What are the accounting implications for insurers?

Getting into more detail

IFRS 17 applies to insurance and reinsurance contracts issued, reinsurance contracts held and, sometimes, investment contracts with discretionary participation features^{1, 2}. Under IFRS 17, the insurance contract liability includes fulfilment cash flows that represent the risk-adjusted present value of insurers’ rights and obligations to policyholders, comprising:

• estimates of expected (i.e. probability-weighted) cash flows;
  
• adjustments for the time value of money (i.e. discounting) and other financial risks; and
• a risk adjustment for non-financial risk.

Insurance revenue depicts the provision of services reflecting the consideration to which insurers expect to be entitled in exchange for those services.

Estimates of expected cash flows

Estimates of future cash flows are ‘explicit’. This means that the adjustment for non-financial risk is estimated separately. The adjustments for the time value of money and financial risk are also estimated separately from the cash flow estimates, unless the most appropriate measurement technique combines those estimates. [IFRS 17.32, 33(d)]

Insurance contract liabilities are subsequently remeasured to reflect current estimates. This means that insurers need to review and update their previous estimates at the reporting date so that:

• the updated estimates faithfully represent the conditions that exist at that date; and
• the changes in estimates faithfully represent the changes in conditions during that period. [IFRS 17.33(c), B54–B55]

Insurers need to take into account their current expectations of future events that might affect the expected cash flows, except for future changes in legislation that would change the company’s obligations. Such changes in legislation are reflected in measuring the expected cash flows only when they are substantively enacted. [IFRS 17.B60, BC156]

Cash flows to include in the estimates

When estimating the expected cash flows, insurers include unbiased estimates of catastrophic losses under existing contracts but exclude possible claims under possible future contracts. However, insurers’ expectations about possible future contracts may impact recognised assets for insurance acquisition cash flows (IACF) related to future contracts or expected renewals. For example, in response to heightened climate-related risks some insurers might choose not to renew contracts in high-risk areas, which may mean that related IACF assets are not recoverable. [IFRS 17.B40]

When assessing the impact on insurance contract liabilities, insurers need to consider the coverage provided under the terms and conditions of issued insurance contracts. Meanwhile, when determining their obligations under insurance contracts, insurers need to evaluate the precise extent of coverage and the impact of exclusions and limitations on coverage. This includes assessing any new directives, laws and regulations that have been substantively enacted and may require insurers to provide coverage or pay claims for insured events in addition to those required by the pre-existing terms and conditions of the insurance contract. Therefore, insurers may need to update their estimates of expected cash flows to reflect changes in coverage provided under insurance contracts.

Market and non-market variables

Insurers need to assess the extent to which current circumstances require them to reassess assumptions about market and non-market variables that impact the measurement of insurance contracts. Market variables generally give rise to financial risk and non-market variables generally give rise to non-financial risk. Consequently, insurers may need to update their estimates of expected cash flows, their financial risk assumptions and the risk adjustment for non-financial risk. [IFRS 17.B43]

Uncertain times may place significant strain on supply chains or add inflationary pressures that may adversely affect both insurers and policyholders. For example, policyholders may be unable to pay their premiums. Insurers will need to consider any impacts of a deterioration in their policyholders’ credit standing. Supply chain disruptions could cause higher claims costs – e.g. because of longer repair times and/or higher prices.

Regulation or contractual terms may provide for profit participation by policyholders. Uncertain times may also impact investment results. Therefore, insurers also need to consider the impact on their obligations under insurance contracts, including deferred bonuses.

Risk adjustment for non-financial risk

The risk adjustment for non-financial risk reflects the amount an insurer charges for bearing the uncertainty over the amount and timing of cash flows arising from non-financial risk (e.g. lapse and expense risk). Management applies judgement when determining this adjustment. Increasing uncertainty could affect management’s estimates and trigger a higher risk adjustment. [IFRS 17.37, B87, B91]

Recognising revenue for insurance contract services provided

Insurers need to consider the impact of changes in the coverage provided under an insurance contract when determining the amount of the contractual service margin recognised in profit or loss because of the transfer of insurance contract services during the period. For insurance contracts measured under the premium allocation approach, an insurer would need to consider if the expected pattern of the release of risk during the coverage period differs significantly from the passage of time. The expected pattern may be impacted by updated expectations of claims payment patterns. These considerations will impact the insurance revenue recognised in the period. [IFRS 17.B119, B126]

What is the impact on your type of business?

Uncertain times could impact your business in different ways and cause policyholder behaviour to change. For example, uncertainties may affect surrender probabilities and insurance fraud, as well as the recoverability of assets for IACF. Measures taken by governments and regulators (e.g. specific assistance or sanctions) may limit sales activity and could impact cash inflows from premiums.

Sanctions may have direct accounting consequences for affected insurance contracts. For example, insurance contract liabilities and assets for IACF may be affected by the collectability of premiums. Non-financial assets may also be impacted by sanctions.

In addition, insurers and reinsurers may have provided coverage for business disruption or cyber security events. Assessing whether particular events and related losses are covered will require legal analysis. Insurers and reinsurers need to update their estimates and may need to provide disclosures about the uncertainty around claims arising from specific events.

In non-life or general insurance, an external event (e.g. a geopolitical event) may affect the following types of insurance.

