Accounting Standards and Insurer Solvency Assessment
  • 1 0000000404811396https://isni.org/isni/0000000404811396International Monetary Fund
  • | 2 0000000404811396https://isni.org/isni/0000000404811396International Monetary Fund
  • | 3 0000000404811396https://isni.org/isni/0000000404811396International Monetary Fund

Contributor Notes

The paper explores the use of accounting standards for insurer solvency assessment in the context of the implementation of IFRS 17. The paper is based on the results of a survey of 20 insurance supervisors. Overall, IFRS 17 is a welcome development but there will be challenges of implementation. Not many insurance supervisors currently intend to use IFRS 17 as a basis for solvency assessment of insurers. Perceived shortcomings can be overcome by supervisors providing clear specifications where the principles-based standard allows a range of approaches. Accounting standards can provide a ready-made valuation framework for supervisors developing new solvency frameworks.

Abstract

The paper explores the use of accounting standards for insurer solvency assessment in the context of the implementation of IFRS 17. The paper is based on the results of a survey of 20 insurance supervisors. Overall, IFRS 17 is a welcome development but there will be challenges of implementation. Not many insurance supervisors currently intend to use IFRS 17 as a basis for solvency assessment of insurers. Perceived shortcomings can be overcome by supervisors providing clear specifications where the principles-based standard allows a range of approaches. Accounting standards can provide a ready-made valuation framework for supervisors developing new solvency frameworks.

Executive Summary

The International Financial Reporting Standard (IFRS) 17 Insurance Contracts was published in May 2017 and is expected to come into force on January 1, 2023. Also, on January 1, 2023, IFRS 9 Financial Instruments will be implemented for insurers. This change to IFRS is one of the most significant developments in the insurance industry in recent years.

Overall, IFRS 17 is a welcome development. It aims at improving global comparability with respect to the structure of liability valuation and transparency in insurer balance sheets, thus benefiting policyholders, investors and, ultimately, financial stability. The current international accounting standards for insurance contracts permit a variety of approaches, which complicate comparison between insurer’s financial results of insurers. Most of the 20 jurisdictions surveyed for this paper expect IFRS 17 will contribute to financial stability through greater transparency.

IFRS provides a ready-made principles-based framework so that supervisors do not have to go through addressing a myriad of accounting issues in developing their own valuation approach. While the objectives of accounting and regulatory standards are different, there are overlaps. The different policy choices have led to and will continue to lead to a wide range of regulatory approaches in the use of existing accounting standards to assess insurers’ solvency position. This paper highlights the different approaches based on a survey among 20 insurance supervisors.

Currently, few surveyed jurisdictions plan to use IFRS 17 for regulatory solvency purposes, mainly because IFRS 17 is not perceived to provide sufficiently comparable financial results. This can be addressed by supervisors specifying some aspects of implementation for regulatory reporting purposes. Where there are no plans to use IFRS 17, supervisors consider that the marginal regulatory implementation costs outweigh the marginal benefits from aligning their valuation bases with IFRS 17. Nevertheless, jurisdictions that have not yet adopted a valuation basis for their regulatory reporting may consider the use of IFRS generally and IFRS 17 in particular for insurance liabilities. Jurisdictions that plan to adopt the standard for solvency purposes mainly seek to benefit from auditing controls, avoid potentially conflicting financial signals from different financial statements and minimize cost for insurers.

Those jurisdictions that are not currently intending to implement IFRS 17 for regulatory solvency purposes should reconsider this position after some experience with IFRS 17. Most solvency systems go through periodic review processes which may provide an opportunity for alignment between regulatory solvency valuation and general-purpose financial reporting. Aligning the implementation of IFRS 17 with the current specification of regulatory valuation approaches may result in a single set of financial statements that is usable for both general purpose financial reporting and regulatory solvency valuation. Greater specification of the techniques and inputs to be used in IFRS 17 should be developed through global coordination to avoid localized versions of IFRS 17 being created.

Despite the expected benefits of IFRS 17, there are significant challenges in implementing the new accounting standards and potential impacts on prudential regulation and supervision of the insurance industry that have not been well identified. IFRS 9 and IFRS 17 implementation are joined for the insurance industry to ensure the accounting for financial instrument assets and accounting for insurance contracts are coordinated for asset-liability management. IFRS 17 is perceived as a complex standard requiring professional judgment and has significant implementation challenges, including an acute shortage of such expertise in many jurisdictions. The implementation challenges are not as significant for IFRS 9 Financial Instruments. This paper therefore focuses on IFRS 17.

Supervisors can play a role in helping to address the implementation challenges. Such a role includes encouraging insurers to start preparing early, engaging closely with the industry to better understand the issues, and potentially guiding choices made within the principles-based framework to achieve greater consistency. It is key to avoid jurisdictional versions of IFRS 17 implementation as this could potentially thwart the goal of global consistency.

Supervisors are encouraged to undertake impact assessments of the introduction of IFRS 17 and IFRS 9 in their jurisdictions even if they do not have immediate plans to use IFRS for prudential purposes. IFRS 17 and IFRS 9 taken together result in restatement of the largest components of both sides of an insurer’s balance sheet. These revised IFRS will shape the way senior management strategically drive the future business of insurers and will shape risk management practices of insurers. The potential financial impact of IFRS 17 is currently unclear, as most jurisdictions have not undertaken a quantitative impact study. Some jurisdictions plan to review their capital adequacy frameworks in response to IFRS 17. In doing so, the guiding principles that supervisors use are to provide the right incentives for insurers to manage risks properly and to achieve appropriate prudential outcomes in terms of policyholder protection.

