Insurers have been watching the wave of accounting change surface on the horizon for years. Unfortunately, due to delays in the IASB’s insurance contracts project, that wave may not make land in one single, sweeping change.
Implementation of IFRS 9 Financial instruments (IFRS 9) on 1 January 2018 followed by IFRS 4 Phase II Insurance contracts (IFRS 4Phase II) may bring about substantial organization-wide changes in their own right.
Financial instruments make up a substantial portion of an insurer’s investment portfolio and consequently, their balance sheet. As aresult, unique challenges may stem from the accounting requirements for insurance contract liabilities undergoing a substantial change soon after the accounting for financial assets held to settle those liabilities has been implemented1. Insurers will want to make decisions for both standards with a view to:
These seemingly simple aims are made more complicated byIFRS 4 Phase II not yet being finalized.
Differences between the measurement bases of insurance contract liabilities and financial assets held to cover them and the presentation of gains and losses in profit or loss or in other comprehensive income (OCI) may give rise to accounting volatility.
As illustrated below, many insurers will be able to minimize accounting mis matches through the effective use of options and elections available under IFRS 9 – e.g. Fair value through profit or loss (FVTPL) designation, fair value through other comprehensive income (FVOCI) option for equity instruments IFRS 4 and/or IFRS 4 Phase II.
However, some accounting mis matches will be unavoidable –e.g. where financial instruments do not qualify for classification in the desired category, or are measured at amortized cost and there are a range of scenarios that could be more complex than the examples above.
Consider an insurer with a mixed measurement model. They will need to decide whether to continue with the status quo, or, to the extent allowed, try to streamline their financial reporting. When moving from one measurement model to another, insurers will need to weigh the advantages and disadvantages of mis matches during the period between implementation of IFRS 9 and IFRS 4 PhaseII, or where permitted, re-visiting decisions made at initial application of IFRS 9.
In addition, volatility will arise where insurers cannot achieve a close economic match between insurance contract liabilities and the financial assets held to cover them – e.g. durational differences, more active or passive investment strategies, other market factors’ impact on measurement.
Two substantial rounds of accounting changes may pose practical challenges to insurers, not the least of which will be a strain on scarce actuarial, finance and IT resources. To lessen the burden,insurers will need a clear view of their future state operating model to determine the most efficient way to get there.
Insurers choosing to present the effects of changes in discount rates in profit or loss will eliminate, to a large extent, the need to track historical discount rates. However, if they avoid accounting mis matches by electing to present changes in the fair value of financial assets through other comprehensive income, they will need to implement the systems and processes necessary to comply with IFRS 9’s impairment model.
Insurers should start to plan for organization-wide impacts of the accounting changes– e.g. regulatory requirements, debt covenants,dividend capacity, management bonuses.
It will take users time to become familiar with interpreting the new reporting requirements for both IFRS 9 and IFRS 4 Phase II. These challenges will be intensified and the comparability of financial information may be impaired during the period between adoption of IFRS 9 and IFRS 4 PhaseII.
Insurers will want to develop plans to educate users of the financial statements and communicate anticipated impacts to the markets and other stakeholders.
Insurers will be facing a number of significant challenges to implement the new accounting standards. Do not hesitate to get in touch with us to discuss how KPMG can help.
These challenges are the basis of on-going discussions on a possible deferral of the effective date of IFRS 9 for insurance companies. Keep up-to-date on the latest IFRS 9 developmenton KPMG's IFRS - Financial Instrument shot topic page.
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