• Trade credit insurance – covering businesses against debts that cannot be paid by their customers or suppliers.
• Workers' compensation insurance – workers claiming they were not adequately protected by their employers.
• Business interruption insurance – businesses no longer being able to operate due to an external event.
• Travel insurance – service providers becoming unable to provide services due to workforce shortages or business interruptions resulting in cancelled travel.

Insurers need to evaluate the impact on the fulfilment cash flows.

Lastly, war-related risks have been excluded from many insurance contracts since 1938. Therefore, many policies will not cover losses related to armed conflict.

Life insurers may face the most significant impacts. A downturn in financial markets and increases in credit risk could lead to impairment of financial assets. Further, an increasing interest rate environment could change policyholders’ behaviour, such as triggering an increase in surrenders of their insurance contracts. Insurers’ own liquidity management may impact their ability to repay surrender amounts. Legacy businesses or products that are highly sensitive to market variables are likely to feel the effects more deeply – e.g. variable and fixed annuities, long-term care insurance and universal life insurance. This applies especially to insurance contracts that contain minimum return guarantees. The measurement of insurance contract liabilities could be affected directly, particularly when contracts are measured under the variable fee approach.

If information affecting the values of assets and liabilities becomes available after the reporting date, then insurers will need to distinguish between events that provide evidence of conditions that existed at the reporting date (adjusting events) and those that are indicative of conditions that arose after the reporting date (non-adjusting events). [IAS 10.3, 8, 10]

Life and health insurers need to monitor external events that may affect mortality or morbidity rates, financial assumptions and policyholder behaviours. External events may give rise to new and emerging trends whose ultimate effects are uncertain. These insurers will have to assess whether they need to revise their assumptions at the reporting date.

Reinsurers will need to respond to losses ceded by direct insurers and perform similar evaluations. For some specialised reinsurers, this could have a major impact.

What is the impact on your investment portfolios under IFRS 9 Financial Instruments?

Insurers need to assess whether the measurement of excepted credit losses appropriately reflects the impact of increased economic uncertainty for financial instruments that are not classified as at fair value through profit or loss.

Insurers need to determine if the fair values of those financial assets measured at fair value are appropriately determined and disclosed. Performing a valuation in these periods of increased economic uncertainty is more challenging, particularly when significant unobservable inputs are used.

What do you need to disclose?

Insurers may need to disclose the following in their annual reports.

• Significant judgements
  Insurers disclose the significant judgements made in applying IFRS 17. This includes inputs, assumptions and estimation techniques used in the measurement of insurance contract liabilities. Insurers also disclose information that focuses on the insurance and financial risks arising from insurance contracts, including sensitivity analyses. This may involve explaining the impact of risks arising from an external event on their type of insurance business, how experience to date varies from existing assumptions about these risks and how they are managed. In addition, an external event may require specific disclosures to explain any impact on the insurer. The disclosures also include considerations around risk concentrations, claims development tables and credit, liquidity and market risk. [IFRS 17.117–132]
  The uncertainty around these events may increase the level of estimation uncertainty when measuring insurance liabilities. This may require enhanced disclosures and may also affect sensitivity analysis disclosures. [IAS 1.125, IFRS 17.93–94, 117–132]
• Financial instruments
  For investment portfolios, insurers disclose the nature and extent of risks arising from financial instruments and how they manage those risks. This means that insurers will need to explain the significant impacts of these uncertainties on those risks and how they are managing them. Insurers will need to exercise judgement to determine the specific disclosures that are relevant to their business and necessary to meet these objectives. [IFRS 7.31–42]
• Subsequent events
  Decreases in asset valuations arising may impact regulatory capital and solvency calculations and disclosures about how the company manages capital. Disclosures may also be required about non-adjusting events occurring after the reporting date that impact subsequent financial asset or insurance liability measurements. [IAS 10.21–22, 134–136, IFRS 17.126]

Some insurers may also need to provide further disclosures around potential going concern issues.

Interim reports

IAS 34 Interim Financial Reporting does not contain specific disclosure requirements for insurance contracts. However, the general principles in the accounting standard apply such that the interim financial statements explain the events significant to understanding changes in financial position and performance, including changes in estimates, since the last annual financial statements. Management considers whether the interim report needs to include an update to information disclosed in the last annual financial statements because of external events or other uncertainties. [IAS 34.10, 15–16A]

What about other accounting topics for insurers?

For other relevant topics, see our Financial reporting in uncertain times resource centre.

Actions for management to take now

• Evaluate the specific implications for your company based on the significant judgements and accounting policies applied under IFRS 17 and assess the impact on assumptions for measuring insurance contract liabilities.
• Ensure that your IFRS 17 measurements (including IACF asset recoverability testing) are based on current estimates of future cash flows and evaluate whether any onerous contract losses or impairments need to be recognised in profit or loss.
• Assess whether the measurement of expected credit losses appropriately reflects the impact of economic uncertainty and external events.
• Consider expanding disclosures about risk management, key insurance and financial assumptions, sensitivities in the assumptions, major sources of estimation uncertainty, and liquidity, market and credit risks. These disclosures need to specifically cover the implications of an external event if it has a material impact on your company.
• Consider your capital disclosures, especially where there are concerns about the capital position relative to regulatory requirements or implications for debt covenants.
  

Read further insights from KPMG insurance leaders across the globe in our Insurance contracts topic page.

References to ‘Insights’ mean our publication Insights into IFRS^®