposes will create additional complexity in the valuation similar risks and therefore would be in different portfolio’s.
models, process and data requirements.
►► Profitability “buckets”: each portfolio is further split into
►► The Liability Adequacy Test (LAT) will be replaced by an at least three groups (to the extent relevant) depending on
“onerous contracts” recognition test. This new test is expected profitability at inception:
expected to be measured at a more granular level than the
current LAT, in many cases, with the potential for certain ►► Onerous contracts which are expected to be unprofitable at
contracts to enter into loss recognition. inception
►► When law or regulation constrains the entity’s ability ►► Resiliently profitable contracts that have no significant
to set a different price for policy holders with different possibility of becoming onerous in the future
characteristics, the entity may be able to include those ►► Remaining contracts in the portfolio
contracts in the same group.
►► Cohorts: cohorts are a breakdown of portfolios according
►► Some life insurance contracts may be considered short- to date of inception. The Standard prohibits entities from
term, potentially accelerating profit recognition and grouping contracts issued more than one year apart
amortization of acquisition costs.
►► An entity may choose to divide a portfolio into more groups
►► Some general insurance contracts may have to be treated if the entity’s internal reporting provides information to make
as long-term, becoming subject to a more complex such sub-divisions
valuation methodology.
Entities can measure sets of contracts together if the entity
►► Additional guidance on the “significant insurance risk” can determine that those contracts can be grouped with others
test means contracts that are currently borderline or with based on reasonable and supportable information at inception.
deferred payment features may not meet the insurance For contracts affected by rate regulation, aggregation into a
contract definition. single group will be permitted if these contracts would fall into
different groups only because of such constraints. If a series of
insurance contracts achieve, or are designed to achieve, an overall
Definition of an insurance contract commercial effect, it may be necessary to treat the set or series of
contracts as a whole to report the substance of the transaction.
Since the definition of an insurance contract under the
This means that entities will have to evaluate when contacts can,
Standard is unchanged from current IFRS 4, most contracts
or should be, combined and measured together as a single group.
will not be impacted.
However, additional guidance on the “significant insurance
risk” test states that it should be based on the present,
rather than nominal value of future potential cash flows of
a particular contract.
Contracts containing deferred payment features or those that are
currently borderline may be at risk of failing this revised test and
may need to apply IFRS 9.
Variable Fee
Discount rate
approach
approach
Definition
and scope Expected value
of future cash flows
Reinsurance Disclosure
Premium allocation
coverage
Cash flows of
claim liability
Investment components
Exhibit 4: Separation and disaggregation “Distinct” investment components should be separated and
accounted for in accordance with IFRS 9.
An investment component is “distinct” if a contract with equivalent
Distinct terms is sold, or could be sold, separately in the same market or
investment same jurisdiction, either by entities that issue insurance contracts
components
or by other parties.
Embedded
Insurance derivatives, Separation
components which are not
closely related
Accounting under IFRS 4
Distinct performance Accounting under IFRS 9
obligation to
provide Accounting under IFRS 15
Non distinct goods and
investment services Accounting under IFRS 4,
component disaggregation for presentation
Variable Fee
Discount rate
approach
approach
Definition
and scope Expected value
of future cash flows
Reinsurance Disclosure
Premium allocation
coverage
Cash flows of
claim liability
►► Contract aggregation at a cohort level or contractual ►► A risk adjustment reflecting the level of compensation the
service margin (CSM) group is expected to be much more insurer would demand for bearing the uncertainty about the
granular than current practice in many cases. Combined amount and timing of cash flows arising from non financial
with the need for probability-weighted expected cash risks. The technique used to determine the risk adjustment is
flows, this will add significant effort and complexity to the not specified, but the result will need to be translated into a
valuation. disclosed equivalent confidence level.
►► Calculating the discount rate and risk adjustment will The CSM is the expected unearned contract profit in an
involve estimations and require new techniques. The explicit insurance contract. At inception, it will be equal and opposite
risk adjustment is a new requirement compared to many to the fulfilment cash flows plus any pre-coverage cash flows
existing models although certain synergies with Solvency II (i.e., acquisition costs). Interest will accrue on the CSM based
might arise. on the discount rate locked in at inception. In principle, CSM will
be released into P&L in a way that best reflects the transfer of
►► The release of the CSM, based on coverage units will affect services under the contract, based on coverage units reflecting
profit emergence patterns. the quantity of benefits provided and the expected coverage
duration of the remaining contracts in the group.