The new accounting standards will not be the top priority for insurance supervisors or insurers during the COVID-19 pandemic. However, the 2023 implementation date is looming. Supervisors and insurers can only afford relatively short period of diverting resources from the implementation of IFRS 17 and IFRS 9 to address the COVID-19 pandemic. Initial impact analysis should ideally start by the beginning of 2021 at the latest.

I. Introduction

1. This paper outlines the range of regulatory approaches in using accounting standards as valuation bases to assess solvency of insurers. 2 The paper also highlights the prudential implications of recent accounting developments. It is based primarily on a survey of 20 insurance supervisors covering diverse regulatory frameworks, geographical locations, economies, and levels of industry sophistication (Appendix I). Given that many insurance supervisors are still considering how to react to recent accounting developments, and in particular to IFRS 17 (International Accounting Standards Board (IASB), 2017a), this paper should be useful in helping regulators make appropriate policy choices.

2. This paper is being published as the impact of the COVID-19 pandemic is still evolving. At the time of publication, there were significant impacts on the financial position of insurers due to the COVID-19 pandemic but this has occurred from a position, in general, where insurer balance sheets and solvency are strong. On an industry-wide basis the pandemic’s impact is material but is not currently judged a major threat to viability. Some insurers, particularly those with weak solvency positions to start with or business areas particularly impacted by the pandemic, may nonetheless face serious challenges. This set of circumstances is naturally the focal point of insurers and supervisors at this time. Insurers and supervisors are also challenged by new working arrangements with most staff forced to work from home. However, moving forward as the pandemic impact becomes more stable and working arrangements normalize, some of the resources of supervisors and insurers currently dedicated to dealing with the pandemic can turn to issues beyond the pandemic. IFRS 17 and IFRS 9 are important developments that have been subject to ongoing delays due to the challenging nature of the development of IFRS 17. While no deadline is immutable, the implementation of IFRS 17 and IFRS 9 should not be delayed further than the recent announcement of the IASB to defer for another year to January 1, 2023.

3. The value of insurance liabilities is one of the largest items on an insurer’s balance sheet. The way in which insurance liabilities are calculated and accounted for has a significant impact on the financial position of the firm and on how its board and senior management shape its business strategies. Most insurers apply some form of accounting standards for public financial reporting and, in some cases, for regulatory reporting. 3 In some jurisdictions, insurance supervisors adopt the local accounting standard as the basis for determining the value of insurance liabilities in assessing the solvency position of an insurer. In such a framework, accounting standards have direct prudential implications as they affect the solvency calculation of an insurer. In other jurisdictions, regulators may prescribe their own valuation basis, which may be significantly different from the local accounting standards. Even under such a regime, accounting standards could still have prudential implications.

4. This paper is divided in seven sections. Section II outlines the range of approaches in the surveyed jurisdictions on application of IFRS on different types of insurers for public financial reporting and prudential purposes. Section III examines the potential impact of IFRS 17 on insurers from a prudential perspective. Section IV describes the implementation challenges faced by insurers and how insurance supervisors could help address some of these challenges. Section V outlines the different approaches on the use of IFRS 17 for prudential purposes. Section VI describes potential regulatory and supervisory implications arising from IFRS 17. Section VII concludes with issues for further consideration by supervisors.

II. IFRS 17 Development and Changes Compared to IFRS 4

5. IFRS 17 has been more than 20 years in the making. It began as a project to undertake a comprehensive review of accounting for insurance contracts. The predecessor of IFRS 17 was IFRS 4 (IASB, 2014), which was added to the agenda of the International Accounting Standards Board (IASB) in 2001—and was in turn a continuation of a project of the IASB’s predecessor that begun in 1997. IFRS 4, issued in 2004, was the first IFRS to cover insurance contracts. IFRS 4 was issued because the IASB saw a need for improved disclosures for insurance contracts, and some improvements to recognition and measurement practices, in time for the adoption of IFRS by listed companies in 2005. IFRS 4 was always intended to be an interim step in the comprehensive review. IFRS 4 did not aim at a uniform accounting policy and did not provide detailed valuation requirements. As a result, during most of its 16 years of development, the project to undertake a comprehensive review of accounting for insurance contracts was better known as “IFRS 4 Phase II”.

6. Insurance contracts were a subject identified for a major joint project between the IASB and the Financial Accounting Standards Board (FASB) in the United States in 2008, but it was abandoned as a joint project in 2014. When the joint project was abandoned, the FASB decided to focus on making targeted improvements to existing U.S. generally accepted accounting principles (GAAP) insurance accounting models, while the IASB carried on with the development of IFRS 17 which was agreed in May 2017 for implementation at the beginning of 2021 initially, now the beginning of 2023 (Appendix II describes key differences between IFRS 17 and the U.S. GAAP project).

7. The objective of IFRS 17 is to provide users of insurer financial statements with the information about an insurer’s financial position, performance, and risk exposure. In doing so, IFRS 17 will necessarily narrow the wide range of insurance accounting practices used under IFRS 4. Use of updated current cash flow assumptions and discount rates, and a market-consistent approach to determining the value of options and guarantees, will better reflect economic reality and more faithfully represent the underlying financial position and performance of insurance contracts. The principles underlying IFRS 17 measurement approaches result in a fundamental change to current practices, with an emphasis on market-based valuation. The requirements are different from most existing models in several aspects that will likely change profit emergence patterns, encourage earlier recognition of losses on contracts that are expected to be onerous, and enrich valuation processes including through more detailed assumption setting processes. Greater granularity in contract groupings will provide more relevant information about insurers’ financial position and financial performance, but will create more complexity in the valuation models, data, systems, and process requirements (Appendix III provides a high-level overview of potential changes in the surveyed jurisdictions arising from IFRS 17). Table 1 highlights selected major improvements that IFRS 17 brings compared to existing practices.

Table 1.

