How Insurance Companies can win the IFRS 17 / FRS 117 battle
The International Accounting Standards Board (IASB) issued IFRS 17 Insurance Contracts in 2017. This new standard aims to significantly change how Insurance companies need to account and report for insurance contracts. The new standard is applicable for reporting periods starting on or after 1st January 2021. That date is quickly approaching and although the IASB gave an almost 3 years notice to prepare for the changes, were Insurance companies actually ready to meet the requirements of the new standard?
According to this article, in March 2020, the IASB pushed back the effective date to January 1, 2023. This would indicate that the insurance companies were probably struggling to meet the initial deadline and requested for more time to comply with the requirements of the new standard. The time extension should be a welcome relief for insurance companies around the world to prepare for the new standard. It is widely believed that the success of IFRS 17 is highly dependent and inter-related with how well companies have complied with IFRS 9 Financial Instruments in terms of managing their balance sheet, assets and liabilities. In that sense the scope of a joint IFRS 9 and IFRS 17 implementation is a gargantuan effort and can be completely overwhelming to undertake concurrently.
The Singapore Accounting Standards Board following closely on the heels of IASB issued FRS 117 (adopted from IFRS 17) for Insurance Companies that report using the Singapore Accounting Standards which is effective on Jan 1, 2021. It remains to be seen if the ASC extends the implementation deadline to 2023 to match the IASB timelines or sticks to the original timeline of 2021.
Is More Time Enough
More time is good, but is more time alone, good enough to get to the finish line? The extension of the implementation deadline is a lifeline for all insurance companies. In my opinion, now would be a good time to re-assess and re-baseline current projects not only for the timeline but also in terms of the quality of the programs, the adequacy of data elements, reports, internal controls, as well as error testing and correction. It is unlikely that the timelines would continue to be pushed back further. This is a good opportunity to evaluate current resources applied against the revised timelines and assess the need for additional resources to supplement current efforts.
From a Singapore perspective, companies are probably working on dual reporting capabilities, under both FRS 104 (superseded) and the new FRS 117. The choice is really between using the standard guidance in retrospective form i.e. apply the requirements of FRS 117 as if they were always in place or some form of Transition rules using a modified retrospective approach or a fair value approach. But if the challenges faced by large global insurance companies are a guide, based on numerous surveys, approximately 40-60% of insurance companies are either confident or somewhat confident of meeting the implementation deadlines. Approximately 40% of the respondents are unsure or have yet to undertake significant steps towards meeting the new requirements.
All European Union based Insurers need to comply with SOLVENCY II. This is a risk management system to address solvency capital requirements integrated with a supervisory system for all insurers, reinsurers and bancassurers. This requirement is in addition to the IFRS requirements which adds another layer of complexity to their global compliance agendas.
Firstly, Data, Systems and Processes across the entire company need to be aligned. Secondly, It is abundantly clear that companies will have to capture and maintain a lot of data that was not being collected before. Thirdly, there is a need to obtain more actuarial information and data in real time more frequently. Fourthly, Complex calculations need to be performed and contract data needs to be aggregated and maintained by portfolio, annual groups and level of resiliency in terms of being onerous or otherwise. Moreover, the Contractual Service Margins may change from period to period which would then drive significant accounting implications on the financial statement presentation and reported results. Perhaps new rule-based accounting engines would need to be built to capture the information required accurately. Lastly, he disclosure requirements have also increased and there is a need to present more reconciliations for movements in balances from one reporting period to the next.
More importantly, in terms of data readiness, insurers will need to review their existing technology infrastructure and make a few key decisions to build a plan for meeting the new requirements. From leveraging legacy infrastructure to building all new systems, to perhaps settling on a hybrid solution. It is critical however, to first understand the data requirements completely and then set out to ensure all required data elements are accurately and completely scoped. Subsequently the work to start building the tools and reporting capabilities in order to generate the required information would commence. Therefore management would need to work closely with actuaries, accountants, IT teams and external stakeholders like auditors, and consultants.
On the people side, it is also critical to assemble the right team of individuals to drive and manage such a major project. The CFO would typically drive the project or be the main sponsor to ensure that the technical accounting and finance requirements of this standard is correctly understood and key stakeholders like IT, Compliance, Finance, Risk, Investment Managers and Actuaries to understand the project deliverables. In addition to internal FTE’s, it may be necessary to work with external parties, insurance specialists and consultants to keep the project on track.
The standard requires that entities use an appropriate discount rate for the present value calculations as well as understand the impact of key financial risk and non-financial risk factors to be used in the various computations. These rates need to be consistent with observable market rates. There has been significant volatility recently in the global interest rate environment as well as bond yields and persistently low inflation globally. Visibility into an accurate long-term discount rate is low and could be another challenge.
Perhaps the biggest change this standard brings about is moving from a historical cost convention to a fair market value convention in terms of valuing the contract liabilities as well as the investment assets. It is expected that the impact of this new standard will likely result in lower margins, the recognition of loss making or onerous contracts up-front will impact the profitability of insurance companies as well as their market valuations. The cost of implementing this new standard will also hit the profitability of insurance companies as the investment in technology, process, people, systems and training is expected to be high. Once the changes have been implemented, it would also be important to train the employees on how to use the new systems, processes, tools and technology accurately to generate the right information.
Firstly, the new standard will increase comparability between financial statements, provide more granular level of information and greater transparency into the business. Secondly, the standard initially may adversely affect Net Assets with higher liabilities being reported and also defer profit recognition to future periods, however the quality of long-term earnings would likely to be more stable, predictable and consistent. Thirdly, the largest benefit will be better risk management capabilities across the entity due to the higher quality of information, better understanding of the risk factors, clarity of investment performance results and actual pay-out liabilities. Finally, In the long term, insurance companies are likely to get better at underwriting standards therefore optimizing the premiums charged to take on the risk of an adverse event. Eventually, insurance companies will be better focused on the efficient use of capital and boosting return on capital rates, thereby increasing easier capital markets access.
Impact of Covid-19 on timelines
The Covid-19 pandemic has probably added another spanner in the works for insurance companies working towards meeting the implementation deadlines. Travel lockdowns, inability to meet colleagues and partners face-to-face and working from home using online tools will simply add to the challenges on the various ongoing projects as unwelcome distractions. Central Bank policies and stimulus for instance, the extended 0 interest rate policies, expansion of credit, purchase or debt instruments affect asset prices and price volatility. The impact of the various central bank policies in the long term will also have a corresponding impact on the financial results of the insurance companies in terms of their ability to generate consistent investment returns.
The Covid-19 pandemic has also negatively impacted a number of industries like Food & Beverage, Airlines, Oil Producers and Refiners, Small Businesses and Brick and Mortar retailers. While the overall death rate due to Covid-19 has been relatively low, the treatment costs due to hospitalizations and intensive care unit stays should be impacting the liability side of the insurer balance sheets adversely. Insurers would do well to add pandemic modelling to their risk models going forward as the last pandemic occurred more than a 100 years ago. But often a crisis situation also generates additional opportunities for revenue growth as the demand for insurance coverage for Covid-19 increases.
Despite the multiple distractions and uncertainty, Covid-19 is forcing a rapid change in the pace of digital technology adoption globally, as businesses restructure their workflows and ways of working. This may be advantageous for Insurance Companies if they leverage, integrate and focus on moving more of their manual processes online with aggressive investments in digital transformation as a way to speed up their journey towards IFRS 17 compliance.
The author of this article is Piyush Singapuri – Director at Ezee Pte. Ltd., a company that provides Accounting, Advisory, Project Management and Outsourcing services.