The key considerations for insurers to effectively implement new accountancy rules
IFRS 17 is the new IFRS accounting standard for insurance contracts, replacing IFRS 4 for accounting periods from 1st January 2023 and with the insurance industry moving from the project and planning stage to preparation and delivery, EY’s Tiarnan O’Rourke analyses the key considerations that may remain to be addressed for effective implementation.
The insurance industry has been anticipating and preparing for IFRS 17 & 9 for some time now, and as of 1 January 2023 it has arrived, even if reporting has not been produced on that basis yet. As the industry moves from project and planning into preparation and delivery, what are the key considerations regarding actions outstanding and issues yet to be confronted?
To that end, we recommend that you reflect on the following:

1. Are you still in project mode or have you moved to Business as Usual (BAU) – and does that reflect the reality of the situation?
The determination of methodologies and the application of policies is now hopefully complete or towards the business end of proceedings. The challenge of embedding the IFRS 17 & 9 world into BAU processes is not one to be underestimated.
Tiarnan O'Rourke
Tiarnan O'Rourke

From a stand back perspective, to what extent do the process and controls in the IFRS 17 environment stand up. There needs to be an evaluation of what reliances currently exist upon implementation partners and the degree of handover that has occurred and how well understood the cradle to grave process is.

The strength and resilience of controls now need to be probed. A sign off from internal committees or implementation partners may signal a strong degree of completeness but may not yet meet the rigour required by internal or external auditors.

It is a worthwhile exercise bringing robust challenge to those IFRS 17 BAU areas that are deemed to be sufficiently embedded in BAU to identify any gaps or remediations that may be required for the reporting cycle.

2. How well understood are the new numbers and in particular the opening balance sheet (OBS)?
A recent and/or upcoming task on many audit committee and board agendas is the review of OBS numbers. This presents an initial opportunity for Directors to holistically challenge the derivation of the insurance result under IFRS 17 & 9.

For many, this will be the first time that the standard begins to make sense. A well explained results bridge or analysis of change on key drivers from the old IFRS 4 world to the new will serve to illustrate the impact of key methodology and policy choices. Where this isn’t available, management must be challenged to provide the same.

This is an opportune time to reflect on key judgements made and to challenge the sensibility of these. With an increasing number of insurers publishing some level of detail on expected impacts, the availability of a benchmarked position is continually improving. And conversely, those positions that don’t quite align with the market. Such outlying positions are unlikely to be an issue if the rationale for the choice is well understood and explained in the financial statements.
There needs to be an evaluation of what reliances currently exist upon implementation partners and the degree of handover that has occurred and how well understood the cradle to grave process is.

Equally, some questions worth asking - are all simplifications and proxies understood? What are the gaps? What are the most and least conservative positions adopted and do all stakeholders understand why?

And the real litmus test for OBS: does it make sense? Can the movements in key numbers be understood upon transition and do the methodology and policy choices applied stack up based upon the actual outcome.

Similar to Solvency II, it is expected that the implementation of IFRS 17 & 9 will influence the design of the insurance products and the internal scorecard of management. From this perspective, the transition and implementation needs to be thought about from a wider perspective than “pure” accounting and actuarial matters. The reality is that the change represents a new way to manage an insurance company with an accounting framework and a regulatory framework that will dramatically increase the level of external scrutiny and judgement over the stewardship exercised by management.

3. For life insurers in particular, how well understood is the Contractual Service Margin (CSM) and how much will translate into future net earnings after add back of non-attributable expenses?
The CSM represents the unearned profit that a (re)insurer expects to earn as it provides services. Unsurprisingly, the derivation of the CSM is seen as the most significant change. This was evident from EY’s analysis of the most recent investor day presentation impacts suggesting that for most (re)insurers there will be a negative impact to book value arising from CSM.

There are a number of inputs, assumptions and techniques to be deployed to arrive at a CSM. The key areas in which IFRS 17 allows judgement, which may lead to variability in computing the CSM, include:
• The identification of contract boundaries
• The determination of coverage units (CUs)
• The level of aggregation
• And the treatment of loss components

We see various practices regarding coverage units, depending on the type of product (including whether investment-type services apply) and the various judgements applied. The CUs drive future profit release pattern from the CSM, which should reflect the provision of insurance contracts services in an appropriate way.

The level of risk adjustment interacts with the level of the CSM as well as the future results through the release of risk. Under many fair value transition methodologies, the difference between the IFRS 17 risk adjustment and the fair value risk adjustment is also the driver of the CSM on transition.

The CSM will require adjustment for changes relating to future service i.e. for a life (re)insurer favourable mortality updates must increase the CSM, unfavourable lapse experience will result in the opposite.

Impact of expenses
The allowance for expenses in future cash flows under new business can have differences in IFRS 17 compared to Solvency II treatment which may lead to different levels of profitability reported under either metric.
The change represents a new way to manage an insurance company with an accounting framework and a regulatory framework that will dramatically increase the level of external scrutiny and judgement over the stewardship exercised by management.

IFRS 17 requires entities to identify those expenses which are directly attributable (i.e. incurred in acquiring and maintaining new business) and those which are not. Expenses that meet the designation of directly attributable will no longer be recognised in the P&L when incurred and instead will be spread over the lifetime of the group of contracts. Conversely, those that are non-attributable will hit the P&L once incurred. The proportion of directly attributable and non-attributable costs at inception will change the pattern at which expenses are recognised (including the impact on day 1). It is likely that the treatment of investment management expenses may vary between IFRS 17 and Solvency II.