The BBA (or General Model) will be the core measurement model,
All fulfilment cash flow assumptions will be updated each reporting
with the insurance contract liability comprising fulfilment cash
period. Changes in fulfilment cash flows that relate to future
flows and the CSM.
services will be added to or deducted from the remaining CSM
The fulfilment cash flows include: (i.e., unlocking of the CSM). Examples of such effects are changes
in assumptions causing a change in the estimate of the future cash
►► The expected, probability-weighted, discounted cash flows
flows of the liability for remaining coverage. Changes relating to
within the contract boundary. The objective is to determine
past and current services (e.g., differences between actual and
the expected value, or statistical mean, of the full range of
expected claims incurred in the current period, and changes in
possible scenarios, which will be discounted to present value at
estimates of fulfilment cash flows of the liability for claims incurred
a discount rate that reflects the characteristics of those cash
in previous periods) should be recognized in profit or loss as part
flows. This scenario-based approach is more complex than
of the insurance service expenses for the period. The CSM cannot
current “best estimate” approaches. If the scenarios represent
become “negative” subsequently. If the CSM has become nil, any
a normal distribution, then a more deterministic approach may
further unfavorable changes in estimates of the present value of
future cash flows are recognized in profit or loss.
Exhibit 5. The building block approach and presentation of changes in the insurance liability
Onerous contracts
Net contract asset or liability
under BBA
Variable Fee
Discount rate
approach
approach
Definition
and scope Expected value
of future cash flows
Reinsurance Disclosure
Premium allocation
coverage
Cash flows of
claim liability
Directly
attributable
acquisition
Premiums costs
received
(plus any
additional
onerous Risk
contract adjustment
liability) Liability for
remaining Present value
coverage of cash flows
Variable Fee
approach
Discount rate
approach
Definition
and scope Expected value
of future cash flows
Reinsurance Disclosure
Premium allocation
coverage
Cash flows of
claim liability
The VFA is the measurement approach for direct participating For some types of contracts, insurers are concerned that these
contracts that meet three criteria: differences will lead to a “cliff effect”, whereby two economically
similar contracts may report quite different results if one does not
1. The contractual terms specify that the policyholder
qualify to use the variable fee approach.
participates in a share of a clearly identified pool of
underlying items. If certain conditions for hedging as risk-mitigation techniques are
met, insurers may opt to recognize the changes in the fulfilment
2. The entity expects to pay to the policyholder an amount
value of financial risk features (such as interest rate guarantees) in
equal to a substantial share of the fair value returns from the
profit or loss.
underlying items.
3. The entity expects a substantial proportion of any change in Differences General Model Variable fee approach
the amounts to be paid to the policyholder to vary with the Subsequent PL or OCI, following CSM (PL if risk-mitigated)
change in fair value of the underlying items. measurement — the general model
financial variables
The VFA assumes that a participating contract creates an
Accretion of Locked-in rate Based on current rate
obligation for the entity to pay the policyholder an amount equal
interest on CSM included in the balance
to the fair value of the underlying items, net of a consideration sheet measurement
charged for the contract — a “variable fee”.
Accordingly, the entity’s interest in the contract would represent
a variable fee for the service of managing the underlying items
on behalf of a policyholder. At inception, this fee comprises the
Variable Fee
biggest change for some insurers will be seen in the Statement
approach
Discount rate
approach
Definition
and scope Expected value
of future cash flows
of Comprehensive Income (SCI), which will now separate
Disclosure
Reinsurance
investment performance explicitly from an insurance services (or
Premium allocation
Separation of
components Liability for
Risk adjustment
underwriting) result.
remaining Discount rate
Transition
approach
coverage
Cash flows of Exhibit 8 provides an example of which line items certain
claim liability
income and expense items will be recognized in. An entity will be
Financial instruments and other accounting changes prohibited from presenting premium information in the statement
of comprehensive income if that information is not consistent
with the commonly understood notion of revenue, governed
Implications by IFRS 15 Revenue from Contracts with Customers. However,
►► Premium revenue will no longer appear on the face of the premium‑related information could still be disclosed in the notes to
P&L, replaced by “insurance contracts revenue”. This is the financial statements or in the Segment Reporting.
calculated based on movements in a number of different Rather than premium revenue, insurance revenue will be shown
elements, requiring stakeholder education about its and calculated as described in Exhibit 8. This represents a
meaning and importance. fundamental change from today’s top-line income statement
►► There is a risk that, if the new format does not provide presentation for life insurance contracts.
useful information to investors, further supplementary Claims and other expenses related to the insurance contracts will
information outside the financial statements will proliferate. then be disclosed, leading to an underwriting result for the entity.
