Making sense of IFRS 17
IFRS 17 is the forthcoming International Financial Reporting Standard that is intended to replace IFRS 4 on accounting for insurance contracts which is estimated to be effective on 1 January 2021. It is believed that there is a need for a new standard mainly because, under the current practices i.e. IFRS 4, the financial statements are not indicating the true reflection of the nature and extent of the risks embedded in insurance contracts.
IFRS 17 will eliminate inconsistencies and weaknesses in existing practices and, will give the users of financial statements comparability and transparency across entities not just within the industry but internationally. Furthermore, IASB states that the proposed standard i.e. IFRS 17 improves the comparability of financial statements with those of other types of contracts and companies. While IFRS 17 is being introduced with the aim of bringing greater transparency to financial reporting by insurers, its implementation brings challenges for insurers, who will have to grasp the understanding of the accounting changes and the impacts on their businesses.
IASB has prescribed three methods to measure a insurance contract.
- Building Blocks Approach (BBA) – Default model for all insurance contracts
- Premium Allocation Approach – Simpler version for short term contracts with little variability
- Variable Fee Approach – To deal with participating business where policyholder liability is linked to underlying items and thus accounting should reflect this.
IFRS 17 considers, BBA as the general measurement model where the company that issues insurance contracts to initially recognize and report them on the balance sheet as the total of the following
The Fulfillment Cash Flows
Present value of the Expected cash inflows and outflows estimated for the insurance contract at the moment of reporting, adjusted to risk of those cashflows. IFRS 17 requires to re-measure the insurance contract, given all newly available information.
Contractual service margin
future unearned profits of the insurance contract, which are to be recognized in the Profit and Loss reporting over the life of the contract.
The change in IFRS will require, changes to systems and processes and greater co-ordintion between the accounting, finance, IT and the actuarial functions of an insurance firm. Implementation is likely to be a costly and time consuming exercise.