IFRS 17: “Further Steps in a Long Journey”
Michael Winkler and Sunil Kansal at Shasat Consulting summarise the positive and critical aspects of the IFRS17 amendments of June 2020
esides moving the effective date of IFRS 17 to January 2023, the International Accounting Standards Board (Board) has also decided on various amendments to the original Standard, establishing clarity for further implementation.
However, IFRS 17 remains challenging: although the Board has addressed some of the concerns of the business, it has also pushed back on other change requests.
CSM based on Investment Services
The profit arising from the contractual service margin (CSM) released is based on Coverage Units, reflecting the quantity of provided coverage as well as the duration of the contracts. The Standard is not very specific on the definition of these Coverage Units; however, they seem to be related to insurance coverage only. This creates a challenge for products like deferred annuities, sometimes not covering any insurance risk during the deferred period: In this case, there would be no CSM release during the deferred period.
According to the corresponding amendment, the Coverage Units can also be based on investment-return services (IFRS 17.B119B). Furthermore, the fulfilment cash flows should also include costs related to investment activities aiming for enhancing the benefits for the policyholders. Therefore, the tools for creating a more reasonable profit recognition pattern are now available; however, the insurance companies still have to take the right decisions on how to weigh insurance coverage versus investment return services in the definition of the Coverage Units.
Commission Payments for Expected Renewals
For many short-term contracts, an upfront commission is paid based on economic substance, considering the expected renewals. Given the short contract boundary of these contracts, this may result in losses, turning all this new business into onerous contracts.
The corresponding amendment (IFRS 17.28B) requires an entity to allocate the insurance acquisition cash flows to related contract renewals and recognise those cash flows as an asset until the recognition of the renewed contracts. In each reporting period, the recoverability of the asset has to be assessed and corresponding adjustments may be necessary (e.g. if the amount of renewals is below expectations).
Insurance Revenue & Income Tax
Amounts related to income tax that are specifically chargeable to policyholders shall be included in the fulfilment cash flows (IFRS 17.B121), Without this amendment, the entity would need to present the amount of consideration related to those income tax expenses as income rather than insurance revenue.
Unexpected Payment of Investment components
IFRS 17.B96(c) requires that differences between any investment component or loan to a policyholder expected to become payable or repayable in the period and the ones that actually (re)payable adjusts the CSM, i.e. differences due to the effect of the time value of money and changes in the time value of money and the effect of financial risk and changes in financial risk.
The amendment clarifies that the above differences are determined by comparing
a) the actual investment component or loan to a policyholder that becomes (re)payable in a period
b) the (re)payment in the period that was expected at the start of the period plus any insurance finance income or expenses related to that expected (re)payment before it becomes (re)payable.
Risk Mitigation Option
The Risk Mitigation Option for contracts with direct participation features is already available for derivatives [IFRS 17.B113(b)]; the amendment extends it to reinsurance contracts and non-derivative financial assets, measured at fair value through profit and loss. This amendment will help to reduce accounting mismatches; however, since there is no retrospective application of the option, the transition may still be challenging.
Reinsurance of onerous contracts
If onerous contracts are reinsured, according to the original Standard, the corresponding profit from this reinsurance is spread over time whereas the loss on the underlying contracts is immediately recognised. Consequently, the risk mitigation intended by reinsurance is not reflected in the accounting statements.
This is addressed by amendment B119G: an entity should use a systematic and rational method to determine the portion of losses covered by the reinsurance contract and use the same method of allocation to determine the portion of subsequent changes in the loss component relating to the underlying insurance contracts.
The definitions of the Liability for Remaining Coverage as well as the Liability for Incurred Claims (IFRS 17. Appendix A) are amended in order to include all obligations arising from Insurance Contracts issued by an entity (e.g. refunds of premiums or expenses payable to a third party).
The Board has approved some amendments providing transition relief but has pushed back on many other proposals. In essence, the amendments are dealing with cases where detailed information at inception is not available, for investment contracts with discretionary participation features (IFRS 17.C9/C21), for reinsurance contracts held (IFRS17.C15A) as well as interim financial statements (IFRS17.B137).
The IASB decided to leave the following areas of IFRS 17 unchanged:
• Level of Aggregation: There has been a request to allow specific exemptions to the annual cohort requirements in case of insurance contracts with intergenerational risk-sharing between policyholders.
• Non-participating Cash Flows in the Variable Fee Approach: There is no change of the requirement to adjust the CSM of insurance contracts with direct participation features for changes in the time value of money and financial risks not arising from the underlying items.
• Changing Nature: The treatment of contracts changing their nature over time is not changed; therefore, a savings contract with an option to convert the maturity payment into a guaranteed annuity may still apply the Variable Fee Approach whereas the annuity contract without the savings phase will apply the General Model.
Statement of Financial Position
As per the new presentational change, the entities are now required to separately present the carrying amount of the portfolios of insurance and reinsurance contracts (reinsurance contracts held) that are assets and liabilities.
Previously, entities were required to link these assets and liabilities to group contracts, but now it will be linked to portfolios at the group level. It is likely to provide more transparency.
Frequency of Reporting
The amended text of IFRS 17 requires the entity to make an accounting policy choice as to whether to change the treatment of accounting estimates made in previous interim financial statements when applying IFRS 17 in subsequent interim financial statements or the annual reporting period. This is to be applied at the reporting entity level. This will certainly provide more flexibility to entities.
The amendments provide some relief in certain areas and in some cases, more clarity facilitating the implementation. However, there is still a need for further guidance as there remains room for interpretations. Therefore, insurance companies will have to make many choices which should be based on a careful analysis of the financial impact.