Key Enhancements of IFRS 17 compared to IFRS 4

article image
Source: IMF and Financial Stability Institute staff.

8. Rather than grandfathering the multiple existing measurement approaches under IFRS 4, IFRS 17 allows three measurement approaches. The three approaches are:

  • The General Model. This model is also known as the building blocks approach under which insurance contracts are valued as the sum of fulfilment cash flows and a contractual service margin (CSM). The fulfilment cash flows are comprised of probability-weighted future cash flows plus a risk adjustment for nonfinancial risk. The CSM removes any day one gains on recognition and represents the profit the insurer recognizes based on the transfer of services to policyholders over time.

  • The Premium Allocation Approach (PAA). This is an alternative simplified approach for eligible contracts with a duration of one year or less or other contracts where the PAA provides similar results as the General Model. The PAA is similar to the existing valuation approach for non-life insurance contracts except for the requirement to discount future cash flows (apart from claims payment due within a year) in calculating the incurred claims liability and using unearned premiums to simplify measurement of liability for remaining coverage.

  • The Variable Fee Approach. This approach applies to contracts with direct participation features. Policyholders of such contracts share the profit from a clearly identified pool of underlying assets. The liability of the insurer is determined based on the obligation for the insurer to pay the policyholder an amount equal to the value of the underlying assets, net of a consideration charged for the contract—the “variable fee”.

9. Following the publication of IFRS 17 in 2017, the IASB published limited amendments to the standard in June 2020 (IASB, 2020). The amendments were intended to reduce implementation costs, make the results easier to explain and ease the transition. The Changes covered areas such as scope exclusions, allocation of acquisition costs to expected renewals, attribution of profit to investment activities, extension of risk mitigation option, reduced accounting mismatches for reinsurance, simplified balance sheet presentation, and additional transition relief.

10. The implementation date of IFRS 17 has moved from the original effective date of January 1, 2021 to January 1, 2023. The IASB’s June 2019 Exposure Draft (IASB 2019) proposed a delay from January 1, 2021 to January 1, 2022. However, based on consultation feedback, this date was extended by the IASB to January 1, 2023. Correspondingly, the implementation of IFRS 9 for insurers will be delayed to the same date.

11. IFRS 9 is also relevant for insurers and, taken together with IFRS 17, represents a major shakeup of the accounting for the most significant items in an insurer’s assets and liabilities. IFRS 9 is not considered to have the same level of impact as IFRS 17 for insurers but will facilitate alignment of accounting on both sides of the balance sheet of insurers. IFRS 17 provides for valuation based on current market inputs. It is expected that most insurers will make choices in IFRS 9 to move the majority of their assets backing insurance liabilities to fair value accounting in order to match the measurement approach in IFRS 17.

III. Overview of Accounting Approaches and Intersections with Prudential Frameworks

12. The way in which IFRS is introduced into local law varies. For several major jurisdictions, the IFRS text is directly incorporated into jurisdictional accounting standards either by reference or automatic endorsement into local law., The European Union (EU) implements through endorsement but permits carve-outs. Every time a new standard is endorsed at EU level, the European Commission publishes an amending regulation that is directly applicable in all EU countries (European Commission, 2002). In the EU, listed companies have to establish their consolidated account statements using IFRS, but local GAAP may be used for other entities. This is significant with respect to IFRS 17 as explained below. See Appendix IV for how IFRS is introduced into local law in surveyed jurisdictions. The scope of application in the surveyed jurisdictions can also differ, from all companies to a subset of companies (e.g., listed companies). In other jurisdictions, IFRS forms the basis of legal accounting standards, but modifications are made to account for the jurisdictional context. In some jurisdictions, reporting using IFRS is permitted, but not required. Some jurisdictions allow insurers to use a major accounting framework; accordingly, some may use IFRS and others U.S. GAAP.

13. Several jurisdictions have not yet decided whether to adopt IFRS 17 in their national accounting standards. A major issue yet to be resolved is the adoption of IFRS 17 by the EU based on the advice of the European Financial Reporting Advisory Group. The EU endorsement is considered a key to international success for the standard.

14. In the United States, domestic public companies must file U.S. GAAP financial statements and insurers file legal entity statutory financial statements with their state supervisors. These legal entity statutory financial statements are based on U.S. Statutory Accounting Principles (SAP) as set by the National Association of Insurance Commissioners (NAIC, 2019). The U.S. state insurance supervisors have developed a comprehensive basis of accounting that all U.S. insurers are required to follow by law. This accounting approach was developed over a multi-year project that was based upon a Statement of Concepts appropriate for policyholder protection, but also leveraging U.S. GAAP. The framework requires the NAIC to adopt, reject, or adopt with modification every U.S. GAAP pronouncement issued by the FASB. It generally requires the adoption of some form of the U.S. GAAP, unless there is a compelling reason to differ. This approach allows U.S. state insurance supervisors to react quickly to changes in the insurance industry that would not be taken up by an accounting standards body due to conflicting priorities. IFRS-based financial statements of foreign insurers are filed with U.S. state insurance supervisors as the NAIC Holding Company Model Act (NAIC, 2014) requires all groups operating in the United States to file financial statements of the group with the lead state supervisor.

15. For most jurisdictions, the implementation of IFRS 9 for the insurance sector is aligned with the implementation of IFRS 17. Aligning the implementation of these two standards is key for some jurisdictions surveyed to avoid accounting mismatches that could convey misleading financial results of insurers. For example, the pricing of risk premia could affect asset valuation more than the value of liabilities, creating volatility in reported equity (capital) of insurance companies. The following are examples of how some jurisdictions are dealing with these issues:

  • Australia and Canada require the implementation of IFRS 9 and 17 to be aligned.

