The IFRS 9 timer is ticking for insurers. Gail Tucker assesses how they should prepare ahead of the deadline.
IFRS 9 Financial Instruments is effective for annual periods beginning on or after 1 January 2018, although amendments to IFRS 4 Insurance Contracts will allow some insurers to defer application of IFRS 9 until 1 January 2021. Implementation of the standard will be challenging due to its interaction with the new insurance contracts standard (IFRS 17), expected to be issued in the second quarter of this year.
Insurers should be assessing now whether their activities are “predominantly connected with insurance” to qualify for the deferral of IFRS 9. This will involve comparing the liabilities from IFRS 4 contracts to total liabilities and considering whether there are any significant business activities not related to insurance. Man y
UK insurers should qualify for deferral but the assessment is at a group level and so some groups may not qualify. Insurers who do not qualify for deferral can use a new overlay approach or existing options in IFRS 4 to address accounting mismatches that arise from IFRS 9.
Even if you do qualify to defer until 2021 you should be considering the disclosures you will need to make from 2018. These will require identifying which financial assets meet the ‘solely payments of principal and interest’ test (SPPI) under IFRS 9 unless they are trading assets or managed on a fair value basis. Additional information will also be required on the credit risk exposure of financial assets.
Here in the UK many insurers measure assets at fair value through profit or loss. For life insurers this reduces volatility in the income statement because insurance liabilities are measured using current assumptions including discount rates. However, insurers in other countries, including subsidiaries in UK groups, may use amortised cost or fair value through other comprehensive income (OCI) to measure financial assets, because insurance liabilities use historic locked in discount rates.
IFRS 9 identifies different business models that drive the accounting for financial assets. How you manage assets will determine the business model – is the objective to sell the assets, collect contractual cash flows on assets or both? IFRS 9 will not significantly impact financial assets measured at fair value through profit or loss. However, even if insurers have business models resulting in assets being measured at amortised cost or fair value though OCI, some assets today measured at amortised cost (held-tomaturity and loans and receivables) or at fair value through OCI (available-for-sale) under IAS 39 will be required to be measured at fair value through profit or loss under IFRS 9. Examples include: debt instruments with embedded derivatives or other features that fail the SPPI test; and equity instruments including puttable instruments on mutual funds (equity instruments may be designated at fair value through OCI, but accumulated OCI is not recyclable to profit or loss on sale).
Under the new insurance standard all insurance contract liabilities will be measured on a current basis (including using current discount rates) but there will be an option to take movements in discount rates to OCI. This means that the implementation of IFRS 9 is going to be closely linked to IFRS 17 as insurers decide how they measure insurance contract liabilities alongside their business models for financial assets. Insurers who adopt IFRS 9 before IFRS 17 will be able to reconsider their asset business models when they adopt IFRS 17.
For assets measured at amortised cost or fair value through OCI, IFRS 9 brings in a new expected credit loss impairment model. This results in higher impairment provisions than the current incurred loss model. The standard gives some relief for “low credit risk”, which may apply to many insurers’ financial assets, but they will still need to collect and store credit data and build impairment models.
IFRS 9 also introduces new hedge accounting requirements, although insurers have typically not made extensive use of hedge accounting under IAS 39. Insurers who currently use hedge accounting under IAS 39 are likely to elect to stay with IAS 39 until the macro hedging project is finalised.
Insurers’ financial statements will look very different once IFRS 9 and IFRS 17 are implemented. The interaction between the accounting for assets and liabilities, particularly for life insurers, will be key inorder to reduce volatility in the income statement. Insurers will have choices under both accounting standards but a significant amount of time and effort will be required to understand these choices, build the accounting models, and develop operating systems and governance over the new processes.
Another challenging area for insurers will be educating stakeholders about the changes and communicating the new financial results. Currently many insurers use alternative performance measures to explain their financial results. It is important to think what story you will be telling your stakeholders based on the new financial statements. Alternative performance indicators may still be a means to explain the results, but they are also likely to need to change.
Once IFRS 17 is issued insurers will have three years to develop the new systems for the measurement of financial assets and insurance liabilities. We strongly recommend you start planning your implementation of these standards now. The countdown for mandatory application of these new standards that will fundamentally change financial statements of insurers has started.