September 2018 Issue
FW moderates a discussion on IFRS 17 between Frank Pfaffenzeller, Mary Trussell, Pierre Planchon and Joachim Kölschbach at KPMG.
FW: Could you provide an overview of what the IFRS 17 standard means for companies? What are the key drivers behind its introduction?
Pfaffenzeller: The impacts of IFRS 17 on the reported numbers will be many and varied, depending on previous accounting policies and practices. Preparing for the new standard will present significant challenges requiring substantial effort – new and upgraded systems, processes and controls, even greater coordination between finance, risk, actuarial and IT, plus educating business users and investors on what to expect.
Trussell: We see business impacts for many insurers, as IFRS 17 will introduce greater transparency about the profitability and costs of acquiring new business, guarantees issued, duration mismatches and the sources of earnings. These may trigger adjustments to asset allocation, product design, reinsurance programmes and even the design of agents’ compensation. But it is also an opportunity – a chance for insurers to gain new insights from data analysis and reporting, and to further enhance the efficiency of their finance function.
Planchon: The previous IFRS standard on insurance contracts, IFRS 4, allowed entities to continue using their existing policies with minor adjustments, which led to a wide variety of accounting practices, making it difficult for investors and analysts, and even company management, to understand and compare insurers’ results. So, most issuers and users have agreed that change is needed, particularly for life insurance contracts which are mostly long duration and highly complex.
Kölschbach: One important further point: some impacts cannot yet be determined. Firstly, in some countries, IFRS 17 may trigger a second wave of activity by local accounting standard setters, tax authorities and prudential regulators. Second, while the board of the European Financial Reporting Advisory Group (EFRAG) will consider an endorsement of IFRS 17 as issued by the International Accounting Standards Board (IASB), some insurers contend that their testing has provided further evidence of significant issues with IFRS 17 which they consider need to be resolved before it is endorsed for use by public companies in the European Union.
“IFRS 17 is a highly complex standard that has been under development for the best part of 20 years and subject to numerous rounds of consultation right up to its issue.”
FW: To what extent does IFRS 17 differ from its predecessor, IFRS 4? How effective, in your view, was the IFRS 4 standard in identifying which insurance contracts were profit making or loss making?
Kölschbach: By establishing consistent principles for the recognition, measurement, presentation and disclosure of insurance contracts, IFRS 17 represents a new era in insurance accounting. It does this by combining current measurements of future cash flows with the recognition of profit over the period in which services are provided. IFRS 4 did not require insurers to identify in a systematic way which insurance contracts were profitable or loss making except at a high level that involved significant discretion. This resulted in different companies offsetting profits on some contracts against losses on others in different ways, making comparisons challenging. That is one of the new features of IFRS 17: it requires entities to first identify homogeneous risk portfolios then divide these into groups based on their profitability. That makes it much more visible whether new business creates or destroys value based on IFRS 17’s conventions.
FW: What challenges does the IFRS 17 standard present? What items should be on a company’s checklist for IFRS 17 readiness?
Trussell: Additional data and new systems, processes and controls will be needed, key financial metrics will change and scarce resources will face pressure like never before. Some accommodations are available to ease the workload on transition but insurers have to present their results as if they had always applied IFRS 17 – and that is a particular challenge because of the long timelines that insurance involves.
Pfaffenzeller: Let us not forget the asset side of the balance sheet – most insurers have chosen to defer implementation of IFRS 9 to coincide with IFRS 17, so they only need to explain changes once to their investors. Once implemented, insurers’ results may exhibit greater volatility in financial results and equity. On the other hand, emergence of profit might be more regular and predictable when assets and liabilities are closely matched. The effect of using current discount rates will vary, but for many will be significant. Economic mismatches between assets and liabilities will become more visible, and so insurers may find themselves wanting to revisit the design of their products and their investment allocation.
Kölschbach: Lastly, IFRS 17 is a highly complex standard that has been under development for the best part of 20 years and subject to numerous rounds of consultation right up to its issue. Many insurers are finding it challenging to work out how it works in practice and interpretations are evolving. The Transition Resource Group (TRG) set up by the IASB to act as a forum for public discussion of implementation issues has been, and will continue to be, active. Though it is not a standard-setting body, its discussions have led to some important clarifications. So companies need to be flexible and keep an eye on its activities.
“It is important not to forget the importance of building in controls over financial reporting and testing those controls ahead of time.”
