What’s the issue?
The COVID-19 coronavirus pandemic, increased risks from climate-related events and rising inflation and commodity prices may have pervasive impacts for both insurance companies and their policyholders.
All of these uncertain events may impact insurers’ balance sheets and capital ratios significantly. For example, volatile markets have affected investment portfolios and bond yields and surging credit-default-swap indices are causing concerns about increased defaults.
Insurance liabilities could also be affected, depending on the specific types of coverage provided and the accounting policies applied under IFRS 4 Insurance Contracts. Insurers need to assess the impact on liabilities for reported claims and incurred but not reported claims. They also need to assess any knock-on effects for assumptions about reinsurance recoveries, future claims and disclosures.
Insurers may face particular challenges in uncertain times, with pressure on their balance sheets from falling asset values and increasing liabilities – e.g. from additional claims relating to the COVID-19 pandemic. Administration and claims costs may also increase because of the higher costs of insured events.
Getting into more detail
IFRS 4 applies to insurance and reinsurance contracts and allows the continuation of pre-existing national accounting practices with few additional requirements – e.g. the liability adequacy test based on current estimates of all contractual cash flows. These practices vary widely by country and the specific accounting policies applied will affect the sensitivity of insurance liabilities to current market conditions. On the asset side of the balance sheet, many insurers continue to apply IAS 39 Financial Instruments: Recognition and Measurement. [IFRS 4.15–19, 20A–K]
When assessing the impact on insurance liabilities, insurers need to consider the coverage provided under the terms and conditions of issued insurance contracts.
Where they still apply, stay-at-home regulations or new ways of working and the resulting operational challenges may affect the claim settlement process and patterns. For example, claims payments may take more time and could result in a change in the paid-claim patterns used in some actuarial methods for calculating insurance liabilities.
When determining their obligations, insurers need to evaluate the precise extent of coverage and the impact of exclusions and limitations on coverage. This includes an assessment of new directives, laws and regulations that may require insurers to provide coverage or incur claims for insured events in addition to those required by the existing terms and conditions in the insurance contract.
Further, when current demographic and market estimates (including discount rates) are reflected under existing accounting practices, an insurer needs to assess the extent to which current circumstances require a reassessment of those estimates. As a consequence, an insurer may need to update its demographic and market assumptions when measuring insurance liabilities.
Regulation or contractual terms may provide for profit participation by policyholders. Insurers therefore also need to consider the impact on their obligations, including deferred bonuses and shadow accounting policies.
The pandemic put significant strain on supply chains, which has increased because of the Ukraine-Russia conflict, and there has been a resurgence in inflation globally. This is placing pressure on both insurers and policyholders. Without government support, policyholders may be unable to meet their usual expenses, including premiums for insurance policies. Insurers will need to consider any impacts of a deterioration in their policyholders’ credit standing.
These supply chain issues are causing specific issues in the insurance market. For example, the increase in used car prices because of shortages in the number of new cars could cause increased claims cost when cars need to be replaced. Similarly, supply chain disruptions might also cause higher claims cost because of longer repair times and higher prices for car parts that need replacing.
What is the impact on your type of business?
These uncertain times will impact your business in different ways. In general, policyholder behaviour may have changed. For example, the uncertainties may affect surrender probabilities and insurance fraud as well as the recoverability of deferred acquisition costs (DAC). New or continuing measures taken by governments and regulators (e.g. to combat the pandemic, or specific sanctions) may limit sales activity and could impact premium income. In some parts of the world there could be further recovery effects after the immediate risk has passed – e.g. delivery of health services that were postponed or more traffic-related incidents as traffic volumes increase.
Supply chain issues and high inflation will directly impact profit or loss, including through increases in administration and claims costs.
The Ukraine-Russia conflict has wide-ranging implications for insurance companies. Insurers with investments in Russia or Ukraine need to consider implications around impairment of financial assets and non-financial assets. The sanctions imposed on Russia may cause certain transactions to become illegal, such as the collection of premiums or the payment of claims. Determining the scope of the sanctions is a legal question; however, sanctions may have direct accounting consequences for those insurance contracts affected, especially for premium receivables, claims payables and related income statement line items.
When premiums remain unpaid, insurers may be able to cancel policies. In specific markets, or for specific products (e.g. engineering or certain reinsurance contracts), premiums may not become due until after an insurer has provided coverage. This could increase collectability risk.
In addition, insurers and reinsurers may have provided coverage for business disruption or cyber security events. The frequency and severity of these events could increase due to the Ukraine-Russia conflict. Similar to the COVID-19 pandemic, assessing whether particular events and related losses are covered will require legal analysis. Insurers and reinsurers need to update their estimates and may need to provide disclosures about the uncertainty around claims arising from these events.
In non-life or general insurance, many policies will have exclusion clauses for pandemic risks, which were strengthened for products such as business interruption and travel insurance after the SARS coronavirus outbreak in 2003.
Event cancellation coverage may cause losses for insurers because some policies cover pandemic risk, although this risk has decreased significantly in many parts of the world. More recently, many organisations are facing workforce shortages and, in some cases, are unable to service their customers. This could lead to cancellation claims – e.g. from flight cancellations. If these events are insured, then insurers may be liable.
The following types of insurance may also be affected.
- Trade credit insurance – covering businesses against debts that cannot be paid by their customers or suppliers.
- Workers' compensation insurance – workers claiming they were not adequately protected by their employers.
