By Gary Kabureck, Member, International Accounting Standards Board
Existing accounting practices in the insurance industry are widely perceived as opaque and inconsistent. For companies applying IFRS Standards, the accounting for insurance contracts currently differs significantly from the accounting for other contracts. This diversity poses unnecessary difficulties for potential investors.
In 2017, the International Accounting Standards Board (Board) issued a new IFRS Standard to help address these and other concerns about the accounting for insurance contracts. IFRS 17 Insurance Contracts—which companies will apply in 2021—is the first truly international standard for insurance contracts. Although the requirements in IFRS 17 are very different to existing accounting for insurance contracts in most of the world, they are based on well-known principles from other IFRS Standards. So IFRS 17 will help reduce the comparability gap between the accounting in the insurance industry and the accounting in other industries.
This article outlines the similarities between the following key requirements in IFRS 17 and those in other IFRS Standards:
- the measurement of obligations at current value; and
- the recognition of revenue as a company provides services to its customers.
Obligations to provide services
In an insurance contract (or policy), an insurer promises a customer (or policyholder) that the insurer will assume the financial consequences of uncertain future events. The outcome of the contract is uncertain and the profit or loss for the insurer may not be known for years. Such a contract combines the features of a financial instrument and the features of a service contract so that those components are interrelated and cannot easily be accounted for separately.
IFRS 17 requires an insurer to report on the balance sheet its obligations from insurance contracts as the total of:
- the current estimates of amounts the insurer expects to collect from premiums and to pay for claims, benefits and expenses, including an adjustment for the timing and risk of those amounts (fulfilment cash flows); and
- the expected profit for providing future insurance coverage (contractual service margin).
Measuring the insurer’s obligations at current value is consistent with the requirements in IAS 37 Provisions, Contingent Liabilities and Contingent Assets for provisions and also with those in IFRS 9 Financial Instruments for financial liabilities. For liabilities with characteristics similar to insurance obligations, both IAS 37 and IFRS 9 require measurements based on current estimates of future cash flows.
Recognising profit at the same time services—such as insurance coverage—are provided is consistent with IFRS 15 Revenue from Contracts with Customers.
If the amounts the insurer expects to pay for claims, benefits and expenses exceed the amounts the insurer expects to collect from premiums, the contracts are loss making and no contractual service margin is recognised. The shortfall is recognised immediately in profit or loss because the measurement of the insurance contracts should reflect the obligation of the insurer to provide insurance coverage in the future. The amount of that obligation should be at least equal to the fulfilment cash flows. This approach is consistent with the way profits and losses on contracts with customers are recognised in applying IFRS 15.
Insurance obligations (that is, the fulfilment cash flows plus the contractual service margin) can also be regarded as having two components:
- liability for remaining coverage—which reflects the insurer’s obligation to provide insurance coverage to its customers and the measurement of which is broadly consistent with IFRS 151; and
- liability for incurred claims—which reflects the insurer’s obligation to pay claims to its customers and the measurement of which is broadly consistent with IAS 37.
Presentation of revenue
IFRS 17 requires insurers to present in the income statement the revenue for insurance services determined in a way that is consistent with the general principles in IFRS 15. Consistent with IFRS 15, an insurer depicts revenue for insurance services at an amount that reflects the consideration for the insurer for those services. This means the insurer:
- recognises insurance revenue in each period as it satisfies the performance obligations in the insurance contracts; and
- excludes from insurance revenue any deposits (referred to as investment components in IFRS 17).
IFRS 17, consistent with IFRS 15, requires that the balance sheet reports the insurance obligations and the income statement reports progress towards satisfying the performance obligation in the contracts. In particular:
- to measure the contract liability at the end of the period, IFRS 15 establishes the amount of revenue to be recognised each period and adjusts the contract liability at the start of the period by the amount of revenue recognised.
- IFRS 17 requires a measurement model that establishes the carrying amount of the insurance obligations at the start and end of the reporting period. The amount of insurance revenue presented is determined by reference to these two carrying amounts.
Deposits collected by an insurer through premiums are amounts that the insurance contract requires the insurer to pay back to the policyholder even if the uncertain future events do not occur.
The obligations to repay deposits to the policyholder, if not included in an insurance contract, would be measured and presented in accordance with IFRS 9. When a deposit is interrelated with the obligation to provide insurance coverage it is measured in accordance with IFRS 17. However, it would not faithfully represent the similarities between financial instruments within the scope of IFRS 9 and deposits embedded in insurance contracts within the scope of IFRS 17 if an insurer were to present the receipts and repayments of such deposits as insurance revenue and incurred claims. Doing so would be equivalent to a bank recognising a deposit as revenue and its repayment as an expense. Accordingly, the requirements in IFRS 17 exclude such deposits from insurance revenue and incurred claims.
In my view, the changes introduced by IFRS 17 will enable a wider range of users to understand insurers’ financial statements and compare them with the financial statements of companies within and outside the insurance industry. As with the revenue in any other industry, insurance revenue will exclude deposits and reflect only the services provided. Apart from facilitating cross-industry comparability, this change will make easier for non-specialist investors to understand insurers’ income statement.
1Except that: (i) for insurance contracts without direct participation features—the measurement is updated for changes in financial assumptions; and (ii) for insurance contracts with direct participation features—the measurement is updated for changes in the fair value of the items in which the entity and the policyholder participate.