CFO, Richard Ahulu
Previous Hollardite writers have educated us on various insurances. This topic will add to our learnings but may seem complicated at first glance. Let’s talk about IFRS.
What is IFRS?
I’ll start by breaking it down. IFRS is an abbreviation for International Financial Reporting Standard. IFRS specifies how particular types of transactions and events should be reported in financial statements. The financial statements of insurance companies have been reported using IFRS 4 since March 2004.
IFRS 4 was issued by the International Accounting Standards Board (IASB) as part of phase 1 of the insurance standards project. The plan was always to replace this standard with global standards as IFRS 4 allowed for a wide range of practices.
The IASB has issued IFRS 17 to replace IFRS 4 on accounting for insurance contracts which is scheduled for implementation in January 2023. It is Phase 2 of the insurance standard project and encompasses a comprehensive set of requirements to achieve uniformity across the insurance sector. The new IFRS17 is a game-changer for insurance companies. It is important to understand why.
The main aim of the IFRS17 is to standardize insurance accounting globally to improve comparability and increase transparency, and to provide users of accounts with the information they need to meaningfully understand the insurer's financial position, performance, and risk exposure.
IFRS 17 applies to all insurance contracts (including reinsurance contracts) that an entity issues and to reinsurance contracts that it holds, except for specified contracts covered by other Standards. It does not apply to other assets and liabilities of an insurer, such as financial assets and financial liabilities within the scope of IFRS 9.
This is the first accounting standard that deals comprehensively with accounting for insurance companies. It establishes principles for the recognition, measurement, presentation, and disclosure of insurance contracts. Also, it applies to all entities that issue insurance contracts including reinsurance companies and health insurance providers. However, it does not apply to product warranties issued by manufacturers, dealers, or retailers.
Here are some must-know definitions:
Insurance Contract, An insurance contract is a contract under which one party (the insurer) accepts significant insurance risk from another party (the policyholder) by agreeing to compensate the policyholder if a specified uncertain future event (the insured event) adversely affects the policyholder. The fee or consideration paid by the policyholder in exchange of the promise made by the insurer is called Premium.
Expected cash flows, Cash flows the insurance company expects to receive and pay. This includes cash flows like expenses, claims, premiums etc.
Discount rate - The expected cash flows are discounted with the discount rate which reflects the time and the financial risk of the contract.
Risk Adjustment - The money the insurer wants to get on top of the cash flows to take the uncertainty of the insurance contract. This is for the insurance risk.
Contractual Service Margin (CSM) - The expected unearned profit of a contract. This is the money that is left if we take the expected cash inflow less expected cash outflow less risk adjustment. If this total is negative then we have a loss component or an onerous contract, instead of the CSM.
Initial recognition
An entity on initial recognition of an insurance contract shall measure the group of insurance contracts as the total of:
The fulfilment cash flows, which comprise:
Estimates of future cash flows
An adjustment to reflect the time value of money and the financial risks related to the future cash flows, to the extent that the financial risks are not included in the estimates of the future cash flows
Risk adjustments for non-financial risk
The contractual service margins
Measurement approaches
IFRS 17 recommends three measurement methods for different types of insurance contracts. These are:
• General Measurement Model (GMM), which is the default method,
• Premium Allocation Approach (PAA)
• Variable Fee Approach (VFA)
Grouping
IFRS17 requires Insurance companies to disclose information based on group of insurance contracts. A group is a managed group (often a product) of contracts with similar risk features. For instance, motor insurance started in 2019. Insurance companies can have several groups of contracts. The process of determining the group is called aggregation.
In conclusion
All insurance companies reporting under IFRS (International Financial Reporting Standard) will be impacted by the new reporting standard when it becomes effective in January 2023. IFRS 17 will result in significant changes to the way that financial information is presented, and adoption will require significant planning.
Progressive insurance regulators such as our National Insurance Commission (NIC) would require all licensed insurers to comply, and a lot of preparation is required to ensure this compliance. The time to act is now.