IFRS 17: 3 early lessons and practical insights

A year and a few months after the issue of the new insurance contracts standard, insurers (issuers of insurance contracts) are recalibrating their IFRS 17 implementation approaches based on the latest technical developments and positions adopted by their peers.

Latest developments include the IASB’s transition resource group discussions, the recent clarifications to IFRS 17 discussed at the June IASB meeting and the standard’s endorsement status in the jurisdictions in which the insurers operate. Below we list three early lessons and practical insights regarding IFRS 17 implementation approaches our clients and their peers have shared with us.

Lesson 1: Leveraging off Solvency II

Maximising the overlap between Solvency II and IFRS 17 will help insurers reduce the implementation costs because both frameworks have a few common measurement principles. However, care must be taken to ensure that the “shared” features that you intend leveraging for IFRS 17 do actually exist in practice for your organisation. There will be differences between the two reporting frameworks that may not be easily reconcilable. These differences arise from different requirements in the two frameworks, regarding, for example, the contractual service margin, the level of aggregation, contract boundaries and discount rates, that reflect the different lenses through which IFRS (IFRS 17 and IFRS 9) and Solvency II look at contracts issued by insurers.

Practical insight: Under IFRS 17, contracts may be grouped at a more granular level than under Solvency II. Under IFRS 17, there is a two-step approach to grouping contracts. The first step is identifying portfolios, i.e. contracts subject to similar risks and managed together as a pool. Lines of business data under Solvency II could meet the IFRS 17 definition of portfolios, but this is not necessarily the case. Even at this step, there may be differences between IFRS 17 and Solvency II. In practice contracts subject to similar or homogeneous risks are not always managed together as a pool.  Insurers need to determine and then document their interpretation of “managed together”.

Lesson 2: Simplified approach may not be that simple

Under IFRS 17, there is an optional simplified approach applicable to contracts that have a coverage period of one year or less. This simplification, known as the “premium allocation approach”, is also optionally applicable to groups of contracts where the insurer reasonably expects the liability for remaining coverage (‘pre-claims liability’) under both the simplified and the default general model not to be materially different (“immaterial difference test”). This eligibility assessment is conducted at the inception of the group and requires consideration of the variability in the fulfilment cash flows. If an insurer expects significant variability in the fulfilment cash flows, this will cause the contract group to fail the immaterial difference test.   Non-life insurers in particular may consider that implementing IFRS 17 will not be unduly challenging for them because the simplified approach is broadly similar to their existing accounting under IFRS 4 / old UK GAAP.  It would be a mistake, however, to assume that the simplified approach will apply to all their contracts.

Practical insight: There will almost inevitably be some contracts with a coverage period in excess of one year and it should not simply be assumed that these are eligible for the simplified approach.  An analysis of the variability of the fulfilment cash flows of these contracts needs to be carried out and the entity will have to try to set objective benchmarks to determine what constitutes “significant variability”.

Another potentially tricky area of the simplified approach relates to onerous contracts. Although entities applying the simplified approach can assume that there are no onerous contracts in the portfolio at initial recognition, this is only the case if there are no facts or circumstances that indicate otherwise.  If there are such facts, the insurer will need to book to profit or loss the amount of the difference between the carrying amount of the liability for remaining coverage based on the simplified approach and the fulfilment cash flows relating to the remaining coverage based on the general model. Many insurers are currently trying to identify which ‘facts and circumstances’ might constitute indicators of onerous contracts.

Practical insight: Some insurers are considering using initial estimated loss ratios to decide whether contracts are onerous and if this approach is taken, entities need to establish, justify and then document how this threshold loss ratio is determined.  For example, is it based on a projected loss ratio for the portfolio?  Or the loss ratio for a less granular line of business?

Lesson 3: Treatment of reinsurance contracts held on a risk-attaching basis

Reinsurance contracts held on a risk-attaching basis, covering underlying contracts with coverage periods of a year or less, might not fall under the scope of the premium allocation approach, subject to the immaterial difference test, because the risk-attaching basis means all claims from ceded underlying policies incepting during the period of the reinsurance contract are covered, even if they occur after the expiration date of the reinsurance contract. As a consequence, the coverage period of the reinsurance is arguably in excess of one year.

Practical insight: Entities will need to consider whether it makes sense to opt for a simplified approach for the inwards business if it is not possible to follow the same approach for the related outwards reinsurance protection. Users may find the financial statements more informative if this potential mismatch is avoided and the general model is applied to both inwards and outwards contracts.

Future discussions

The challenges brought about by IFRS 17 are significant and many insurers are looking for solutions that capitalise on existing practice. The extent to which these solutions and implementation approaches will reflect IFRS 17’s new principals is an area of much interest. It is expected that many of these views and approaches will be deliberated and positions clarified through discussion forums and as implementation experience develops.

With the application date of IFRS 17 fast approaching, insurers are trying to understand what changes need to be made in order to be IFRS 17-ready. If you would like to discuss your transition to IFRS 17, please feel free to contact the Mazars Financial Reporting Advisory team.