Profit after tax X ►►Calculated using locked-in rates (if the OCI
option is selected)
Other comprehensive income (X)
Variable Fee
Discount rate
approach
approach
coverage
Cash flows of
claim liability modified such that the CSM is calibrated to the expected
present value of the net cash flows — effectively spreading
Financial instruments and other accounting changes
any gain or loss on reinsurance over the period of the
contract. However, for retroactive contracts, a negative “day
Implications one difference” (cost of reinsurance) must be recognized
immediately in P&L if it relates to past events.
►► Reinsurers will measure insurance contracts issued under
the Standard insurance contract models (the BBA or PAA). ►► The reinsurance asset will include an allowance for reinsurer’s
default in the expected fulfilment cash flows.
►► Cedants have some additional specific areas of guidance.
►► If the underlying direct contract is considered onerous at
►► The reinsurance assets will use the same inputs and inception, even if the reinsurance arrangement is profitable for
assumptions in valuing the underlying contracts to value the direct insurer, the two cannot be offset.
the reinsurance asset. However, some mismatches will still
occur, as outlined below. These requirements could lead to a number of accounting
mismatches between measurement of the reinsurance contract
and that of the related direct insurance contracts.
Reinsurers will measure reinsurance contracts applying the
same principles as those for all insurance contracts. As such, the To take an extreme example, an entity with 100% quota share
requirements and observations made throughout this document reinsurance and no retained risk or profit share may still report an
apply to them as well. underwriting profit or loss due to accounting mismatches from one
period to the next. Over the life of the contracts, this will even out,
but it will impact profits from one period to the next.
The variable fee approach cannot be applied to reinsurance
Exhibit 9: Reinsurance measurement for cedants (BBA) contracts held and reinsurance contracts issued.
reinsurance asset
assumptions plus
Same inputs and
Definition
and scope Expected value
of future cash flows
Disclosure
For entities where the adoption of IFRS17 and IFRS 9 will have a
Reinsurance
cash tax impact, there will be:
Premium allocation
coverage
Cash flows of earnings or OCI on implementation, plus
claim liability
the practice.
Variable Fee
approach
Discount rate
approach
Definition
and scope Expected value
of future cash flows
Reinsurance Disclosure In particular, the entity will need to determine the appropriate level
of disaggregation of these disclosures, which might include:
Premium allocation
coverage
Cash flows of
claim liability
►► Geographical area
►► Reportable segment
Financial instruments and other accounting changes
This includes providing information about: how much risk the In general Insurance risks Other risks
insurer has taken on, how much uncertainty is contained in the
amounts reported, what drives performance, how much an insurer Risk appetite Risk exposure Risk exposure
expects to pay to fulfil its insurance contracts, and the value of Risk management Risk concentrations Risk concentrations
embedded options and guarantees. Regulatory law Claims settlement Maturity analysis
Although some of this information can be provided on the face Sensitivity analysis Sensitivity analysis
of the financial statements, much will come in the form of more concerning
detailed disclosures in the footnotes. Exhibit 11 provides a market risks
summary of these new disclosure requirements.
Explanation of recognized amounts
Some disclosure requirements are comparable to existing
Insurance finance income or expenses
requirements under IFRS 4. However, new and more extensive
disclosures are required for recognized amounts and roll-forwards. Significant judgments
IFRS 4 IFRS 17
Key changes
Assets Assets ►► Groups of insurance (or
Reinsurance contract assets Reinsurance contract assets reinsurance) contracts that are
in an asset position presented
Deferred acquisition costs Insurance contract assets separately from groups of
insurance (or reinsurance)
Value of business acquired
contracts that are in a
Premiums receivable liability position
Claims payable
IFRS 17
Start of IFRS 17 effective date 1
IFRS 17 Final comparative period January 2021. Deferred
Standard issued IFRS 9 effective date.
(May)
*Unless IFRS 9 will be deferred based on the conditional deferral option.
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