  • For EU jurisdictions, as IFRS 17 is not yet endorsed, it is unclear if or how the implementation of IFRS 9 and 17 will be aligned. Subject to EU endorsement for a further deferral of IFRS 9, implementation to align with IFRS 17 implementation, most insurers will likely apply any such optional deferral of IFRS 9 until January 1, 2023 or later.

  • Optional alignment of implementation of the two standards applies in Hong Kong SAR, Singapore, South Africa, and South Korea subject to conditions in the applicable accounting standard (e.g., an entity’s predominant activity must be related to the issuance of insurance contracts within the scope of IFRS 4). Several insurers in South Africa have already adopted IFRS 9. In Hong Kong SAR, it is expected that many insurers will defer IFRS 9 implementation to align with IFRS 17 adoption.

  • IFRS 9 is not aligned with the IFRS 17 implementation in Chile, as IFRS 9 is already implemented.

  • Entities that are allowed to report under IFRS in Japan and insurers in New Zealand do not have an option to align IFRS 9 and IFRS 17 implementation.4

16. Accounting and prudential regulatory standards have different objectives, which could justify different valuation results. The Figure 1 shows the range of regulatory approaches to the use of IFRS in public financial reporting and/or regulatory solvency assessment (Appendix V presents ways IFRS are implemented in the surveyed jurisdictions). The primary aim of accounting standards is to provide transparent and comparable financial information of firms to enable investors and other market participants to make informed decisions. On the other hand, regulatory solvency standards are aimed at assessing the ability of insurers in meeting their obligations to policyholders. In the context of valuation of insurance liabilities, accounting standards seek to measure how much profit an insurer can recognize from an insurance contract in each reporting period. While such a purpose drives the balance sheet valuation, regulatory standards aim to establish how much funds an insurer should set aside to be able to meet its commitments to policyholders. Accordingly, it is understandable that accounting and regulatory standards may have somewhat different emphases and priorities that could manifest themselves in diverging technical requirements (Table 2). However, while emphases may be different, regulatory solvency standards and accounting standards have similarities in their objectives as evident from the fact that some jurisdictions have aligned these two sets of reporting obligations.

Figure 1.
Figure 1.

Applicability of IFRS for Public Financial Reporting and Prudential Solvency Reporting

Citation: IMF Working Papers 2020, 146; 10.5089/9781513551807.001.A001

Source: Survey results and Financial Stability Institute staff.
Table 2.

Key Differences Between Accounting and Prudential Standards

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Source: IMF and Financial Stability Institute staff.

17. Importantly, accounting and prudential regulatory standards share some common aims and features. Both sets of standards aim to enable comparison of financial results of firms including insurers and providing useful information to users, which should include insurance supervisors. Given these common aims, significantly different accounting and prudential requirements may be difficult to reconcile. Accounting standards are usually principles-based whereas regulatory standards are typically more prescriptive.

18. Comparability is important to help ensure that all insurers are treated consistently, especially when supervisory actions are taken on the basis of balance sheet triggers. Some supervisors take the view that accounting standards are more focused on performance measurement, which seems to imply that these are not relevant for supervisors. This is not necessarily the case as supervisors should be interested in performance measures to assess sustainability of an insurer’s business model. Similarly, investors and other users of general purpose financial reporting are very interested in the financial position of an insurer. The basis for regulatory valuation tends to be conservative. However, increasingly, modern risk-based capital regimes are taking a so-called market consistent approach, which in theory should remove any such conservatism (see below discussion of the total balance sheet approach to solvency assessment). As such, the valuation approaches seem to share similar goals (Figure 2 compares the primary focus and objectives of accounting and regulatory standards).

Figure 2.
Figure 2.

Objectives of Accounting and Regulatory Standards

Citation: IMF Working Papers 2020, 146; 10.5089/9781513551807.001.A001

Source: Financial Stability Institute staff.

19. To fully understand the prudential implications of accounting standards on insurance contracts, it is important to recognize the interaction between insurance liabilities and other components of regulatory and accounting balance sheets. Figure 3 shows how different valuation bases for insurance contracts could result in different capital resources or equity position, even though the underlying economics of an insurer are exactly the same. Figure 3 presents the regulatory balance sheet as having a more conservative valuation of liabilities than the accounting balance sheet. However, as noted in the previous paragraph, this may not always be the case. The valuation bases for assets and liabilities, including insurance contracts, can be specified by the insurance supervisor or be based on accounting standards (with or without adjustments). The difference between assets and liabilities is the amount of equity or capital available. From a regulatory perspective, this amount (known as capital resources), should be available to absorb losses, and therefore is subject to certain regulatory criteria that seek to ascertain its loss absorption capacity. An insurer’s regulatory solvency position is determined by comparing the level of capital resources to its capital requirements. If its capital resources fall below capital requirements, supervisors may take a range of actions to rectify the situation. Therefore, the value of insurance contracts plays a critical role in determining the solvency position of insurers.

Figure 3.
Figure 3.

Components5 of Accounting and Regulatory Balance Sheet

Citation: IMF Working Papers 2020, 146; 10.5089/9781513551807.001.A001

Source: IMF staff.

20. The valuation approach embedded in accounting standards also has prudential implications through its impact on strategic decisions of the board and senior management of insurers. Certain valuation methods may produce results favorable to a particular kind of insurance product. For instance, valuation approaches that are based on locked-in assumptions can be favorable to longer-term life insurance contracts as compared to valuation approaches based on current assumptions. Thus, a change to the accounting basis could induce some insurers to reconsider their strategic priorities. There are also incentives for management to choose particular accounting policies within a valuation framework for public financial reporting. The disclosure and market conduct implications of these choices can be important for insurance supervisors.