Insurers need to evaluate the impact on liabilities for reported claims, incurred but not reported claims, future claims liabilities (including claims handling costs) and related assets for reinsurance recoveries.
Lastly, war-related risks have been excluded from many insurance policies since 1938. Therefore, many policies will not cover losses related to the Ukraine-Russia conflict.
Reinsurers will need to respond to losses ceded by direct insurers and will need to perform similar evaluations. For some specialised reinsurers, this could have a major impact.
Mortality or morbidity rates from a pandemic (e.g. COVID-19) could affect the insurance liabilities of health insurers. These insurers need to monitor developments and assess whether they need to revise their assumptions at the reporting date. A pandemic may give rise to new and emerging trends whose ultimate effects are unknown – e.g. long-COVID-19 cases for which treatments and coverage are still being investigated in many instances.
Life insurers may face the most significant impacts. The downturn in financial markets and increases in credit risk could lead to impairments of financial assets. Legacy businesses or products that are highly sensitive to market variables are likely to feel the effects more deeply – e.g. variable and fixed annuities, long-term care insurance and universal life insurance. This applies especially to insurance contracts that contain minimum return guarantees. The measurement of the insurance liabilities could be affected directly if these guarantees are measured on a current basis; or indirectly, if a deficit arises in the liability adequacy test that is recognised in profit or loss.
If information affecting the values of assets and liabilities becomes available after the reporting date, then insurers will need to distinguish between events that provide evidence of conditions that existed at the reporting date (adjusting events) and those that are indicative of conditions that arose after the reporting date (non adjusting events). [IAS 10.3, 8, 10]
What is the impact on your investment portfolios under IAS 39?
Insurers need to assess whether impairment losses need to be recognised for investments that are not classified as at fair value through profit or loss. Under IAS 39, an investment is impaired if there is objective evidence of a loss event since initial recognition that has an impact on the estimated future cash flows. Indicators of impairment include a borrower’s significant financial difficulties or it becoming probable that the borrower will enter bankruptcy or financial reorganisation. A decline in the fair value of a debt instrument or a change in its credit rating may not in itself be an indicator of impairment. However, it may be evidence of impairment when it is considered with other available information. [Insights 7I.6.410.60, 420.10]
For available-for-sale equity investments, IAS 39 requires an impairment loss to be recognised if there has been a significant or prolonged decline in the fair value of the investment below its cost. [Insights 7I.6.430.10]
What do you need to disclose?
Insurers disclose assumptions for, and sensitivities in, the measurement of insurance liabilities. For pandemic risks, this may involve explaining the impact of these risks on your type of insurance business, how experience to date varies from existing assumptions about these risks and how they are managed. In addition, the Ukraine-Russia conflict may require specific disclosures to explain any impact on the company. The disclosures also include considerations around risk concentrations, claims development tables and credit, liquidity and market risk. [IFRS 4.38–39A, IG41–IG70]
The uncertainty around these events may increase the level of estimation uncertainty when measuring insurance liabilities. This may require enhanced disclosures and may also affect sensitivity analysis disclosures. [IAS 1.125, IFRS 4.39A]
For investment portfolios, insurers disclose the nature and extent of risks arising from financial instruments and how they manage those risks. This means that insurers will need to explain the significant impacts of these uncertainties on those risks and how they are managing them. Insurers will need to exercise judgement to determine the specific disclosures that are relevant to their business and necessary to meet these objectives. [IFRS 7.31–42]
Decreases in asset valuations arising may impact regulatory capital and solvency calculations and disclosures about how the company manages capital. Disclosures may also be required about non-adjusting events occurring after the reporting date that impact subsequent financial asset or insurance liability measurements. [IAS 10.21–22, 134–136]
For some insurers, further disclosures around potential going concern issues may be required.
IAS 34 Interim Financial Reporting does not contain specific disclosure requirements for insurance contracts. However, the general principles apply and the interim financial statements explain events that are significant to understanding changes in financial position and performance, including changes in estimates, since the last annual financial statements. A company considers whether the interim report needs to include an update to information disclosed in the last annual financial statements because of the pandemic or other uncertainties. [IAS 34.10, 15–16A]
What about other accounting topics for insurers?
For other relevant topics (including IFRS 9 Financial Instruments implications for insurers that have not applied the temporary exemption), see our Financial reporting in uncertain times resource centre.
Actions for management to take now
- Evaluate the specific implications for your company based on the accounting policies applied under IFRS 4 and assess the impact on assumptions for measuring liabilities for reported claims, incurred but not reported claims, future claims and reinsurance recoveries.
- Ensure that your liability adequacy test (including DAC recoverability) is based on current estimates of future cash flows and evaluate whether any deficit is recognised in profit or loss.
- Evaluate the collectability of insurance premiums and reinsurance recoveries, especially in cases where amounts are received in arrears.
- Evaluate whether a significant or prolonged decline in fair value has arisen for any available-for-sale equity investments.
- Assess whether there is a loss event that has affected the estimated future cash flows of any debt investments and whether to recognise an impairment loss.
- Consider expanding disclosures about pandemic risk management, key demographic and market assumptions, sensitivities in the assumptions, major sources of estimation uncertainty, and liquidity, market and credit risks. These disclosures specifically cover the implications of the Ukraine-Russia conflict if they have a material impact on your company.
- Consider your capital disclosures, especially where there are concerns about the capital position relative to regulatory requirements or implications for debt covenants.
Read further insights from KPMG insurance leaders across the globe in our Insurance contracts topic page.
References to ‘Insights’ mean our publication Insights into IFRS®
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