Diving into IFRS 17/9: transition approaches

To properly manage the impact on the balance sheet, it is crucial to choose the right transition approach and input data. The fact that the initial balance sheet is so important for the years to come is another reason why so many insurers are currently busy finetuning the transition.

The start of the new year 2023 marks one of the most important milestones in the history of insurance accounting. After several years of implementation phase and the postponing of the original effective date, IFRS 17 and IFRS 9 are applicable going forward. 

Both IFRS 17 and 9 are implemented retrospectively. The retrospective application of IFRS 9 refers to the date of initial application, which is the beginning of the reporting period in which an insurer first applies IFRS 17/9. However, IFRS 17 is applied at the date of transition, which is the beginning of the period immediately preceding the date of initial application.Therefore, the period in which transition effects are recognized is not necessarily identicall. 

Generally, the full retrospective approach is applied for IFRS 17, according to which comparative information for previous periods must be restated. Other approaches such as the modified retrospective approach or the fair value approach are only permitted in case the full fetrospective approach is impractible.

Unlike IFRS 17, insurers are allowed but not required to restate comparatives for IFRS 9, if this is possible without the use of hindsight.This different treatment in restating comparative information for previous periods can result in accounting mismatches, which can be solved by applying the overlay approach. 

Generally, current investor reports include mainly qualitative information about transition approaches. One third of the insurers observed have also disclosed percentages for estimating the contratctual service margin (CSM) based on the transition approaches. The proportion of CSM determined by the full retrospective and the modified retrospective approach ranges between 30 and 95 percent, for the fair value approach between 5 and 70 percent accordingly. These wide ranges again indicate that it is currently difficult to determine an absolute CSM impact based on the transition approaches for the insurance industry. This will be only possible when quantitative information will be provided in the first interim reports published in 2023 or even in the 2022 year-end reports, if disclosed.  

Our observations are based on the analysis of the investor reports of 27 insurance companies. For the Life business 14 insurers indicated that they are using the full retrospective approach where possible. Out of these, there are 9 insurers who will apply all three apporaches. Overall, 17 insurers will make use of the fair value appraoch.

Applying the full retrospective approach for life insurance contracts comes with certain complexities. For estimating the CSM as at the transition date, sufficient historical data needs to be provided, since hindsight is prohibited under IFRS 17. 10 insurance companies are specifically mentioning that the full retrospective approach is impractible, 6 disclose their reasoning. Among the most cited reasons are a lack of historical data, problems in making a segmentation of insurance groups or to run models at initial recognition. 

The extensive use of the fair value approach in the Life area is also noticable. Insurers are generally not giving specific information on why they apply the fair value approach. However, the modified retrospective approach only allows for a few simplifications from the full retrospective approach to the extent that reasonable and supportable information is available without undue cost and effort. Apparently, the lack of historical data for longer duration conctracts in the Life business also impacts the application of the modified retrospective approach so that many insurers use the alternative fair value approach.

For the Non-Life business insurers disclosed less information compared to the Life business. 8 of them are applying the full retrospective approach, 4 insurers are also using the modified retrospective approach and only 1 specifically indicated to use the fair value approach. 9  insurance companies did not disclose information for the Non-Life business. 

However, insurers are applying the full retrospective approach for Non-Life business in a more natural way compared to life business. Due to the shorter duration of many P&C contracts, historical data is easily available for most insurance groups. Therefore, it is not necessary to use other approaches. It appears that insurers do not believe it is necessary to publish further information on the full retrospective approach because it seems to be a matter of course for short term Non-Life business. 

In terms of the IFRS 9 transition, 8 of the 27 insurers will restate comparative periods for IFRS 9. 5 insurers mentioned that they will not restate previous periods because they estimate the transition impact on financial instruments to be immaterial. 10 insurers will apply the overlay approach. The majority of them uses the overlay approach in order to prevent accounting inconsistencies that especially occur for financial assets that serve as underlying items for insurance contracts using the VFA. 

In total 4 insurers are planning the retrospective application of IFRS 9 impairment rules which is not required under the classification overlay but can also help avoid volatility resulting from accounting mismatches. 4 insurers will not apply the overlay approach due to the fact that IFRS 9 was implemented before 2023. All of 13 insurers do not disclose further information on the classification overlay.

The decision about the appropriate transition approach and all input data used is important for the effects in the initial balance sheet. Since the initial balance sheet is so crucial for the upcoming years, many insurers are still busy with finetuning their transition strategies.