IFRS 17 & 9 series: a fork in the road

In the final part of this series on the impact of the international financial reporting standards (Ifrs) on insurers' financial reporting, Vincent Huck looks at the potential impact of the standards on risk appetite, and why insurers want to postpone implementing them.

Rarely could one describe an industry as gripped by accounting standards, except accountants. Now, insurers get close. The international financial reporting standards (Ifrs) 9 and 17 are the latest main culprits.

As well as introducing issues of classification that will trigger insurers to think about their asset allocation and in particular asset liability-matching strategies, the new standards introduce changes that could make it easier for insurers to invest in foreign assets, but that could restrict their appetite for equities.

Equities are already a low share of the overall asset allocation of insurers, particularly of life firms. But the new standards will also put a greater focus on mismatches between assets and liabilities.

A burning question is whether this facet of Ifrs 17 & 9 will push insurers to close the gap using non-equity investments, and so make them even more conservative investors than they already were?

It depends on what part of the world we look at, Darrel Scott, a member of the International Accounting Standard Board (IASB) which sets the international standards answers. "The conservatism in investment already started in Europe when Solvency II came out in 2016. Solvency II picked up that the biggest cause of failure for insurers is not insurance risk, which most insurers understand really well. Rather, it is financial risk. It is the circumstances where I promise you 10% in 50 years but then I go play with your money, and hope I'll earn that 10%."

Solvency II already penalises aggressive investment strategies, so insurers have changed the way they manage the assets in their general funds as a result, Scott adds. "What Ifrs 17 does is to provide that same information to the investor community. It gives them insight into what is happening."

However for jurisdictions that are not under Solvency II, and where there is not that level of strictness, things might change because of implementing Ifrs 17.

US-based insurers using Ifrs 17 will, for example, either have to report the mismatch between their assets and liabilities, or change their asset strategy to better match the duration of their liabilities.

"Berkshire Hathaway is not going to change its strategy, it is just going to tell people what it has told people anyway, that it runs a mismatch and people buy Hathaway because they trust its investment strategy," Scott says. "It is extra transparency and if I'm not happy to tell my shareholders [about running a mismatch], I'll have to figure out something."

One of the questions the IASB gets asked a lot is why Ifrs 17 is not the same as Solvency II, Scott says. Each has different objectives, he explains. Solvency II doesn't look at performance. It looks at whether an insurer has enough capital available to pay out its future obligations. Ifrs 17, on the other hand, is mostly concerned with performance.

"Analysts and investorsmay welcome the IASB's efforts to enhance the relevance of insurers' financial statements and better reflect their performance drivers and sources of earnings," Laure Guegan, partner at EY says.

Monica Rebreanu, director at EY adds: "Some stakeholders, such as EIOPA, expressed concerns that entity-specific inputs and assumptions may hinder comparability."

While these concerns are still to be addressed, those preparing financial statements at insurance companies have to recognize early in the implementation efforts that transparency and comparability will require comprehensive and granular disclosures about the judgments and assumptions the insurer is making, including the sensitivity of model results to various inputs.

Prashant Shama, head of international fixed income insurance at J.P. Morgan Asset Management, says evolution in risk appetite will depend on how insurers have managed risk internally. "For example, there are insurers which are already quite prudent, [and] if they continue to [be prudent], from an economic perspective they are pretty set. There might be some challenges around P&L volatility, but my sense is that [the standard] aligns your accounting results with the economic reality of holding the portfolio."

A fork in the road

Ifrs 17 represents the most significant change to insurance accounting in over 20 years and it demands a complete overhaul of insurers' financial statements, according to Guegan.

In October various stakeholders including regulatory bodies asked the Iasb to address 25 concerns and implementation challenges raised. The 25 topics that were identified cover many aspects of Ifrs 17, including its scope, measurement, presentation, the date it takes effect, and the transition to it.

The Iasb appears to be open to considering limited changes in the coming months, and has already surrender on the industry's request to defer the current planned implementation date of 1 January 2021. Although insurers asked for a two year deferral, the Iasb has agreed on one year.

Although the Iasb said it was postponing the standard it did so before deciding if it would make any amendments to it, which in private conversations with Insurance Asset Risk has been a source of a few verbal jibes by a number of accounting and insurance professionals.

The European Financial Reporting Advisory Group (Efrag), the body advising the European Commission on Ifrs adoption, put its endorsement process on ice.