21. Regulatory valuation requirements interact with other components of a solvency framework. A coherent solvency framework should be based on a total balance sheet approach that recognizes interactions between the valuation of assets and liabilities, capital resources and capital requirements. Indeed, insurance supervisors typically require insurers to deduct intangible assets from capital resources as these items are unlikely to have much loss-absorbing capacity in times of a financial stress. The valuation requirements for assets and liabilities need to be consistent with capital requirements for the overall solvency results to be meaningful (e.g., capital requirements for life insurance risks can be established by stressing assumptions used in insurance liability valuation in which case, the valuation approach will have a direct impact on the capital requirements). In fact, some valuation bases used in modern capital frameworks may be less conservative than general purpose financial reporting, particularly with respect to recognizing profits at the inception of a contract. In the context of a total balance sheet approach to solvency assessment, conservatism or lack of conservatism in balance sheets is not necessarily a concern as adjustments can be made in capital requirements or recognition of capital resources to allow for the degree of conservatism of the valuation basis. A total balance sheet approach to solvency assessment should be forward looking and calibrated to adequately protect policyholders without creating capital requirements so onerous that insurance becomes prohibitively expensive.

22. The degree to which accounting standards are used in solvency frameworks affects the adjustments that prudential supervisors need to make to capital adequacy requirements. Prudential supervisors that do not use accounting standards as the basis of prudential balance sheets do not need to make adjustments to the recognition of capital resources and capital requirements. Nevertheless, even where tat is the case, supervisors should still be aware of the potential for indirect impact to the extent any component of their solvency framework rely on accounting results or indicators. Those supervisors that do use the accounting balance sheet as a basis will need to consider consequential changes to their solvency frameworks on implementation of IFRS 17.

23. Different measurement bases can give rise to the risk that the grounds for corporate insolvency could be met before regulatory intervention is triggered. If Insurance Core Principle 17 Capital Adequacy (International Association of Insurance Supervisors, 2019) is observed in a jurisdiction, there should be a ladder of intervention defined by the supervisor with the minimum capital requirement (MCR) defined as a solvency control level that, if breached, will trigger the strongest supervisory intervention. This strongest supervisory action may take several forms with examples being withdrawal of license leading to the insurer being put into run-off and ultimately proceedings to wind-up the company.

24. Supervisory intervention levels will be determined in relation to regulatory balance sheets. Ordinarily, at the point of the strongest supervisory intervention, an insurer is likely to have more assets than liabilities on an accounting balance sheet.6 However, in unusual circumstances, it is possible that an insurer could have less assets than liabilities on an accounting basis but remain above the MCR even though the regulatory balance sheet is more conservative before a market stress. Figure 4 shows how diverging insolvency signals could appear after a market shock. In the example, the regulatory value of insurance liabilities falls more than the accounting value as some risk premiums from assets are recognized in the discount rate of the regulatory valuation of insurance liabilities, but under accounting a small illiquidity premium over the risk-free rate is applied. Assuming an MCR of 100 percent this insurer’s solvency ratio remains above the MCR but has less assets than liabilities on an accounting basis. The problem with this situation is that the insurance supervisor may not have a legal basis to impose the strongest supervisory measures prior to a corporate insolvency triggered by a creditor in an insolvency regime that relies on accounting balance sheets.

Figure 4.
Figure 4.

Illustrative Example of Different Insolvency Signals from Different Balance Sheets

Citation: IMF Working Papers 2020, 146; 10.5089/9781513551807.001.A001

Source: IMF staff.

25. Some supervisors contend that a regulatory balance sheet should take a ‘gone concern’ view compared to the ‘going concern’ view of the accounting standards. This affects the types of assets the prudential supervisor may recognize for prudential purposes and how components of the valuation of liabilities are treated for prudential purposes. For example, some of the margins in insurance liabilities may be recognized as capital resources by a prudential supervisor because these margins are available to absorb losses in a gone concern. A variation on this theme is the attempt to align both sides of the balance sheet using fair value for assets and transfer value as a proxy for the fair value of liabilities. In that case, the gone concern view is taken through a lens of transfer value, reflecting that the resolution of an insurer may involve a transfer of liabilities and assets backing those liabilities in a commercial transaction. This contrasts with a fulfilment or run-off view of liability valuation which would open the way to more insurer specific valuation parameters, which takes a going concern view of valuation. This does not necessarily mean that the resolution mechanisms in place in jurisdictions will perfectly align with the view of valuation, but these different views will color the philosophy of the valuation basis and how components of assets and liabilities are viewed for prudential purposes.

IV. Potential Impact on Insurers

26. Most of the surveyed jurisdictions have not yet been able to assess the potential financial impact of IFRS 17 on their insurers. This can be attributed to several factors, including insurers’ need to further develop information technology (IT) systems and data to implement the standard, continuing development of technical expertise to undertake the valuation and high implementation costs that need to be spread over time.

27. Very few of the surveyed insurance supervisors have undertaken an impact assessment on their insurers. Uncertainties, including the possibility of further revisions to the standard, could also contribute to supervisors’ hesitation to launch impact assessment exercises. However, without this, it is difficult to anticipate how IFRS 17 could impact insurers’ financial position and the corresponding influence this may have on their business strategy and risk management. Of those who have done impact studies, two jurisdictions expect similar valuation results and two others expect lower liability value under IFRS 17. One jurisdiction expects increased liability value for certain life insurance products that offer higher guaranteed investment returns than current interest rates. The low interest rate environment prevalent in several economies may exacerbate the problem due to lower rates to discount an insurer’s future cash flows.7

28. Some supervisors expect a less significant impact on non-lifenon-life insurers. It is generally expected that there will be little change in the accounting for short-term contracts that qualify for the simplified PAA (Box 1). There may be more wide-ranging implications for long-term insurance business. Some supervisors expect life insurers’ measured profitability to suffer under IFRS 17, which may place greater pressure for insurers to improve operating efficiency to reduce cost, potentially taking advantage of technology such as artificial intelligence.

