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Ifrs 4 Ifrs 17 Deloitte | A Middle East Point of View - Spring 2020 | IFRS 17 38 Deloitte | A Middle East Point of View - Spring 2020 | IFRS 17 New kid on the block IFRS 17: An overview IFRS 17, the latest standard issued by the International Accounting Standards Board (IASB), establishes principles for the recognition, measurement, presentation and disclosures of insurance and reinsurance contracts issued and held by entities. The standard, similar to IFRS 4, focuses on types of contracts rather than types of entities and hence, generally applies to all entities that write insurance contracts. The standard is expected to be effective 1 Jan, 2022. Considering that we still have two years to comply, why discuss this now? The reason lies in the complexity of the standard itself, not only with respect to its application, but also in relation to its interpretation. 39 Deloitte | A Middle East Point of View - Spring 2020 | IFRS 17 The key difference IFRS 17 will supersede IFRS 4, which is (discretionary because the benefit to the current financial reporting standard the policy holder is discretionary and between IFRS 17 and under which insurance companies market-related). IFRS 4 is the consistency prepare their financial statements. This article discusses how IFRS 17 differs from IFRS 17 vs. IFRS 4 of application of IFRS 4, and provides an overview of the The key difference between IFRS 17 and accounting treatments to standard and its application. IFRS 4 is the consistency of application of areas such as revenue accounting treatments to areas such as IFRS 17 applies to the following contracts: revenue recognition and liability recognition and liability • Insurance contracts issued by an entity, valuation. Under IFRS 4, entities were free valuation. • Reinsurance contracts issued by an to derive their own interpretations of entity, revenue recognition and calculation of • Part of the insurance contracts that a reserves. For example, it was at the company has ceded (sold/transferred discretion of the companies to include risk) to the reinsurance company risk adjustment in the liabilities under (reinsurance contracts held by an IFRS 4, whereas it is now mandatory entity), under IFRS 17. The table below provides • Investment contracts with discretionary more detail around the fundamental participation features, provided the differences between IFRS 4 and IFRS 17. entity also issues insurance contracts Table 1: Key differences between IFRS 4 and IFRS 17 IFRS 17 • Upfront revenue IFRS 4 recognition is not • Profit recognition at the permitted. Mandatory early start of the contract. recognition of losses on • Revenue includes premium onerous contracts. and may include an • Revenue excludes any investment component. investment component and • Reinsurance is calculated represents the reduction of on a net basis. the liabilities held as the • Change in value of market entity provides insurance variables goes through P&L. service and respective risk • Disclosures help users is released. understand amounts in the • Reinsurance is calculated insurer’s financial separately. statements. • Change in value of market • Discretion in determining variables may go through separation of components. P&L or OCI. • Disclosures are more detailed and granular. • Separation of components is required only if distinct. 40 Deloitte | A Middle East Point of View - Spring 2020 | IFRS 17 Table 2: Existing issues vs. how IFRS 17 improves accounting Under IFRS 4, companies were able to use their Existing issues IFRS 17 requirements discretion with respect to Variety of treatment Consistent accounting for all determining unbundling, depending on type of contract insurance contracts by all while under IFRS 17 and entity interpretation. companies. there are strict criteria that should be met Estimates such as discount Estimates updated to reflect before unbundling can rates for long-duration current market-based contracts not updated. information. be done. Discount rate based on Discount rate reflects estimates does not reflect characteristics of the cash economic risks. flows of the contract. Lack of discounting for Measurement of insurance measurement of some contract reflects time value contracts. where significant. IFRS 17 – Key requirements insurance component and account for Unbundling it under a separate accounting standard Entities often have products that such as IFRS 9 or IFRS 15. Investment- have insurance and non-insurance related components will generally go components. IFRS 17 advises that the under IFRS 9, while any component that non-insurance component of the pertains to goods or services will fall contract should be segregated from the under IFRS 15. overall contract, and treated under the relevant accounting standards if such Under IFRS 17, insurers need to assess non-insurance component is distinct. if a policy holder can benefit from a This process of separating the non- particular service as part of a claim or insurance component from the insurance irrespective of the claim/risk event. In contract is called unbundling. case a service may only be benefited from when an insured event occurs— Under IFRS 4, companies were able to such as an accident in the case of motor use their discretion with respect to insurance— then that service does not determining unbundling, while under need to be unbundled. However, if a IFRS 17 there are strict criteria that service such as road-side assistance, should be met before unbundling can can be availed of by the policy holder be done. irrespective of a claim event, then the insurer might be required to unbundle In the case that unbundling is required, that component and account for it under companies need to segregate the non- IFRS 15, and not under IFRS 17. 41 Deloitte | A Middle East Point of View - Spring 2020 | IFRS 17 Level of aggregation already lodged, or about to the lodged, Under IFRS 17, the entities will need to for a particular policy, such as an accident identify portfolios of insurance contracts in the case of a motor policy. LRC refers at initial recognition and divide them into to the company’s expectation of future a minimum of the following groups: claims on a particular policy. The – Contracts that are onerous at inception; company is required to create liability for – Contracts that have no significant both LIC and LRC. possibility of becoming onerous subsequently; and General Measurement Model (GMM) – Remaining contracts in the portfolio. The General Measurement Model is defined as follows: at initial recognition Losses on onerous groups of contracts an entity shall measure a group of are immediately recognized in the profit contracts as the total of (a) the amount or loss account. of fulfilment cash flows (FCF)—which comprise estimates of future cash flows, An entity cannot include contracts issued an adjustment to reflect the time value more than one year apart in the same of money (TVM) and the financial risks group. Therefore, each portfolio will be associated with those future cash flows, disaggregated into cohorts consisting of and a Risk Adjustment (RA) for non- periods of one year or less. financial risk—and (b) the contractual service margin (CSM). The discounted estimates of future cash flows along with Under IFRS 17, insurers need to assess the RA will provide the fulfilment cash flows to be created for the insurance if a policy holder can benefit from a contract. The CSM will provide the unearned income to be recorded for the particular service as part of a claim or insurance contract and forms part of the irrespective of the claim/risk event. liability for the remaining coverage. At every subsequent reporting date the entity will recalculate the FCFs and CSM Measurement models in similar fashion as described above. IFRS 17 provides three measurement approaches for the accounting of Premium Allocation Approach insurance contracts. These include the An entity may simplify the measurement General Measurement Model—or of the liability for remaining coverage of Building Block Approach (BBA), the a group of insurance contracts using Premium Allocation Approach (PAA or the Premium Allocation Approach (PAA) simplified approach) and the Variable Fee instead of the General Measurement Approach (VFA). The three models lay Model on the condition that the down the approach to be followed for measurement of the liability would not calculating the components of the be materially different from the insurance contract liability, namely the measurement of the liability under the liability for incurred claims (LIC), and the GMM, or the coverage period of liability for remaining coverage (LRC), as insurance contracts in the group is one appropriate.” LIC refers to the claims year, or less. 42 Deloitte | A Middle East Point of View - Spring 2020 | IFRS 17 The key simplification in the PAA IFRS 17 provides three approach is the exemption granted from calculating and explicitly accounting for measurement the CSM. PAA is not applicable for the approaches for the Liability for Incurred Claims for which the GMM (or BBA) will apply. A fragmented and complex IT accounting of insurance infrastructure legacy contracts. These include Involvement of IT vendors and Variable Fee Approach the General The Variable Fee Approach (VFA) can be consultants with proven experience at used for contracts where cash flows are early stages. Measurement Model—or market-dependent, such as investment Building Block Approach returns. The variable fee equals the company’s share of the fair value of the (BBA), the Premium underlying items, or investments,
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