IFRS 17 an accounting standard for insurance contracts, KNEWS


By Pantelis Pavlou – Director and member of the IFRS Central, Eastern and South-Eastern Europe & Central Asia (CESA) team at EY [1]

As the title attests, this short article aims to bust the myth that IFRS 17 – Insurance contracts is only relevant for insurers or for companies regulated as insurance entities.

While it is true that IFRS 17 will have a predominant impact on the insurance industry, all entities (including non-financial businesses) should carefully assess whether the new standard applies to their transactions and events. . As a reminder, the IFRS standards are not specific to a sector, but they deal with particular transactions and events, in this case: the recognition of insurance contracts.

High level summary of IFRS 17

Before elaborating further on its scope, let me set the scene for the new standard. IFRS 17 is the most recent addition to the standards of the International Accounting Standards Board (IASB) and replaces IFRS 4, which has been qualified as a temporary standard. IFRS 4 allows for the anticipation of previous practices and, as such, has contributed to the divergence in the accounting for insurance contracts. Therefore, IFRS 17, being the first truly international accounting standard for insurance contracts, introduces many changes and challenges when transitioning to the new requirements.

In short, for the first time, accrual accounting will be implemented for insurance contracts. The statement of financial position will reflect the risk-adjusted present value of future cash flows, including the unvested profit of the group of contracts (also referred to as contractual service margin or CSM), which is then published in profit or loss. over the coverage period. . This means that the income and statement of financial position of companies issuing insurance contracts would better reflect the economics of these contracts, which in turn would limit the need for other performance measures to explain the financial situation, financial performance and cash flow. for insurance contracts. Finally, IFRS 17 will improve comparability between different entities and countries.

The myth

IFRS 17 is only relevant for insurers and businesses regulated as insurance entities.

Break it up : IFRS 17 is not industry standard, it applies to all insurance contracts. But to better understand this statement, we need to look at the standard’s scope, scope exceptions, and key definitions.

Scope and Scope Exceptions

The scope of the standard refers, in fact, to insurance contracts. These are defined as contracts under which one party (the issuer) accepts significant insurance risk (= non-financial risk) from another party (the policyholder) by agreeing to indemnify the policyholder policy if a specific uncertain future event adversely affects the policyholder[2].

“Risks” exist for all entities and come in different forms. Financial risks can affect an entity through changes in market prices, including changes in interest rates, foreign exchange rates, credit ratings, stock prices or commodity prices. While non-financial risks are other risks unrelated to financial risks and specific to a party to the agreement.

Examples of non-financial risks include obsolescence or damage to inventory, death of an individual, motor vehicle accidents causing property damage or loss of life, and inability of property or a service to be fit for purpose. To mitigate non-financial risk, for example, the risk of a storm causing damage to a manufacturing plant, a manufacturer may consider diversifying its manufacturing sites, entering into a co-ownership arrangement, or entering into a contractual agreement that compensates storm damage. it can happen.

Here are some examples of arrangements designed to address the impact of non-financial risks (mitigate for a client; create a risk for the protection provider):

  • Life and general insurance policies,
  • Guarantee terms,
  • Residual value guarantee contracts,
  • Rental guarantees,
  • Financial guarantee contracts,
  • performance guarantees,
  • Contingent consideration agreed as part of a business combination.

As defined above, non-financial risk becomes insurance risk when a party accepts that risk from a counterparty. For example, when a manufacturer offers warranties for goods it sells to customers, it is in effect accepting the insurance risk that the product may be defective by promising to indemnify or repair with the customer.

According to this broad definition, a certain number of contracts should be accounted for in accordance with IFRS 17, even if other standards could apply to such transactions. To this end, the standard includes a list of provisions which are excluded from its scope.[3]. Analyzing the scope of the standard is therefore a very important step. In particular, the standard excludes:

  • Insurance contract as policyholder unless it is a reinsurance contract,
  • Warranties issued directly by the manufacturer, reseller or retailer in connection with the sale of the underlying item,
  • Assets and liabilities of employers from employee benefit plans,
  • Contractual rights or obligations contingent on future use or the right to use a non-financial item (e.g. future lease payments made only when COVID-19 restrictions are lifted),
  • Residual value guarantees provided by the manufacturer, trader or retailer of the goods it sells, and those provided by a lessee when incorporated into the lease,
  • Financial guarantee contracts (unless the issuer claims it is an insurance contract and accounts for it as insurance),
  • Contingent consideration to be paid or received on a business combination,
  • Certain credit card contracts that offer insurance coverage without assessing the insurance risk of the person concerned.

Theory to practice
To make this more tangible, the following practical examples help explain the above points.

Practical example 1

ABC Company Ltd sells monitors to customers offering a 4 year extended warranty for their product.

In this example, it is clear that the exception from the scope of IFRS 17 applies, such as the warranty issued directly by the retailer in connection with the sale of products. This means that ABC Ltd will not apply IFRS 17 to account for the guarantee, but rather will fall within the scope of IFRS 15 – Revenue from contracts with customers.

Practical example 2

The DEF Group has two wholly owned subsidiaries: GHI Ltd which sells monitors to customers and JKL Ltd which provides a four year warranty to GHI Ltd customers.

For consolidated financial statements, the reporting entity is DEF Group, and the fact pattern and conclusion are similar to Example 1 (above).

However, different considerations apply to separate financial statements, where JKL Ltd issues a warranty for products of which it is not the manufacturer, dealer or retailer. In this case, the scope exception does not apply and JKL Ltd must determine whether the terms and conditions of the warranty contract meet the definition of an insurance contract. If this is the case, it must apply the provisions of IFRS 17.

Practical example 3

MNO Group has a number of wholly owned subsidiaries. In accordance with local law, employers must provide workers’ insurance (employer’s liability insurance). Given the size of the group and its workforce, the group has created an insurance entity, PQR Ltd, which provides insurance contracts for all its sister companies. PQR Ltd has no contracts with external parties.

In this de facto model, there is no enforceable insurance contract with external parties, MNO Group will ignore the self-insurance agreement and book any workers’ compensation liability as than provision for employees under IAS 19.

The analysis is different for the corporate accounts of PQR Ltd which, from its perspective, issues contracts falling within the scope of IFRS 17.

Final

The examples above show that IFRS 17 could also be relevant for non-regulated entities such as insurance companies. Again, like other standards in the literature, IFRS 17 applies to transactions and events, not to a specific industry.

A good understanding of the main requirements, and in particular the principles surrounding its scope and definition, is the starting point for an in-depth analysis to determine whether an entity should apply this new standard.

As a reminder, IFRS 17 applies for annual periods beginning on or after 1.1.2023 and during the transition, the comparatives of the previous year must be restated, so that the transition date is the start of the annual periods opened. from 1.1.2022. In addition, entities are reminded of the requirements of IAS 8 regarding the inclusion of sufficient information on the anticipated impact of the new standard in the financial statements for 2022 (interim and annual).[4].

Accounting for insurance contracts is indeed a complex subject. At EY, we are committed to maintaining a cutting-edge understanding of the changes that may affect the business environment. Our tool, EY Atlas Client Edition[5] (here) is available free to everyone and provides access to EY interpretations and thought leadership content.

Connect with the author via LI: www.linkedin.com/in/ppantelis

[1] The opinions expressed in this article represent the personal opinions of the author and not necessarily the official position of EY

[2] IFRS 17.Appendix A

[3] IFRS17.7

[4] esma32-339-208_esma_public_statement_on_implementation_of_ifrs_17.pdf (europa.eu)

[5] https://www.ey.com/en_gl/audit/atlas-client-edition

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