IFRS 17 and Non-life Insurers—Impact Likely to be Less Significant

Valuation results under the PAA are generally in line with the “unearned premium” approach. This approach is currently used in many jurisdictions under IFRS 4 for short-term, non-life insurance business (IASB, 2018). Revenue is recognized by allocating the expected premium over the coverage period. Accordingly, the IASB expects relatively little change in the accounting for short-term contracts that qualify for the simplified PAA (IASB, 2017b).

The PAA simplification applies to the liability for remaining coverage (LRC) only. The computation for the liability for incurred claims (LIC), to be determined using the general measurement model (GMM), can also be less complex because discounting is not required if claims are expected to be paid in one year or less from the date the claims were incurred. Overall, complexities arising from CSM calculations are removed as CSM is not required under the PAA. Longer contracts may also be eligible for the PAA if the LRC under the PAA is not expected to differ materially from that if the GMM had been applied.

For those non-lifenon-life insurers for which discounting is not a feature of existing accounting practice, the requirement to discount in determining the LIC will reduce insurance contract liabilities. A risk margin must be included in the LIC. If there are higher risk margins under IFRS 17 than IFRS 4, this will increase insurance contract liabilities and reduce reported equity and vice versa. The combined impact of any reduction due to discounting and the impact of the requirement to include explicit risk margins will also depend on the level of risk margin currently held under IFRS 4.

In many emerging markets, non-life insurance dominates the insurance market while life insurance often accounts for a smaller share with relatively simple products. The impact of IFRS 17 on insurance markets dominated by non-lifenon-life insurance is therefore likely less significant than those markets dominated by life insurance.

29. In jurisdictions that do not use accounting standards as a basis for assessing insurer solvency, IFRS 17 could still impact insurers. This could be a cause of concern as supervisors in those jurisdictions may not be aware of potential consequences on insurers and ultimately, their policyholders. Without adequate preparation and consideration of greater alignment between general purpose financial reporting and regulatory solvency reporting, the new accounting standard could adversely impact insurers through several channels: (i) conflicting financial position signals from multiple valuation bases, making it difficult for insurers to navigate their business; (ii) misaligned incentives influencing insurers’ behavior and business strategy that may not be in their best interest in the long-term or to their policyholders; (iii) non-compliance with the accounting standard leading to qualified audit statements, which in turn could trigger capital flight from the insurance industry; (iv) high costs of maintaining multiple systems and sets of accounts being transmitted to policyholders through higher premium rates; (v) ill-prepared insurers becoming outliers and losing their competitive edge; and (vi) increased operational risks due to system changes to comply with IFRS 17, which could also affect the preparation of solvency figures if insurers draw on the same underlying system for common data.

30. Managers may be unable to meet objectives based on prudential measure benchmarks while at the same time meeting objectives regarding the level of accounting-based earnings. Earnings are linked to the ability to declare dividends. It is important for a healthy insurance industry that companies are profitable, but profitability be based on economic measures of income and not arbitrary conservatism or excessive optimism in accounting estimates. Regulatory and accounting balance sheets that diverge significantly will complicate management decision-making about where to allocate capital to generate earnings under accounting or regulatory capital measures.

31. Despite the benefits associated with the IFRS 17 implementation, there are risks from such a fundamental transformation of the economic measurement of insurer’s businesses. Accordingly, supervisors should be aware how insurers and policyholders could be impacted even if regulatory frameworks do not rely on IFRS 17. Supervisors that undertake impact assessment of the standard on insurers will be better prepared to assess any such implications.

32. In general, insurers are not expected to change their business strategy significantly during the transitional period prior to the implementation date of IFRS 17. In the year preceding the implementation date, insurers need to value their insurance contracts as though IFRS 17 had always applied. In practice, this could result in a significantly different profit profile of insurance products underwritten by insurers. Those products would have been designed and priced based on existing accounting standards, which could have allowed upfront or earlier profit recognition unlike IFRS 17. Nevertheless, most of the surveyed jurisdictions do not expect insurers to significantly change their business strategy during the transitional period. Insurers will likely select approaches that will have least financial and operational impact.

33. In a few jurisdictions, insurers may need to review their asset-liability management strategy and the associated internal controls. As a result, they could potentially shift their investments towards longer duration assets to manage profit emergence that will take a longer time. Some insurers could adjust their reinsurance arrangements to minimize accounting asymmetries that could arise due to differences in the valuation approach for reinsurance contracts held compared with the underlying insurance contracts. 8 From an operational perspective, insurers may start to fine-tune key performance indicators based on the new performance metrics under IFRS 17. The reason for this is that the traditional measure using premiums will no longer be a key feature as a performance metric in the statement of profit and loss under IFRS 17 and will only be secondary information available in the notes.

34. While there may be short-term adverse implications on insurers’ measured profitability, there could be positive impact on sustainability of their business model in the longer term as they discontinue economically unprofitable products that relied on upfront profit recognition. Once IFRS 17 comes into force, insurers are likely to renegotiate contractual terms of certain types of insurance products and change their product range to maintain profitability targets. This is mainly driven by a significant change in how profits emerge under IFRS 17, the definition of contract boundary, and improved disclosure and data availability to track profitability of different groups of insurance policies. In general, any losses must be recognized upfront when a policy is underwritten, but profits should be recognized gradually as the insurance coverage is provided over the policy duration. This effect is achieved through the CSM component of IFRS 17. Under previous accounting models allowed within IFRS 4, profit could emerge significantly on day one of recognition of the contract and more modest profit recognition in subsequent years (IASB, 2017a).