FW: What steps should companies be taking to prepare for IFRS 17 implementation? And what should they be doing if they have not started yet?
Trussell: If you have not started preparing for IFRS 17 yet, you need to start now – even property casualty insurers, where the impacts might seem less than for life insurers. Based on our market surveys, around one in 10 insurers see the time pressure to get ready for IFRS 17 as so acute that they are actively lobbying for extra time. So, please do not take unnecessary risks. Start now if you have not already done so. We see preparations typically falling into four phases. First, activities to assess the financial and operational impact of IFRS 17 and build an initial work plan and budget. Second, a design phase to develop accounting and actuarial policies and methodologies and deliver new data, systems and processes. Third, mobilising the business to execute the implementation plan, including dry runs to produce results on the new basis then building up familiarity by producing results on the old and new bases of reporting in parallel. Lastly, sustaining the new practices, to securely embed them in business as usual.
FW: With the IFRS 17 standard effective as of 1 January 2021, how do you expect preparations to progress between now and then?
Planchon: Within the four phases of IFRS 17 preparation, one of the key tasks that is needed is designing, configuring and testing software solutions. A new feature of IFRS 17 is the contractual service margin, or CSM, which represents the unearned profit an entity will recognise as it provides services over the coverage period. Most entities, except the very simplest, will need a CSM engine to calculate, record and store the CSM and calculate how it gets released to profit or loss. Around a third of companies currently believe they will build their own CSM engine – and that is no small undertaking to deliver and test in time for dry runs. Of the companies that plan to buy a solution, two thirds have yet to choose their provider. Then they need to get the solution configured, plumbed in to their existing data feeds and systems, and tested. So that is a significant package of activity.
Trussell: Clearly, this is a complex standard and people are not going to grasp every nuance immediately. So, as well as allowing for dry runs, you will also need to build in enough time to refine initial submissions. If you work from right to left, you quickly realise that time is running out to get systems designed and tested, products analysed, and accounting and actuarial policies defined. That is why we say, if you have not started IFRS 17 preparations yet and you know that it is relevant for your business, you really should get started now.
“As well as thinking through everything that needs to be done, do not forget ‘right to left’ thinking – working back from where you need to get to, to where you are now.”
FW: What risks do companies face in implementing IFRS 17? What governance and oversight do they need to manage those risks?
Pfaffenzeller: Companies that have not yet started preparations are running the risk that they simply will not have enough time to deliver IFRS 17 results in a controlled manner. As well as the obvious risk of misstatement, one of the biggest risks relates to people – nine out of 10 insurers are concerned that they will not be able to secure sufficient skilled resources. Companies that start late face a double jeopardy – they have more ground to make up and a smaller talent pool from which to augment their resources. In terms of governance and oversight, because this is a complex process and the results are not immediate or intuitive, we see companies delaying getting the board and senior management involved because they want to be able to show them the finished solution, when in fact they need to be taking those charged with governance on the journey with them. IFRS 17 is fundamental to how you report to the capital markets and the board and senior management need to understand the impact that it will have on their business and its key metrics, and the key policy decisions being made. Putting in place effective governance and oversight that keeps those key risks in view is vital.
FW: How can companies ensure that their accounting and actuarial processes will be robust and efficient under IFRS 17 and their accounting policy choices defensible?
Planchon: With all this talk about new systems and presenting results on a new basis, it is important not to forget the importance of building in controls over financial reporting and testing those controls ahead of time. Banks and other corporates have already had to digest a significant body of change to implement IFRS 9 on financial instruments and IFRS 15 on revenue recognition – and I would argue neither change is as profound as IFRS 17. We have seen too many companies focused on getting just over the finish line, able to produce numbers on the new basis, but not yet able to demonstrate that they have effective controls in place. So, do not forget controls testing. Also, allow enough time for external audit and responding to those observations. As well as that basic level of control, it is important to remember that as a principle-based standard, IFRS 17 requires significant exercise of judgment, and so there is an important role for industry benchmarks. That is why it is important to take investors and analysts along with you, and start to educate them not only on what is coming but also on how you plan to exercise the judgements required by the standard. Examples of this include the identification of discount rates, the estimation of future cash flows, the risk adjustment and profit release patterns, to name just a few. And before sharing those outside the house, they need to be thoroughly evaluated and challenged inside the organisation.
