IFRS 17: Definitions, Objectives and Key Features

The long expected new International Financial Reporting Standard (IFRS) 17, issued by the International Accounting Standards Board (IASB), marks a transformative shift in the accounting for insurance contracts.

Effective from January 1, 2023, IFRS 17 replaces IFRS 4, introducing a more transparent, consistent, and principle-based approach to financial reporting for insurance companies.

The objective of IFRS 17 is to ensure that an entity provides relevant information that faithfully represents the recognition, measurement, presentation, and disclosure principles for insurance contracts within its scope. This information gives a basis for users of financial statements to assess the effect that insurance contracts have on the entity’s financial position, financial performance, and cash flows.

The primary goal of IFRS 17 is to provide a uniform accounting framework that enhances the comparability and transparency of financial statements for entities issuing insurance contracts.

In this way it is expected to, gradually, help overcoming the limitations of the previous framework that allowed a wide range of accounting practices, leading to inconsistencies and a lack of comparability across companies and jurisdictions.

The detailed disclosure requirements that accompany the new standard lead to greater transparency in financial statements, aiding stakeholders in understanding the insurer’s financial performance and risk exposure.

The new standard provides clear guidance for the contracts under scope in terms of recognition, de-recognition and the definition of the lowest unit of account.

In terms of measurement the standard introduces three distinct measurement models to cover the diverse nature of insurance contracts:

• General Measurement Model (GMM), this is the default measurement approach under IFRS 17. It is based on four components:

o The new concept of Contractual Service Margin, representing the unearned profit from insurance services that will be provided in the future. This margin is systematically adjusted over the life of the contract as services are delivered.
o Expected future cash flows: These are current estimates of future cash flows, discounted for the time value of money and adjusted for non-financial risk. This ensures that the insurance liabilities reflect the present value of expected future cash flows.
o Risk Adjustment: IFRS 17 mandates the inclusion of a risk adjustment for non-financial risks, reflecting the uncertainty in the amount and timing of future cash flows. This provides a more accurate representation of the insurer’s risk exposure.
o Time value of Money: All the above elements are reported in the financial statements, taking into account the time value of money according to current rates.

• Premium Allocation Approach (PAA): The PAA is a simplified approach for measuring the liability for remaining coverage, primarily applicable to short-duration contracts, typically one year or less. It is similar to the unearned premium approach used under previous accounting standards. While the PAA was considered a simpler and less costly to implement than the GMM, it still involves a lot of complex detailed calculations and interacts in many points with the General Model principles.

• The Variable Fee Approach (VFA) is a specific adaptation of the GMM, designed for direct participating contracts where policyholders share in the returns on underlying items. The VFA adjusts the CSM based on changes in the entity’s share of the fair value of the underlying items, ensuring that the measurement of insurance liabilities reflects the variable nature of these contracts.

• Income Statement: Under IFRS 17, revenue from insurance contracts is recognized based on the delivery of insurance services rather than the receipt of premiums. This approach aligns revenue recognition with the performance of the insurer’s obligations, similar to the rest of the industries.
• Balance Sheet: Insurance contract liabilities are measured based on current estimates of future cash flows, discounted to present value and adjusted for risk. This provides a more accurate representation of the insurer’s financial position.
• Enhanced disclosure requirements ensure that entities provide detailed and useful information about the amounts recognized in financial statements, including the key analysis of changes tables that include detailed information at a very granular level.

IFRS 17 requires retrospective application of the standard, however making available three approaches for transitioning to the new standard:

• Full Retrospective Approach: This approach involves applying IFRS 17 retrospectively, as if the standard had always been in effect. It requires comprehensive historical data and is the most rigorous but provides the highest level of comparability.
• Modified Retrospective Approach: This approach is used when full retrospective application is impracticable. It aims to achieve the closest possible outcome to full retrospective application, using reasonable and supportable information available without undue cost or effort.
• Fair Value Approach: This approach measures the insurance contract liability at the transition date using the fair value of the contract. It is simpler and less data-intensive than the retrospective approaches but may result in less comparability.

Selecting the appropriate transition approach depends on the availability of historical data, the complexity of existing contracts, and the cost-benefit considerations of each method.

IFRS 17 represents a significant advancement in the accounting for insurance contracts, aiming to improve transparency, comparability, and accuracy in financial reporting.

While the transition to IFRS 17 poses considerable challenges, the long-term benefits of improved financial reporting quality and better risk management are expected to outweigh the initial implementation costs.

As insurers adapt to the new standard, stakeholders will gain deeper insights into the financial health and performance of insurance companies, fostering greater confidence in the sector.