"Under our original timetable we would have issued by now a draft endorsement advice for consultation. But as the Iasb has given some indication that the standard might be changed, Efrag decided it would not be appropriate to proceed with an endorsement advice until we can be clear the standard is a stable platform," said Andrew Watchman, Efrag's chief executive, who talked to Insurance Asset Risk before the Iasb announced it was prepared to defer for a year.

"We are now at a fork in the road. If, over the next few Iasb meetings, it becomes clear that there will be no significant changes to Ifrs 17, then we would proceed with our endorsement process. If the Iasb reopens Ifrs 17, we would put our endorsement process on hold temporarily, and focus on responding to the Iasb's new proposals."

Asked whether insurers' arguments for a postponement are valid, Watchman says: "Efrag has not taken a position as to whether the 2021 date is achievable. We certainly heard feedback from industry participants, actually not just in Europe, but outside Europe as well, that 2021 is too soon. But we felt it wasn't appropriate to start talking about effective dates until the final shape of the standard is known."

The endorsement advice process is now running behind the original timetable, he says. "Given this delay, which will then be followed by the European institutional process, there is a serious question on whether 2021 remains achievable. But Efrag hasn't turned its attention to it, because we need to evaluate the final standard before we can evaluate the effective date."

Also talking before the Iasb announced the delay, Patrick De Cambourg, of the Autorité des normes comptables, the French standard setter, said: "There is a legitimate level of concern. The implementation of Ifrs 17 implies major and costly IT projects. There is also a suggestion that the Iasb is considering amendments to the standard in order to improve its relevance and understandability, and to simplify its implementation. In this context the question of the deadline probably needs to be revisited."

Following the announced one year delay, De Cambourg says: "Delaying by one year is a good initiative, but in order to be able to assess if this is sufficient and from a more comprehensive perspective, it is also crucial to address, urgently, and in substance, the issues raised by Efrag and many other stakeholders.".

Patrick Menard, partner at EY, warns that regardless of the delay insurers should be ready to communicate the potential financial and business impacts on them to their investors and other stakeholders as early on as possible. "Given the scale of changes introduced, expected data requirements, systems and process changes are substantial. Change programs will require significant time and effort over the next years and span well beyond financial and actuarial functions."

The meaning for Ifrs 9 of delaying Ifrs 17

To mitigate the effects of certain accounting mismatches that may arise if an insurance entity applies Ifrs 9 before Ifrs 17 becomes effective, the Iasb has issued amendments to the existing Ifrs 4.

Under these amendments to Ifrs 4, which will be replaced by Ifrs 17, there will be a temporary exemption from applying Ifrs 9 (the 'deferral approach') provided that the entity's predominant activity is issuing insurance contracts, or an allowance to reclassify from the P&L to the OCI some of the income or expenses that arise for qualifying financial assets (the 'overlay approach').

The European Union considered that the deferral approach wasn't sufficiently broad to meet the needs of all significant insurers. Therefore, it introduced a modification (referred as a 'top-up'), that allows financial conglomerate to apply a mixed Ifrs 9/IAS 39 measurement model for financial instruments in their consolidated financial statements.

While the deferral approach will expire in 2021, there is no deadline set for the overlay approach. Therefore, if Ifrs 17 implementation were to be postponed, insurers could potentially elect to adopt the overlay approach, until Ifrs 17 finally comes into play.

However, the overlay approach is operationally more challenging as it requires both Ifrs 9 and IAS 39 accounting records.

This has led many to suggest that the deferral of insurers implementing Ifrs 9 should be extended, to put its implementation in line with that of Ifrs 17.

Speaking at S&P's 2018 European Insurance Conference, Iasb vice chair Sue Lloyd said deferring Ifrs 17 for more than a year might hinder the standard's interconnectedness with IFRS 9.

Watchmann says deferring Ifrs 9 in line with 17, is a question that needs to be asked. But it is not one that Efrag has answered yet, because it hasn't taken a position on the effective date of Ifrs 17.

"Efrag was a strong advocate of aligning the effective dates of both standards for insurers," Watchmann says.

"If the Iasb decided to defer the effective date of Ifrs 17, then they would need also need to deliberate on whether to extend the temporary exemption in order to maintain the alignment of effective dates. There might also be a separate EU decision on whether the so-called 'top-up' should be extended."

This is the last article of a three-part series on the new accounting standards. 
Part one is available here: IFRS 17 & 9 series: Drivers of profitability - underwriting vs investments

Part two is available here: IFRS 17 & 9 series: Asset allocation considerations

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