By Ross E. Chapman, Global Marketing Director, Aptitude Software
IFRS 17 is arguably the most significant change to insurance accounting that has ever taken place. The standard requires insurance CFOs to produce new financial reporting and will challenge their ability to explain the business clearly to investors, boards, regulators and other stakeholders.
The principles-based standard drives forward-looking estimates onto the balance sheet, placing finance teams under an even brighter ‘audit spotlight’ with the need for new controls and governance processes, extensive disclosures and the ability to substantiate reported results.
While initially the focus was on the addition of a new required calculation, the contractual service margin (CSM), insurers and advisors are realising that correctly calculating the CSM over time is just one aspect of achieving IFRS 17 compliance. Insurance IFRS 17 project teams recognise the challenge extends well beyond where to home the CSM calculation and are focused on delivering an end-to-end IFRS 17 reporting process.
IFRS 17 compliance requires a series of financial accounting changes. First, insurers need to fit their entire book of business into new measurement models, to create and apply complex accounting posting rules over hundreds of contract types and product lifecycle events.
Second, finance need a new IFRS 17 chart of accounts and to produce extensive new disclosures, delivering IFRS 17 accounting quickly within the ‘working day timetables’ which (for finance) are more frequent (monthly) and typically more accelerated than other regulatory insurance reporting such as Solvency II.
Finally, finance teams need to manage IFRS 17 transition closely, as new balances will drive profitability for years to come and will be under scrutiny from investors, regulators and tax authorities.
Importantly, IFRS 17 reporting cannot be delivered in isolation as financial balances are invariably affected by many other GAAP reporting standards including IFRS 9, IFRS 15 and other rules such as those that dictate the application of fair value.
An overview of finance’s IFRS 17 requirements
- Chief Financial Officers are vested with Chief Actuarial Officers to deliver IFRS 17 reporting accurately, on-time with controls and audit-ability
- Complying with IFRS 17 requires more than delivering Contractual Service Margin calculations – IFRS 17 requires finance to harmonise data, processing and control across the entire systems environment
- In a post-IFRS 17 world, CFOs will be challenged to clearly explain the business strategy and results, but it offers many obvious opportunities to improve finance’s capabilities
The challenge of explaining business performance in the post-IFRS 17 world
CEOs rely on their CFOs and clear financial reporting to explain their business to investors, boards, regulators and management teams. Many insurers expect IFRS 17 to result in more volatile results and the new standards may affect the ability of companies to pay dividends and even impact executive bonuses. In the IFRS 17 world, finance teams will have to focus on how all reporting processes across metrics will work together, including for things such as planning and forecasting.
“Whilst ultimate economic profits will not change, the emergence of those profits can change significantly. Both insurers and their analysts will need to assess the full impact in terms of telling the performance story of their companies.” – Alex Bertolotti, PwC
For the external audiences, the common language of IFRS 17 will (eventually) reduce variation in reporting practices and place pressure on CFOs to quickly and clearly substantiate financial results. Experience adjustments will have to be applied and explained, and accountants will have to understand how profit and loss statement changes can be attributed to changing assumptions such as interest rates.
Insurance companies need to deliver comparative reporting starting in 2020, challenging CFOs to explain the variations between reporting bases. Consistency of treatment across the business will be under much higher scrutiny, and investors will expect CFOs to explain variations across multiple GAAPs and regulatory reporting regimes.
“We should be able to produce a set of parallel books to let the users [of financial statements] make a judgment as to whether it is useful. But, that will be costly…we will need to run parallel systems and have to reconcile between the bases.”
Comparative reporting will challenge CFOs for many years to come, with many insurers already hearing from tax authorities that they will want to see results presented using old and new models for up to seven years, and managers wanting to continue non-IFRS 17-related KPIs for employee performance management processes.
What we learned with global European and Asian insurers through our first three IFRS 17 proof-of-concepts and hundreds of market interactions
- Most mid-sized and large-insurers will need to bridge the gaps between actuarial systems and general ledgers; between CSM engines and accounting; and data integration and calculations. One client had 250+ source systems, with many holding data in proprietary formats.
- Compliance requires tackling a whole host of detailed accounting requirements, e.g. managing full and delta ledgers, auto-reversing journals, the ability to manage manual adjustments, transition balance management, following the sun to produce IFRS 17 across Asian, European and American entities, simulation of accounting impact under different scenarios, aligning management information systems will with IFRS 17 financial data, and reconciling existing Solvency II and local GAAP accounting.
- IFRS 17 brings significant new volumes of accounting. Many firms are recognising the requirement to store contract or even lower “cover” level-data, but for many insurers this equates to hundreds of thousands (if not millions) of accounting line items per day.
