As IFRS 17 came into force on 1 January 2023, KPMG UK Insurance Partners Nathan Patten and Susan Dreksler look at what the reforms mean, assess insurer readiness across the market and reflect on next steps.
Deferral of new business profits in line with the service provided. Under the default model, a contractual service margin (CSM) is created on the balance sheet which is effectively a stock of future profit. This particularly impacts UK annuity writers where profits will be spread over long periods of time rather than using current generally accepted accounting principles (GAAP) where a large proportion of profits are recognised upfront.
Prudent margins under current GAAP are replaced with best estimate liabilities and an explicit risk margin.
Liabilities must be discounted. The choice of discount rate will affect the speed and volatility of the profit that emerges.
IFRS 17 must be applied retrospectively to the opening balance sheet as if it has always been in force.
The day one transition impacts for annuity writers will have been significant. Whilst the scale of the impacts on transition will not be so material for general insurers - for example, many are able to avoid calculating an explicit CSM - the impacts should not be under-estimated. Rules on how liabilities should be calculated, together with the new disclosure requirements, are likely to reduce insurers’ flexibility in setting reserves, potentially leading to more volatility in the profits of general insurers under IFRS 17.
A key change is the new requirement to hold an explicit margin and to disclose a confidence level: essentially the probability that even if things turn out worse than expected, the reserves - including the margin - will be sufficient for the insurer to meet its obligations. At the moment, many insurers include margins in their reserves but these margins are determined judgementally and are usually not explicitly disclosed. Under IFRS 17, the transparency of the margin and the confidence level is likely to reduce flexibility because any changes will be exposed to the possibility of external challenge. It is likely that many companies will target a specific confidence level, thereby essentially removing the ability to flex the margin from year-to-year and smooth volatility.
It is fair to say that implementation of the standard has been hugely complex, taken longer and cost more than the industry originally anticipated.
At the start of the process, ambitions were high to use the implementation of IFRS 17 to transform finance functions and carry out strategic changes at the same time. Many firms have now scaled back ambitions for go-live date and will now have significant projects continuing on into 2023 to make sure working day timetables can be met in a sustainable way going forwards, to put operating model plans into place and to eliminate manual workarounds.
In particular, the unit of account requirement has meant that insurers are having to account for insurance contracts at much more granular level than previously. This granular information has provided the business with some greater insights on profitability and if this information can be made readily available either on a drill-down basis or through regular MI, benefits will be gained by the business.
For general insurers, implementation was sometimes left later because the financial impact was less material. However, the complexity of IFRS 17 was underestimated in some quarters, leaving firms with a lot to do. This is particularly the case with getting data end to end from source systems through data warehouses, into calculation engines and then into ledgers at the right level of granularity, with the required tagging to bucket together in the right way.
Most insurers have been well aware of the need for controls, not least with a view to avoid the risk of an embarrassing restatement at some point in the future. However, while insurers are implementing in a way that is aligned to their control frameworks and taking care to build controls into their processes, they don’t always look to adjust their wider accounting policies with controls in mind. More likely drivers of accounting policy decisions are consistency with Solvency II, minimising profit volatility and consistency with other reporting requirements.
However IFRS 17’s concept of ‘Unit of Account’, means that insurers must now account for their insurance contracts at a much greater level of granularity and deal with the large quantities of data and complexity this creates. This means it is critical for implementation that they assess the end to end control environment and test it to ensure it remains effective. This will be key in ensuring that decisions on the basis of IFRS results can be taken with confidence, particularly in the early periods of reporting when results may be less intuitive.
For many insurers communicating their finances will be more challenging under IFRS 17. There are more moving parts than under IFRS 17 with the introduction of concepts such as loss component and the impact of discounting.
New key performance indicators (KPIs) will also need to be defined such as the new business CSM. Ensuring that analysts and other stakeholders really understand these ahead of their first publication will be critical. It is also important that insurers are really clear what messages could be taken from a detailed review of the full set of IFRS 17 disclosures to ensure any potential unexpected read across into Solvency II measures or other areas of the business are not mis-interpreted externally.
Insurers were ready for publishing required IAS8 disclosures at FY22. Work on opening balance sheet restatements is generally well progressed across the market. However, many insurers will still need to do substantial work in H1 2023 to be in a position to be able to report the full and extensive new set of disclosures that IFRS 17 requires. These disclosures are required to be published in part at HY23 and then fully for FY23 in Q1 24. This means there is still time to get things right. As noted above, insurers will also want to minimise the risk of misinterpretation, including from misunderstanding of links between IFRS 17 disclosures and business considerations, for example, solvency.
All this means there is going to be a significant period of bedding in throughout 2023, as implementation projects wind down and transfer into BAU. Understandably, for most insurers there is still some way to go in getting this all to run smoothly end to end, with strategic and efficient reporting systems, processes and controls.
Auditors have been gearing up for this for some time now. Focus to date has been on auditing the opening balance sheet and also reviewing and testing new systems, processes and controls.
There is going to be some challenges for auditors in Q1 2023, when insurers will be reporting on an IFRS4 basis and then in parallel or fast follow producing IFRS 17 results for FY22. This is going to stretch audit teams but KPMG has planned accordingly.
Postponing the go-live date and aligning IFRS 9 and IFRS 17 was the right thing to do and has allowed the industry to get to grips with the complexity of IFRS 17 and get comfortable with it. While implementation has taken longer than expected, it is hard to see how an earlier start would have benefited the industry or shareholders.