12.3 IFRS 17 and accounting for insurance contracts

IFRS 17 revolutionizes insurance accounting, introducing a consistent approach for all types of insurance contracts. It aims to enhance transparency and comparability in financial reporting, replacing the interim standard IFRS 4 with a principle-based framework effective from January 1, 2023.

The standard introduces new measurement models, including the general model, premium allocation approach, and variable fee approach. It requires current measurement of insurance contracts, separates underwriting from financial results, and enhances disclosure requirements to provide more detailed information about risks and performance.

Overview of IFRS 17

• IFRS 17 is a comprehensive standard for accounting and reporting of insurance contracts issued by the International Accounting Standards Board (IASB) in May 2017
• Aims to provide a consistent and principle-based approach for all types of insurance contracts, enhancing comparability and transparency in financial reporting
• Replaces the interim standard IFRS 4 Insurance Contracts and is effective for annual reporting periods beginning on or after January 1, 2023, with early adoption permitted

Key principles of IFRS 17

• Requires current measurement of insurance contracts using updated assumptions and discount rates that reflect the timing and risk of cash flows
• Introduces a new measurement model based on the concept of contractual service margin (CSM), representing the unearned profit from the insurance contract
• Separates the underwriting results from the financial results, providing more transparency in the sources of profitability
• Enhances disclosure requirements to provide more granular information about the risks and performance of insurance contracts

Scope of IFRS 17

Qualifying insurance contracts

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• Applies to insurance contracts issued, reinsurance contracts held, and investment contracts with discretionary participation features
• Insurance contract is defined as a contract under which the entity accepts significant insurance risk from another party (the policyholder) by agreeing to compensate the policyholder if a specified uncertain future event adversely affects the policyholder

Exclusions from IFRS 17

• Certain contracts are excluded from the scope of IFRS 17, such as:
  • Warranties provided by a manufacturer, dealer, or retailer
  • Employers' assets and liabilities under employee benefit plans
  • Contingent consideration payable or receivable in a business combination
• Contracts that meet the definition of an insurance contract but have as their primary purpose the provision of services for a fixed fee are also excluded (e.g., fixed-fee service contracts)

Measurement models in IFRS 17

General measurement model

• Default model for measuring insurance contracts under IFRS 17
• Comprises the fulfillment cash flows (estimates of future cash inflows and outflows, discounting, and risk adjustment) and the contractual service margin
• CSM represents the unearned profit and is recognized as revenue over the coverage period

Premium allocation approach

• Simplified approach allowed for short-duration contracts (coverage period of one year or less) or when it approximates the general measurement model
• Liabilities for remaining coverage are measured based on the allocation of premiums over the coverage period
• Liabilities for incurred claims are measured using the general measurement model

Variable fee approach

• Applicable for insurance contracts with direct participation features, where policyholders participate in a clearly identified pool of underlying items
• Modifications to the general measurement model to reflect the variable nature of the fee, with changes in the fair value of underlying items adjusted in the CSM

Components of insurance contracts

Estimates of future cash flows

• Include all cash inflows (premiums) and outflows (claims, benefits, expenses) within the contract boundary
• Reflect the entity's unbiased and probability-weighted estimate of the range of possible outcomes
• Incorporate all available information in a way that is consistent with observable market information

Discount rates

• Adjust the future cash flows to reflect the time value of money and the financial risks associated with those cash flows
• Based on current market rates that reflect the characteristics of the cash flows and are consistent with observable market prices for instruments with similar cash flow characteristics

Risk adjustment for non-financial risk

• Compensation that the entity requires for bearing the uncertainty about the amount and timing of cash flows arising from non-financial risks
• Determined using a technique that captures the entity's perception of the degree of diversification benefit and risk aversion

Contractual service margin

• Represents the unearned profit that the entity expects to recognize as it provides insurance coverage
• Determined at initial recognition and adjusted subsequently for changes in fulfillment cash flows related to future coverage and services
• Recognized as revenue over the coverage period based on the passage of time or the expected timing of incurred insurance service expenses

Recognition of insurance contracts

Initial recognition

• Insurance contracts are recognized from the earliest of the following:
  • Beginning of the coverage period
  • Date when the first payment from the policyholder is due
  • When the entity determines that the contract is onerous

Subsequent measurement

• At each reporting date, the carrying amount of insurance contracts is remeasured using current assumptions and discount rates
• Changes in estimates of future cash flows and risk adjustment are recognized in profit or loss, while changes related to future services adjust the CSM
• Interest accretion on the CSM is recognized in profit or loss using the discount rates locked in at initial recognition

Presentation in financial statements

Statement of financial position

• Insurance contracts issued are presented as insurance contract liabilities or assets, separately from other liabilities and assets
• Reinsurance contracts held are presented separately from insurance contracts issued
• Liabilities or assets for insurance acquisition cash flows are also presented separately

Statement of financial performance

• Insurance revenue depicts the provision of coverage and other services, excluding any investment components
• Insurance service expenses include incurred claims, expenses, and amortization of insurance acquisition cash flows
• Insurance finance income or expenses reflect the change in the carrying amount of insurance contracts due to the time value of money and financial risk

Disclosures under IFRS 17

Explanation of recognized amounts

• Reconciliation of the opening and closing balances of insurance contract liabilities, insurance contract assets, and CSM
• Analysis of insurance revenue recognized in the period
• Effect of new contracts recognized during the period on the financial position

Significant judgments

• Methods used to determine the components of insurance contracts, including inputs, assumptions, and estimation techniques
• Process for estimating the risk adjustment, including the confidence level used
• Yield curve(s) used to discount future cash flows

Nature and extent of risks

• Exposure to insurance risk, financial risk, and the concentration of those risks
• Sensitivity analysis showing the impact of changes in risk variables on profit or loss and equity
• Claims development table that compares actual claims to previous estimates

Transition to IFRS 17

Full retrospective approach

• Default approach that requires entities to apply IFRS 17 retrospectively to all eligible groups of insurance contracts
• Practical expedients available when full retrospective application is impracticable

Modified retrospective approach

• Permitted when the full retrospective approach is impracticable
• Modifications to specific requirements of the full retrospective approach to address data limitations

Fair value approach

• Used when both the full retrospective and modified retrospective approaches are impracticable
• Insurance contract liabilities and assets are measured at fair value at the transition date, with the difference recognized in retained earnings

Comparison of IFRS 17 vs IFRS 4

• IFRS 17 introduces a comprehensive and consistent framework for accounting for insurance contracts, replacing the diverse accounting practices permitted under IFRS 4
• Key differences include:
  • Measurement models based on current assumptions and discount rates
  • Separation of underwriting results from financial results
  • More granular disclosure requirements
  • Improved comparability and transparency in financial reporting

Impacts of IFRS 17 on insurers

Operational challenges

• Significant changes to data, systems, and processes required to comply with IFRS 17
• Need for closer collaboration between finance, actuarial, and IT functions
• Potential changes to product design and pricing strategies to optimize performance under the new standard

Financial reporting implications

• Changes in the timing and pattern of revenue recognition and profit emergence
• Increased volatility in financial results due to the use of current assumptions and discount rates
• Possible impact on regulatory capital and solvency requirements
• Need for educating stakeholders (investors, analysts, regulators) on the new financial metrics and key performance indicators