By Nick Anderson, Member, International Accounting Standards Board
Six months ago, the International Accounting Standards Board (Board) issued IFRS 17 Insurance Contracts. This new IFRS Standard replaces the requirements for accounting for insurance contracts in IFRS 4 Insurance Contracts from 1 January 2021.
IFRS 17 introduces fundamental changes to existing insurance accounting practices for some companies. Investors and analysts will need to factor these changes into their analyses. Although many investors and analysts were consulted during the development of the new Standard, it is important that they become familiar with IFRS 17 now that it has been finalised. For that reason, we will continue to invest considerable resources into meeting and educating investors and other users of financial statements.
Educating investors and analysts
Between May and October 2017, members of the Board and technical staff have met more than 300 investors and analysts to explain how IFRS 17 information will differ from information available today.
These educational activities for investors and analysts demonstrate the Board’s commitment to supporting the implementation of IFRS 17 and engaging with investors, including participants in the IASB Investors in Financial Reporting programme.
In addition to face-to-face meetings, the IFRS Foundation and the Canadian Accounting Standards Board have co-hosted an IFRS 17 educational webinar tailored to investors.
In the coming months, we will continue the work initiated by former Board member Stephen Cooper with the support of our investor engagement team and our IFRS 17 project team. Stephen and I will hold further educational meetings with investors and analysts around the world, including investors that do not specialise in the insurance sector.
Top five questions on IFRS 17The initial investor reactions to IFRS 17 were collated by technical staff and shared with the Board at the July 2017 Board meeting. Most investors and analysts we spoke to welcome the improvements in transparency and comparability introduced by IFRS 17. They believe that IFRS 17 will improve financial reporting for insurers, particularly in explaining the source of profits for long-term insurance contracts. Here are the top five questions from investors and analysts so far:
1. Will IFRS 17 affect dividend payouts?
Not necessarily. Insurers’ dividend payouts are affected by several factors, such as regulatory capital requirements, capital management policies, legally distributable profits and reported profits. IFRS 17 only affects the timing of recognition of profit for insurance services, not the total profit recognised. IFRS 17, therefore, does not change the total dividend distribution capacity of an insurer.
The timing of recognition of profit from insurance services currently varies significantly by jurisdiction and by product. For example, some insurers recognise profit immediately when an insurance contract is written, some insurers recognise profit only when the contract ends and other insurers recognise profit over the duration of the insurance contract on the basis of the passage of time. IFRS 17 introduces consistency by requiring insurers to recognise profit as they deliver insurance services. As a result, it is possible that some insurers, when they transition to IFRS 17, may reassess their dividend payment policies in the short-term while they adapt to the change.
2. How can a principle-based Standard like IFRS 17 improve comparability between insurers?
IFRS 17 removes the diversity in accounting for insurance contracts, enabling investors, analysts and others to meaningfully compare insurers. The existing interim Standard, IFRS 4, allows insurers to account differently for insurance contracts they issue in different countries, even if those contracts are similar. Further, some multinational insurers currently prepare their consolidated financial statements by adding up non-uniform numbers from their subsidiaries.
Like other IFRS Standards, IFRS 17 is principle-based. IFRS Standards encourage companies to use their professional judgement in applying the principles to transactions specific to a company or to an industry to provide a faithful representation of the economics of those transactions. Although IFRS 17 allows flexibility in determining some components for the measurement of insurance contracts (for example, discount rates), it requires companies to describe and disclose the process for estimating those components. These disclosures will help investors analyse how insurers’ judgements affect comparability between companies.
3. Will IFRS 17 bring global comparability to the insurance sector?
Yes, except for jurisdictions that do not apply IFRS Standards. The main exception relates to the United States. Under US GAAP, US insurers apply different requirements depending on the type of insurance contract they issue (for example, short-term insurance contracts or long-term insurance contracts). The US Financial Accounting Standards Board is working on a project to improve, simplify and enhance the financial reporting requirements for long-term insurance contracts issued by companies using US GAAP. Some of the proposed changes to US GAAP, if confirmed, are expected to reduce the differences between IFRS 17 and existing US GAAP, including the use of current assumptions. However, the two sets of requirements will remain different.
4. What are the main differences between IFRS 17, regulatory reporting and embedded value reporting?
IFRS 17 and regulatory reporting have different objectives. For example, the European regulation for capital requirements, known as Solvency II, focuses on capital required and is not designed as a performance reporting metric. However, there are some similarities with IFRS 17 regarding the measurement of insurance contract liabilities, including the use of estimates of future cash flows, discount rates consistent with current rates in the financial markets and adjustments for risk. The key difference between IFRS 17 and Solvency II is the requirement in IFRS 17 to calculate and maintain a ‘contractual service margin’—the yet-to-be earned profit that a company recognises in the income statement as it provides the insurance coverage. Solvency II has no equivalent concept.
Embedded value reporting is voluntarily prepared by some insurers to provide information about long-term insurance contracts that is not available in financial statements prepared under IFRS 4. Although useful for many investors, this information is not presented consistently or by all companies. The information IFRS 17 will provide about the current and future profitability of all long-term insurance contracts will be more comparable than the information provided by embedded value reporting. IFRS 17 information might, in time, replace performance measures computed using embedded value or similar measures.
5. How will removing insurance premiums from the income statement improve comparability?
When applying IFRS 17, many insurers will, for the first time, present an item described as ‘insurance revenue’ in the income statement. Insurance revenue will replace items typically described as ‘premium income’, ‘written premiums’ or ‘earned premiums’ in insurers’ income statements. Insurance revenue will reflect the insurance coverage provided and exclude any deposit components received through premiums.
IFRS 17 applies a commonly understood IFRS principle to the accounting for insurance contracts—the recognition of revenue when a service is provided to a customer. Accordingly, IFRS 17 reduces the differences between the requirements for insurance contracts and those for contracts with customers in other industries.
In addition, many insurers currently present premiums due in full as the top line in the income statement. Those premiums often include deposit components, which are amounts collected from customers that are repaid to them even if an insured event does not occur. IFRS 17 excludes the deposit components from the income statement—the collection of a deposit is not revenue and the repayment of that deposit is not an expense. Banks do not recognise deposits received as revenue under IFRS Standards and as such IFRS 17 will enhance comparability between revenue recognised by insurers and revenue recognised by banks.