The long overdue restructuring of accounting for insurance contracts is now on our doorstep. There are many proposals, and the International Accounting Standards Board’s publications deliver continued clarifications.
Just in time, the board has put forward suggestions for revised key standards affecting the insurance industry.
IFRS 4 Phase I Insurance Contracts left many gaps in view of the fact that its implementation, which dates back to 2004, was intended only to enhance disclosure requirements for insurance companies and serve as a temporary fix, while a more formal re-evaluation of insurance accounting took place.
Standard-setters argue that, while insurance contracts expose entities to long-term and uncertain oblig-ations, its accounting does not provide existing and potential investors, lenders and other creditors with the information they need to understand the financial statements of insurers and compare financial data between market players.
Relevant standards will be coming into effect in the medium-term, these being IFRS 9 Financial Instruments (published, effective January 1, 2018) and IFRS 15 Revenue from Contracts with Customers (published, currently proposed to be effective by January 1, 2018).
IFRS 4 Phase II Insurance Contracts is not yet published and its effective date is expected to be approximately three years after issue.
The proposed remedy is a single-accounting approach, but despite the significant benefits that are expected to emerge, a critical area within the current proposals that remains is volatility.
Volatility in profit or loss and equity may be created due to the use of current assumptions in measuring insurance liabilities or due to changes in the values of minimum guarantees arising from short-term market rate fluctuations.
The accounting treatment of the corresponding investment port-folio and, therefore, the adoption of IFRS 9 plays an important role in managing such volatility. Although the permissible measurement bases for financial assets – amortised cost, fair value through profit or loss and fair value through other comprehensive income – are similar to IAS 39 Financial Instruments: Recognition and Measurement, the criteria are significantly different.
Volatility in profit or loss and equity may be created due to the use of current assumptions in measuring insurance liabilities
Insurers therefore need to consider options and elections available under IFRS 9 and the forthcoming insurance contracts standard to minimise the mismatches between the accounting for insurance contract liabilities and the financial assets held to back them.
Ensuring financial assets are classified appropriately under IFRS 9 will require insurers to determine the objective of the business model in which the financial assets are managed, and, where relevant, analyse the contractual cash flow characteristics of financial assets. Naturally, entities holding financial assets at amortised cost will face more significant initial volatility upon initial application of the standard.
With respect to the revenue stream of an insurance company, the board iterates that revenue from insurance contracts should be consistent with that from non-insurance contracts, in effect implying the application of IFRS 15. Although this new revenue standard does not apply to insurance contracts, it may be relevant to other arrangements an insurer may take on – such as asset management, insurance broking and claims handling.
Insurance companies should therefore determine which contracts fall entirely, or partially, in scope of the new revenue standard through a comprehensive review of contracts with customers.
The insurance accountant will then apply the new revenue recognition standard to any such non-insurance agreements or non-insurance components within insurance contracts.
Insurance entities are already undergoing an operational challenge with the upcoming Solvency II, effective from January 1, 2016. We view – as an imperative – the immediate need for insurance accountants to understand the ways in which the requirements of the new IFRSs can be incorporated with Solvency II’s ground-breaking change.
Having a single internal governance process that looks at the entity’s reporting under each of these frameworks together and using a single set of analytical reviews and approvals will ensure that any inconsistencies are identified, discussed and thoroughly understood by management before going live.
Deferring the amalgamation of such standards is sure to place an entity doing so at a disadvantage against the forward-looking market player.
This article was submitted by KPMG.