“Some insurers see this as a once in a career opportunity to overhaul legacy systems, whether that is upgrading to new actuarial modelling systems.”
FW: What advice can you offer to companies on replacing legacy systems, training and education, and communicating the effects of IFRS 17 to their investors?
Pfaffenzeller: Some insurers see this as a once in a career opportunity to overhaul legacy systems, whether that is upgrading to new actuarial modelling systems, a finance data warehouse or a finance workflow management system. The larger insurers which typically started to address IFRS 17 earlier are the ones more likely to be undertaking this more transformational activity. We hear almost all of the very largest insurers – those with annual premium income of $10bn or more – saying that they will explore related opportunities while implementing IFRS 17, whereas one in five smaller insurers are saying they will just focus on achieving compliance.
Planchon: The important thing here is to focus on tailoring training and education so people are equipped for the new world. Do not overlook the need to include the board and senior management in that training programme. Many insurers are worried about how they will educate investors and analysts on the impacts of IFRS 17. IFRS 17 is a journey for investors and analysts, just as it is for management, so think of gradually narrowing down the uncertainty for them, rather than delivering a single point in time explanation of the impact of IFRS 17.
FW: Are there any opportunities that companies might have overlooked as they get ready for IFRS 17?
Kölschbach: Remember to explore the impact of changes in macroeconomic assumptions because you do not know what the markets will be doing up to the date of transition. Under IFRS 4, many insurers discount liabilities using discount rates locked in at inception, if they discount at all. This leaves their net equity at risk of a decline if interest rates increase as bond values, which are marked to market, decline, while liabilities are relatively insensitive to movements in discount rates. In an IFRS 17 world, we should see greater alignment of movements in assets and liabilities if the two sides of the balance sheet are economically matched. Therefore, thinking through the impact of the transition to IFRS 17 in a variety of scenarios could be well worthwhile.
Trussell: Do not overlook the impact for related opportunities – the largest companies are over two times more likely to be exploring opportunities for transformation of their finance systems and processes than smaller companies. And, as well as thinking through everything that needs to be done, do not forget ‘right to left’ thinking – working back from where you need to get to, to where you are now. With those two cornerstones in mind, companies will set themselves on the right path to unlock opportunities as well as overcome the challenges of IFRS 17.
Frank Pfaffenzeller has been providing audit and accounting advisory services to global financial services institutions for over two decades, with a particular focus on the insurance and reinsurance industries. He possesses deep knowledge in the audit of multinationals according to German GAAP, IFRS, Solvency II and US GAAP including S-OX 404 within the (re)insurance, banking, asset management and information technology sectors, including numerous IFRS and US GAAP conversion projects in Asia and Europe. He can be contacted on +49 89 9282 1027 or by email: fpfaffenzeller@kpmg.com.
Mary Trussell is KPMG’s Global Lead Partner for Insurance Change and KPMG’s representative at the IASB’s IFRS 17 Transition Resource Group. She brings deep expertise covering the entire range of insurance markets, from life and health and personal lines to specialty risks and reinsurance, across Asia Pacific, Europe and North America. Ms Trussell focuses on advising clients on how they can best address the challenges of financial reporting, regulatory change and improving performance. She can be contacted on +49 89 9282 6383 or by email: maryhelentrussell@kpmg.com.
Pierre Planchon joined KPMG in 2017 as an audit partner for insurance companies with the Paris office after 28 years with another Big 4 firm (16 years as a partner, 10 years as French Insurance Leader practice). His areas of coverage include life, savings and health, property-casualty, reinsurance and bancassurance. Mr Planchon has extensive experience in audit of financial statements under IFRS, French and US GAAP at corporate and Group level and review of Solvency II reporting. He can be contacted on +33 155 689 559 or by email: pplanchon@kpmg.fr.
Joachim Kölschbach is KPMG’s Global IFRS Insurance Leader. In this role, He is responsible for leading the development of KPMG’s guidance on accounting for insurance companies. Mr Kölschbach currently leads KPMG in Germany’s Department of Professional Practice for Insurance, having been a partner of KPMG in Germany since 1999. He has also been a key participant in several European Commission studies on these matters and is member of the European Financial Reporting Advisory Group’s (EFRAG) Insurance Accounting Working Group. He can be contacted on +49 221 2073 6326 or by email: jkoelschbach@kpmg.com.
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