35. From a market conduct perspective, IFRS 17 provides incentives to insurers that are in line with the regulatory objective of treating policyholders fairly. Under certain accounting standards, an insurer may recognize profits upfront even though a policyholder may terminate the contract before it expires. This may not be fair to the policyholder as the insurer has not provided insurance coverage beyond the termination date and yet, it is able to recognize profits for that period. Under IFRS 17, insurers will be incentivized to maintain insurance policies as long as possible, as they can only recognize profits as they emerge over the policy duration.

36. The impact of IFRS 17 on insurers’ regulatory solvency position is unclear, regardless of whether the standard is used for prudential purposes. In jurisdictions where insurance supervisors are considering using IFRS 17 for regulatory purposes, impact studies are planned or underway. One impact that is worth considering is the day one transition impact on retained earnings and its effect on solvency where retained earnings are a key component of capital resources for an insurer or the insurance sector. In IFRS jurisdictions that will not use IFRS 17 for insurer solvency assessment, there could still be an impact to the extent any accounting metric is used in the capital adequacy framework. Given the significant change to how profits are measured under IFRS 17, this could have a significant impact on an insurer’s capital resources and thus, overall solvency position. Some jurisdictions may mitigate this by recognizing the CSM as capital resources.

37. IFRS 17 is expected to contribute positively to enhance insurers’ enterprise risk management (ERM) frameworks mainly through stronger actuarial function and data governance controls. As required under Insurance Core Principle 8 Risk Management and Internal Controls, insurers should establish actuarial functions to evaluate technical provisions, or to undertake valuation of insurance contracts. Given that IFRS 17 is a principles-based standard, there will be heavy reliance on the accounting, auditing and actuarial professions to facilitate consistent implementation of the standard. In practice, this can be achieved through issuance of professional standards or guidance by the relevant bodies. The International Actuarial Association is developing International Actuarial Notes on IFRS 17 that will serve as educational material for actuaries (IAA, 2019a). IFRS 17 is also expected to prompt insurers to improve other aspects of their ERM frameworks including the internal audit function, risk management function and to enhance collaboration among various control functions.

V. Implementation Challenges

38. Supervisors in the surveyed jurisdictions saw IT changes, costs, and lack of actuarial and accounting expertise as the most challenging aspects of IFRS 17 implementation for insurers. In particular:

  • On IT changes, the data needed to undertake the valuation of an insurance contract based on IFRS 17 may not be available or readily available in an insurer’s IT system. For example, IFRS 17 requires insurance contracts to be grouped according to their expected level of profitability when they first come into scope of the standard. Some policies may have been issued decades ago and the valuation basis may not have been well recorded.

  • Costs can increase given the significant task to reconstruct history in order to satisfy the transition requirements of the standard (even if some changes to transitional arrangements could alleviate these). In June 2020, the IASB agreed on some amendments to the transitional provisions that may provide some relief, but the economic consequences of choosing one of the new options is not yet clear until companies analyze the options or conduct pilot studies. This further emphasizes the progress needed in organizing projects for transition to IFRS 17 and conducting industry-wide impact studies.

  • The other implementation challenges cited by the surveyed supervisors stem from the lack of expertise with the standard. For example, difficulties in interpreting the standard, communicating the accounting results to certain parties such as board of directors, and the short timeframe to have the necessary infrastructure up and running. Some of the surveyed supervisors expect smaller insurers to face more challenges in implementing the standard.

39. Given the principles-based nature of IFRS 17 there will be heavy reliance on professionals. Professionals such as actuaries and accountants may be able to facilitate consistent implementation of the standard to achieve its objective of providing comparable financial results across insurers. In this context, the shortage of actuarial and accounting professionals, particularly in emerging economies, poses a serious obstacle to the successful implementation of the standard.

40. Actuarial and accounting professionals are bound by their technical and professional standards, which adds a layer of assurance their work. Without these safeguards, financial results insurers report may be inaccurate (this may have already been an issue but will become more significant due to the complexities of IFRS 17). If the results serve as basis for solvency assessment purposes, inaccuracies may impact on supervisors’ solvency assessments. Note this is not a criticism of the standard, but an observation of the operational risks of getting the implementation of IFRS 17 wrong if appropriate professionals are not engaged to assist with the transition. Although some of the surveyed supervisors acknowledged that professional actuarial and accounting standards can help promote consistent implementation of the standard, not many felt the need to provide additional regulatory guidance in these areas. This can be attributed to the fact that most of the surveyed supervisors think that existing oversight of actuaries, accountants, and auditors is already adequate.

41. According to the surveyed supervisors, the most challenging technical aspects of IFRS 17 are the required level of aggregation of insurance contracts; the treatment of reinsurance contracts; and determination of contract boundary, discount rates and annual cohorts. It is expected that the industry will build capacity and experience in these areas over time. There could be some uncertainty on these issues at the initial stage of implementation of the standard, which could lead to some volatility in the accounting results. Over time, practices are expected to become more stable and so will the reported financial statements.

42. Supervisors can play a role in addressing the implementation challenges by encouraging insurers to start preparing early and engaging closely with the industry to better understand the issues. Specific examples from the surveyed supervisors of such support include: (i) requiring insurers to provide pro forma financial statements; (ii) closely liaising with the national and international accounting standard setters to monitor discussions on the application and interpretation of the standard; (iii) regular monitoring of implementation progress, for example through industry surveys; (iv) organizing industry roundtables to encourage exchange of views on how to address common implementation challenges; (v) organizing training for the industry, possibly in conjunction with the relevant professional actuarial or accounting bodies, and (vi) setting up dedicated task force at the national level to answer queries from the industry.