- Finance need to “run the business” in a post-IFRS 17 world and many are incorporating finance improvements into their projects – including “fast close” requirements; chart-of-accounts consolidations; improvement of Solvency II reporting outputs and timetables; reducing manual processing; improving reconciliations cycles; standardising finance data across business lines; and “digitising”/modernising finance’s IT architecture.
- Coordinating across divisions and geographies will make IFRS 17 compliance more difficult. Many insurance companies have grown through acquisitions with federated business divisions and a single group finance function consolidating results. (Several of Aptitude Software’s prospects had more than 40 General Ledgers!) Group-level IFRS 17 project teams will need to define IFRS 17 accounting approaches, unit of account, measurement models, transition methods, using financial accounting hubs to ensure divisions deliver appropriate data and apply accounting policy correctly.
Who’s got financial control and governance?
Those insurance companies that have performed deeper analysis or completed proof-of-concepts have highlighted the need for finance teams to harmonise data, processing and controls across actuarial, policy administration and finance systems, to create and manage IFRS 17 portfolios, to ultimately produce highly-controlled financial results.
Expected cash flows sourced from actuarial systems environments will form the basis of most IFRS 17 calculations. A lot of these numbers have been done by actuaries for many years, but insurers will need higher levels of comfort and greater control frameworks around the actuarial data sets.
Ownership of these figures is driving actuarial and accounting teams much closer, but ultimately finance will need to be able to deliver the controls around the end-to-end process. This goes well beyond the CSM calculations.
Whereas data for these judgements may source from actuarial, pricing or policy systems, finance’s role is to manage the end-to-end process to deliver consistent, auditable results with the ability to quickly and clearly explain business performance to all stakeholders. Having the ability to drill down into the provenance and transformation of underlying data will be a key success factor for insurance CFOs.
“How are we going to link the ‘pricing guys’ to understand whether a contract is onerous, when information from pricing is not typically good enough to use in our finance systems? How will we allocate costs to groups of contracts? How are we going to show that the Premium Allocation Approach is applicable as it produces similar results to the general measurement model? On the life side, what are our rules for coverage units? How are we going to use discount rates, as it looks like it’ll be different from what’s in use for Solvency II? How do we deal with diversification? And where we hedge… how are we going to account for that in this new world?” – Questions raised by a lead technical accountant and member of the IFRS 17 Transition Resource Group
Summary of learnings from Aptitude Software’s 4Q 2017 Global IFRS 17 Readiness Assessment
- 39% of firms that have started their analysis expect to kick-off implementation projects in Q2 2018. The 8.2% that are already in active implementation phases have an average gross written premium (GWP) of £15.3bn ($20.4bn). The average GWP of companies at a pre-impact analysis phase is £6bn.
- IFRS 17 is challenging insurers of all types and sizes. It’s not just a life insurance issue; it is having a significant impact on smaller, regional and non-life insurers.
- The industry has learned that IFRS 17 requires much more than delivering CSM calculations.
- Functionally, CFO’s are taking the lead on IFRS 17 but working closely with chief actuaries with the goal of harmonising data, processing and control across finance and actuarial environments.
- With many insurance companies expected to start implementation in mid-2018 and with project teams consisting of 50+ FTEs, a major skills gap is expected.
Shifts in thinking – financial reporting requirements shadow CSM calculation decisions
84% of firms included in the Aptitude Global IFRS 17 Readiness Assessment cited a disparate actuarial environment, which will be a constraint to delivering consistent calculations (cashflows, discounting, risk adjustments, CSM).
Project teams are also grappling with how to capture granular contract data necessary to support the application of IFRS 17 measurement models, how to connect heterogeneous actuarial and finance systems environments, and how to manage the all-important transition balances.
88% of insurance company IFRS 17 project leads highlight that new processes are needed to support IFRS 17 disclosure requirements. Most insurers cited the need to incorporate parallel reporting requirements, including local statutory reporting standards and the new IFRS 9 accounting rules governing financial instruments. And many respondents expressed the desire to fix or improve Solvency II reporting requirements as part of their IFRS 17 project.
How do CFO’s equip themselves for their IFRS 17 expeditions?
It is possibly premature for insurers to seek ‘strategic benefits’ from their IFRS 17 programmes when their routes to compliance are not yet defined. However, when considering how to tackle the standard, it is important for CFOs to keep focused on improving (rather than reducing) their ability to explain business performance.
With this need in mind, some insurers are already tying their IFRS 17 programmes into broader finance improvement initiatives, with insurance CFOs wanting to gain a
single chart-of-accounts across their business, support new business models and product lines, deliver cost reductions (through reduced manual processing), and build better financial data foundations to drive better insights into the business. For some, these ‘strategic’ benefits come with an incremental cost but will provide insurance companies with important capabilities to compete effectively in a post-IFRS 17 world.