International Financial Reporting Standard for Insurance Contracts (IFRS 17) in Sri Lankan insuran

Insurance accounting has never been easier for accountants due to the complicated nature of insurance contracts when assessing the liability arising from insurance contracts. This is where actuarial skills and expertise are required in order to calculate the policy liabilities both in life and non-life insurance. International Financial Reporting Standards 17 (IFRS 17) is creating a new financial language for insurance contracts. International Accounting Standards Board (IASB) issued the new accounting standard on 18 May 2017 after long years of making it. With the implementation of this will transform how insurers’ account for their income and liabilities in the balance sheet arising from insurance contracts. Adopting IFRS 17 by all insurers around the world will create a consistency in the financial reporting among insurance companies introducing transparency at a higher degree. Also this new standard will bring good and most needed dialogue between accounting and actuarial professionals who are working in the insurance industry. 

Sri Lankan insurance industry is just completing second year after implementing the Risk Based Capital framework as the solvency assessment starting from 1 January 2016. Most of the companies just familiarising this new solvency regime and its impact to individual company and without even a small break industry needs to get ready for another major transformation in the accounting standards.

Besides an entirely new profit recognition model, the new standard will require new models, systems, and processes. Also this may influence the development of future products and investment strategies. Insurers are expected to begin to be reported on this new basis by Jan 2021.

Currently, Sri Lankan insurers use the SLFRS 4 standard which is the adoption of IFRS 4 to the local insurance industry. The main requirement under SLFRS 4 on the liability front is to perform the liability adequacy test (LAT).LAT required companies to calculate their liabilities using the discounted cash flow method with the best estimate assumptions and check whether the liability booked (using any methodology) is not lower than the liability calculated using the discounted cash flow method.

The most important change in IFRS 17 is that it does not allow a gain at inception of the contract. IFRS 17 introduces uniformity of profit reporting through a more prescriptive method introducing the Contractual Service Margin (CSM) to the reserving methodology. CSM is the unearned profits in the insurance contract which will be released over the future term of the contract. IFRS 17 uses the retrospective roll forward methodology for the emergence of profit from CSM instead. The profit will also include the release of risk adjustment along with the CSM. 

IFRS 17 requires to create groups of contracts to manage the profit reporting emergence separately. For each of these groups, the CSM, Risk adjustment and profit emergence needs to be managed separately. Risk Adjustment is based on the risk appetite of the entity to showcase the company’s perception for the effect of the uncertainty about the timing and amount of cash flows that arise from the portfolio

Grouping is based on the profitability at the point of commencement of the contract. Company needs to club profitable, non-profitable and contracts with no significant risk of becoming non profitable together. Each group cannot contain more than 12 months of new contracts sold of similar characteristic. The determinations of which policies are to be sold by the company will be driven by the above factors, whether the company writes non-profitable contract, whether it might become non-profitable in future or whether it is never expected to be non-profitable. This will drive companies to do product development and pricing more cautiously, which will not be ending up creating non-profitable products and limiting the cross subsidy between contracts.

The key measurement model for longer term contracts under IFRS 17 is called the Building Block Approach (BBA). For shorter duration contracts which are less than 12 months, the approach is called Premium Allocation Approach (PAA). When the contract has a participation features (Eg: Unit Linked/Universal Life contract/With Profit) the Variable Fee Approach applies and the deferred profit/CSM is revalued in line with the variables of the underlying assets that contracts are backed with.

The most challenging requirement under IFRS 17 is that the CSM needs to be calculated for each group from the inception of the contract as if IFRS 17 had always been there. Finding the retrospective information related to these contracts would be very challenging. To eliminate this difficulty, there are two other approaches suggested to be used based.

Most of the countries have already accepted this new change and have already started the implementation process. It is very important to understand the new standard before we come to an early conclusion whether this is suitable or not suitable to our industry. Especially how this would affect the profit reporting and any changes required in the business itself. This might be a good starting point for some insurers to review their Key Performance Indicators and align with the company growth factors. 

STAR Actuarial Academy is bringing expertise panel of global Actuaries to Sri Lanka in conjunction with the Deloitte Consultancy to conduct a deep dive workshop of the IFRS 17. The workshop will be held from 24 January to 26 January 2018 at JAIC Hilton Residencies. This three-day workshop will provide in depth knowledge on the standard and its implementation hurdles to our market, by analysing important products sold in our market. The participants of this workshop will take away the hands on modelling experience of applying IFRS 17. 

All participants will learn the reporting, disclosures, implementation and IT system requirement aspects. Further, the workshop will discuss the impact to the current insurance regulatory framework with the implementation of the new standard. This workshop will be a rare opportunity for CEOs, CFOs, Actuaries and Finance professionals who work in the insurance industry to acquire knowledge on this international accounting standard.

(The author is the Founder and the Managing Director of STAR Actuarial Academy (www.staractuarialacademy.com). She is Associate member of Institute and Faculty of Actuaries, UK (IFOA) and holds bachelor’s degree in Mathematics from University of Colombo. Further she holds MSc in Actuarial Science and Post Graduate Diploma in Actuarial Management from Heriot Watt University, UK. She currently works as an independent actuarial consultant in the life insurance sector. She is the current president of Actuarial Association of Sri Lanka.)