In June 2020, the International Accounting Standards Board (IASB) issued an amended version of IFRS 17 Insurance Contracts. One notable change is that the application date is extended by two years – IFRS 17 now applies for accounting periods beginning on or after 1 January 2023 instead of 1 January 2021. For insurance entities, the use of the temporary exemption from applying IFRS 9 Financial Instruments has similarly been extended to 2023.
IFRS 17 establishes principles for the recognition, measurement, presentation and disclosure of insurance contracts. IFRS 17 applies to insurance contracts issued, but not to those held. It does, however, apply to reinsurance contracts both issued and held and also to investment contracts with discretionary participation features.
The application of the amended standard in both the UK and EU will be subject to endorsement. As neither the amended nor the original version of IFRS 17 were endorsed by the EU prior to the end of the UK’s transition period, endorsement for its use in the UK will fall to the new UK Endorsement Board.
Why should non–insurers be interested in IFRS 17?
IFRS 17 is not a standard for insurance entities but for insurance contracts. While the definition of an insurance contract has not changed materially from IFRS 4 Insurance Contracts, the consequences of a contract qualifying as an insurance contract have.
IFRS 4 allowed entities to use their previous accounting policies for contracts that qualified as insurance contracts, and many non-insurance entities, such as banks and service companies, applied guidance from other standards, such as IFRS 9 and IFRS 15 Revenue, to recognise and measure insurance contracts. Unless there is specific relief permitting use of another accounting standard, this is no longer possible because IFRS 17 has detailed recognition, measurement and presentation requirements for insurance contracts.
In addition, IFRS 4 permitted voluntary separation (known as ‘unbundling’) of deposit components from insurance contacts, so entities could account for a hybrid contract partly under IFRS 4 and partly under another IFRS. Under IFRS 17, unbundling is no longer voluntary; depending on criteria, it is either mandatory or not permitted.
What is an insurance contract?
IFRS 17 defines an insurance contract as:
“A contract under which one party (the issuer) accepts significant insurance risk from another party (the policyholder) by agreeing to compensate the policyholder if a specified uncertain future event (the insured event) adversely affects the policyholder”.<
The key elements in the definition are ‘uncertain future event’, which may be, for example, damage or breakdown, or the failure of output to generate revenue, and the fact that the event must ‘adversely affect the policyholder’, which rules out derivative products that might pay out without the policyholder suffering a loss. The definition does not quantify ‘significant insurance risk’, but the application guidance does state that if an insured event could cause the insurer to pay significant additional amounts that exceed those which are payable if no insured event occurred (excluding scenarios that have no commercial substance), significant insurance risk is present. This is the case even if the insured event is extremely unlikely or if the expected (ie, probability-weighted) present value of contingent cash flows is a small proportion of the expected present value of all the remaining contractual cash flows. Significant insurance risk must be assessed at an individual contract level not at a portfolio level.
Targeted changes
The June 2020 amendments made targeted changes to IFRS 17 in response to concerns and challenges raised by stakeholders during implementation. The major changes from the amendments likely to be most relevant to non-insurers are:
- permitting an entity to apply either IFRS 9 or IFRS 17 on a portfolio basis to loan contracts that limit the compensation payable to a policyholder to an amount less than the outstanding loan balance in certain circumstances, such as death (eg, loans with death waivers, equity release mortgages, student loans); and
- excluding credit card contracts (or similar) that contain insurance coverage because the issuer is required to refund the customer for claims against a supplier in respect of misrepresentation or breach of purchase agreement (eg, failure to deliver goods). These are excluded from the scope of IFRS 17 if, and only if, the issuer does not reflect an assessment of the insurance risk associated with an individual customer in setting the price of the contract with that customer.
However, allowing for the above changes, non-insurers may still have issued contracts which, while not regulated as insurance contracts, meet the definition of an insurance contract under IFRS 17 and therefore fall within the scope of its measurement model.
IFRS 17’s standard measurement model is complicated and involves calculating the current value of the insurance liabilities on a probability-weighted basis, discounted and risk-adjusted. Profit is allocated over the period which service is provided. IFRS 17 does have a simplified approach, the premium allocation approach, which results in profit recognition similar to IFRS 15, but only contracts with a boundary of one year or less qualify automatically for this simplified approach. A number of the contracts issued by non-insurers that might be insurance contracts (examples are discussed below) would provide cover or service for more than one year.
Warranties issued (including extended warranties)
Warranties provided by a manufacturer, dealer or retailer in connection with the sale of its goods or services are outside the scope of IFRS 17. However, other warranties, such as those provided by a third party or those provided by a manufacturer, dealer or retailer not connected with the sale of its goods are within scope.
Guarantees issued (eg, of profit, revenue, goods delivery)
In general, a guarantee is very similar to an insurance contract. However, residual value guarantees provided by a manufacturer, dealer or retailer and a lessee’s residual value guarantees when they are embedded in a lease are excluded from the scope of IFRS 17. In addition, financial guarantees (narrowly defined in IFRS 17) are also excluded from IFRS 17’s scope unless the issuer has previously asserted explicitly that it regards such contracts as insurance contracts.
Other types of guarantees not covered by the exclusions may be within IFRS 17’s scope, for example a guarantee of residual value not given by a manufacturer, dealer or retailer.
Fixed fee service contracts
In a fixed fee service contract the level of service depends on an uncertain event, but the fee does not. These contracts can cover, for example, roadside assistance, or lift or boiler maintenance. Such contracts are considered to be insurance contracts because the service provider could suffer a significant loss if the cost of repair exceeds the fixed price of the service. However, under IFRS 17, entities have a choice of applying either IFRS 17 or IFRS 15 to such contracts depending on the conditions met. The most important condition for applying IFRS 15 is that the price set does not reflect an assessment of the risk associated with an individual customer (ie. the company should not charge its customers a price for breakdown service based on individual claims history).
The way forward
Non-insurers that issue guarantees or warranties should not assume these contracts are outside the scope of IFRS 17, and entities should perform product classification exercises sooner rather than later. This involves identifying the population of contracts that are potentially considered to be insurance contracts and performing a robust analysis of whether they meet the definition and whether any of the exemptions above are available.
The lesson learned from adoption of other standards is that this action should be taken at the earliest opportunity, as implementation can be time-consuming and/or costly if performed at a late stage.
More detail on IFRS 17’s requirements can be found in the faculty’s factsheet on IFRS 17 Insurance Contracts for non-insurers, which is available at icaew.com/IFRSfactsheets
About the author
Timothy Rogerson is Associate Partner at EY
