IFRS 17 for Insurance Companies

The introduction of IFRS 17 for insurance companies, developed by the International Accounting Standards Board, replaces IFRS 4.

The aim is to create a unified and transparent framework for insurers worldwide.

IFRS 17 standardises the recognition and measurement of insurance contract services and insurance liabilities.

This improves comparability and gives stakeholders a clearer view of financial performance

What does IFRS 17 cover?

IFRS 17 establishes the principles for the recognition, measurement, presentation, and disclosure of these insurance contracts.

Its primary goal is to ensure that an entity provides relevant information that faithfully represents those contracts.

This information gives a basis for users of financial statements to assess the effect that insurance contracts have on the entity's financial position, performance, and cash flows.

The scope is broad, covering everything from life insurance and annuities to property and casualty policies in the insurance industry.

Core Components of IFRS 17

• General Measurement Model (GMM): This is the default model. It measures an insurance contract using building blocks: the present value of future cash flows, a risk adjustment for non-financial risk, and the Contractual Service Margin (CSM).
  

• Premium Allocation Approach (PAA): This is a simplified model for short-term contracts, typically those with a coverage period of one year or less. Instead of calculating future cash flows, the PAA allows a company to recognise the liability for remaining coverage based on the premium received.
  

• Variable Fee Approach (VFA): This model is a modification of the GMM and is designed for direct participating contracts. These are contracts where the insurer's obligation to the policyholder is directly linked to the returns on underlying items, like a specific pool of assets.

What is CSM in IFRS 17?

Contractual Service Margin, or CSM, represents the unearned profit that an entity expects to realise over the life of a group of insurance contracts.

At the initial recognition of a group of profitable contracts, the CSM is calculated as the balancing figure that prevents any gain from being recognised immediately.

Instead, this expected profit is deferred and then systematically released into the profit or loss statement as the insurer provides services over the coverage period.

The CSM ensures that profits are recognised as they are earned, not when the contract is written, providing a more accurate depiction of an insurer's performance over time.

It also highlights insurance service expenses as they are incurred rather than upfront.

What is interest accretion under IFRS 17?

Once the CSM is established, its balance must be updated at the end of each reporting period to reflect the time value of money. This adjustment is known as interest accretion.

The CSM balance is accreted with interest using the discount rates determined at the inception of the contract.

This process increases the carrying amount of the CSM over time, reflecting insurance finance income as part of the financial performance.

Subsequently, the CSM is reduced as the insurer recognises profit for the services provided during the period.

Interest accretion ensures that the measurement of the CSM remains current, reflecting the financing effect of deferring the profit.

When is profit recognised in IFRS 17?

Profit recognition is tied to the delivery of insurance coverage and services. The standard moves away from previous accounting practices where profits could be recognised upfront.

With the CSM, expected profits are locked in at the beginning of a contract and are only recognised in the income statement as the insurer fulfils its obligations to the policyholder.

Each reporting period, a portion of the CSM is released to profit or loss based on the coverage units provided in that period.

This systematic release ensures that profit recognition aligns directly with the service provided, resulting in a more stable and predictable pattern of earnings.

How are contracts grouped for IFRS 17?

Effective implementation of IFRS 17 requires contracts to be aggregated into specific groups based on three criteria:

1. Portfolio: Contracts are first allocated to a portfolio, which consists of contracts subject to similar risks and managed together. For example, an insurer might have separate portfolios for car insurance and life insurance, with significant insurance risk considered in the grouping.
   

2. Profitability: Within each portfolio, contracts are then divided based on their expected profitability at inception. They are separated into groups that are onerous (loss-making), have no significant possibility of becoming onerous, or are profitable.
   

3. Issue Year: Finally, these groups are further subdivided by their year of issue. An entity is generally not permitted to group contracts issued more than one year apart.

This granular level of grouping ensures that profitable and loss-making contracts are not bundled together, preventing the concealment of losses and improving transparency.

Implementation Challenges and Benefits

Transitioning to IFRS 17 presents several key challenges, especially since the requirements apply to annual reporting periods beginning on or after 1 January 2023:

• System and Process Overhaul: Insurers must invest heavily in new systems, processes, and data analytics capabilities to comply with the standard.
  

• Increased Collaboration: Actuarial and finance teams need to work together more closely to produce the necessary calculations and disclosures.
  

• Specialised Expertise: The complexity of the models, particularly the General Measurement Model (GMM), demands significant expertise and strong governance frameworks to ensure accurate implementation.

Despite these hurdles, the new standard provides several advantages for both internal and external stakeholders:

• Greater Transparency: IFRS 17 delivers more clarity into the profitability of insurance contracts, offering stakeholders a clearer picture of an insurer's financial health, which is especially important as many insurance companies operate globally.
  

• Improved Comparability: It standardises reporting practices, which improves comparability between different insurance companies on a global scale. This allows investors and analysts to make more informed decisions.
  

• Better Strategic Decision-Making: Internally, the detailed insights generated can drive better business strategies, from product pricing and design to risk management and capital allocation. Furthermore, the standard also addresses the reporting for reinsurance contracts, enhancing transparency in ceded and assumed risks.

Ensure Accurate and Compliant Reporting

IFRS 17 standard reshapes financial reporting for insurers, demanding a higher level of accuracy, transparency, and consistency.

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