While stable practice will no doubt take time to emerge, the derivation of the CSM must be scrutinised to a granular level early on. An overly inflated CSM will likely result in reductions and result in variability in the early years as the drag begins to emerge. A CSM that is sub optimal or not reflective of the profitability of the book may require significant explanation if the early subsequent years require significant adjustment that undermines investor confidence in the messaging in profitability.

Accordingly, it is important that management comprehend the drivers of the CSM and can adequately, and to a granular level, explain the drivers of the CSM to those in Governance, Investors and Analysts.

4. What quality gates will the methodologies, models and results be put through prior to disclosure and what assurance has been provided by the External Auditor?
The first challenge for most in the industry is to assess what level of disclosure of IFRS 17 & 9 impacts will be made in the 31 December 2022 financial statements. IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors requires disclosure of an impending change in accounting policies when an issuer has yet to implement a new IFRS that has been issued but is not yet effective.

The expectation is not to be underestimated. The European Securities and Markets Authority (ESMA) issued a public statement in May 2022 which set a significant expectation in terms of the level of disclosure required. This statement called upon the need to disclose qualitative and quantitative information on the new standard to the extent that reasonably estimable quantitative information on the impact is known.

Amongst other minimum requirements, the ESMA statement also called for information on significant accounting policy choices upon initial application to be explained and disaggregated in a way that is meaningful to the users of the financials. It also called for the nature of the impacts on recognition, measurement and presentation to be clearly described in terms of the key drivers of change from the accounting principles under IFRS 4.

Over the course of the last quarter, a number of (re)insurers have recently published IFRS 9 and IFRS 17 updates as part of their 2022 investor days.

At EY we have been analysing these presentations, and whilst the content and depth of these presentation varies, there are quite a few (re)insurers who decided to disclose expected quantitative impacts of adopting IFRS 9 and IFRS 17, in most cases either in terms of change in equity levels or change in net asset amounts. Clearly defined IFRS 17 KPIs is another topic arising from these publications.

Some key highlights of messages to users of the accounts noted by EY include:
• Most insurance groups expect minimal disruptions from IFRS 17 & 9, which is reassuring to the analyst community. Prudential and dividend capacity is not expected to change significantly with the new standard.
• CSM will become a key indicator, impacting reported equity negatively in most instances. Overall insurers are welcoming the new standard for the improvements it brings on disclosures.
• Performance KPIs are shifting to cash-based metrics.
• The planned publication of the impacts of the new standard in the 2022 financial statements vary by insurer. Most of the panel of insurers that were considered do not plan to provide a detailed OBS in their current year results announcements.
• The publication of 2022 comparative numbers should be provided to the market in the HY 2023 presentations for the majority of insurance groups.
• Gross written premiums remains a popular metric with most insurers planning to disclose it as a non-GAAP measure.

5. What support has been put in place to support the users of the financial statements to understand the opening position and the future key metrics and performance indicators that management will use to run and report on the business?
This brings us to reflect on one of the main ambitions of the standard – to improve comparability. In deploying the methodology and calculation for the first time, the hope of most companies is to be able to explain the initial transition from existing IFRS to the new standard.
In particular, to bridge the result from IFRS 4 and to be able to discuss the main drivers of change in a coherent way. What cannot be lost in this is the basic principles of IFRS; that financial information is relevant, faithfully represented, comparable, verifiable, timely and understandable.

The use of non-GAAP measures will be prevalent. In a recent survey conducted by EY with over 85 respondents across the globe, the top 3 KPI measures noted were operating profit, combined ratio and return on equity respectively.

Interestingly, amongst the respondents who noted operating profit as the key measure, there were seven different definitions of operating profit cited with various combinations of insurance service result, insurance finance result, investment result and EBIT. Perhaps more surprising was that 15% of respondents were considering a definition outside of this and 30% of respondents noting that they had not decided yet.

This serves to underline the potential for a lack of comparability when the results do start being published. So, it is time to look at relevant competitors and what metrics are being adopted once available. As with all major accounting standards, the application of IFRS 17 may give rise to implementation and interpretation questions, both during the transition phase and subsequently. Consequently, it would be expected that (re)insurers may continue to adjust and consider the reported KPIs as the new standard embeds in the longer term.

At this time, some have more room to manoeuvre than others. Experiences with Solvency II implementation less than 7 years ago will stand to many, even if the scale of the task on financial and reporting systems is more impactful under IFRS 17 & 9.

The tempo of implementation will continue to increase over the coming months but there is still time to take stock of progress and undertake a robust assessment of those areas that deserve appropriate scrutiny – in particular the Transition Disclosures and OBS.

The level of interdependency between the Finance and Actuarial teams has never been so profound. It is important that the actuarial judgements can be understood and well challenged from a finance perspective and vice versa.

The outcomes of policy papers must stack up from a practical and applied perspective. It is better to identify any concerns early so that the ultimate stability of the opening numbers is assured and subjected to the appropriate level of rigour and control.
Tiarnan O’Rourke is a partner in EY’s Financial Services Assurance practice.
This article appeared in the April 2023 edition.