43. Consultation on adjustment to any regulatory requirements that are creating implementation challenges should occur as early in the transition phase as possible. This will allow sufficient time for insurers to prepare themselves. A few of the surveyed jurisdictions did not think that it is the role of supervisors to help address the implementation challenges.

VI. Use of IFRS 17 for Prudential Frameworks

44. Most regulatory regimes do not currently use inputs consistent with general purpose financial reporting standards, with or without modification, to assess solvency of insurers. Instead, insurers value their insurance liabilities based on specifications prescribed by insurance supervisors. The valuation requirements are typically prescriptive (more than accounting standards) to achieve the prudential objective of enabling insurance supervisors to compare solvency positions across insurers. Current shortcomings under IFRS 4 and postponement of the implementation date of IFRS 17 could explain the continuation of such a regulatory approach. Interestingly, one of the surveyed jurisdictions only requires life insurers (and not non-life insurers) to use accounting standards for regulatory solvency purposes, while another jurisdiction uses the regulatory valuation results for financial reporting. Both approaches are not common in practice.

45. Despite the publication of IFRS 17, few of the surveyed jurisdictions plan to adopt it with or without modification, for regulatory solvency purposes 9 (see Appendix 5 for more detail). Most of the surveyed jurisdictions do not see compelling reasons to change existing regulatory valuation requirements that have served prudential objectives well. Other reasons cited are provided in Table 3.

Table 3.

Reasons Reported for Maintaining Existing Valuation Requirements

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Source: IMF and Financial Stability Institute staff based on response to survey.

46. A very small number of jurisdictions have decided to use IFRS 17 for regulatory solvency general purpose financial reporting. Common reasons cited for this approach is to avoid potentially conflicting financial signals from multiple sets of financial statements and minimize cost to insurers. It is currently unclear if other jurisdictions will follow suit, even though some supervisors plan to review their existing regulatory approaches and may consider using IFRS 17 for solvency assessment. Some jurisdictions will likely consider adopting IFRS 17 if larger jurisdictions do so, especially if the regulatory frameworks are similar. In the EU, there is currently no clear indication as to whether IFRS 17 will be adopted as an accounting standard. Even if it is adopted, the prevailing regulatory framework in the EU, Solvency II, currently specifies valuation requirements that are not based on IFRS. Those jurisdictions considering whether IFRS 17 should be the basis for their solvency valuation should consider the arguments set out in this paper by advocates of and non-advocates of using IFRS 17. Two key points come to mind: is there a viable current solvency valuation framework distinct from current accounting standards and how comprehensive is the application of IFRS to insurers in the jurisdiction?

47. Some jurisdictions are planning to use IFRS 17 as a starting point and modify the standard for regulatory solvency purposes. Examples of components of IFRS 17 that may need to be modified include: (i) level of aggregation of insurance contracts; (ii) contract boundary; (iii) discount rates; (iv) risk adjustment; and (v) CSM. Some of the modifications are relatively straightforward (e.g., allowing only the bottom-up approach instead of the two possibilities of bottom-up or top-down approach that are permitted under IFRS 17 to determine discount rates). 10 Others are more significant (e.g., combining reinsurance with the underlying insurance contracts and valuing them together).

48. Care should be exercised when comparing regulatory and accounting standards as the level at which such a comparison is carried out may yield different conclusions. Some supervisors view their regulatory valuation basis as being consistent with IFRS 17, albeit at a high-level. This may well be the case as most modern risk-based solvency frameworks will consist of the key components of IFRS 17 (i.e., contract boundary, current estimate, and margin over current estimate). However, the concept of contractual service margin would be less common. Drilling down to further details may reveal more divergences.

49. The surveyed jurisdictions were divided on whether it is important for insurers to implement IFRS 17 so that financial positions are comparable across jurisdictions. A concern among the surveyed jurisdictions is the principles-based nature of the standard that allows a wide range of accounting practices, which may lead to some differences in valuation results. On the other hand, an international standard such as IFRS 17 is usually principles-based in order to be adaptable to local markets, products and circumstances. Several jurisdictions (Australia, Canada, Chile, New Zealand, South Africa, and South Korea) plan to review their capital adequacy frameworks in response to IFRS 17. Table 4 sets out potential changes to regulatory requirements as a result of IFRS 17.

Table 4.

Potential Changes to Regulatory Requirements

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50. Most supervisors use two main guiding principles when reviewing capital adequacy frameworks in relation to IFRS 17. These principles are: (i) provide the right incentives to insurers to manage risks properly and (ii) achieve appropriate prudential outcomes in terms of policyholder protection. Factors considered by supervisors to a lesser extent are maintaining conceptual consistency, minimizing regulatory burden on insurers and maintaining similar level of overall industry capitalization are factors to consider. One of the surveyed jurisdictions mentioned that adherence to the Insurance Core Principles and maintaining equivalence with other solvency regimes are also important considerations.

VII. Regulatory and Supervisory Implications

51. Most of the surveyed jurisdictions expect that IFRS 17 will contribute positively to financial stability. Some jurisdictions have not established a view on this, while several smaller jurisdictions expect no positive or negative impact on financial stability. The IASB (2017c) expects that improved transparency will contribute positively to financial stability by making available useful information so that the relevant parties, including insurance supervisors, can take appropriate actions in a timely manner. More specifically, the positive contribution of IFRS 17 on financial stability can take the following forms (in order of consensus among the surveyed jurisdictions): (i) allows investors to judge the performance of an insurer more easily; (ii) provides better information on profitability trends and immediate recognition of losses of an insurer; (iii) provides proper and regularly updated measurement of insurance liabilities including the cost of options and guarantees; (iv) ends upfront profit taking and revenue recognition; and (v) provides comparable financial information of insurers reporting on IFRS basis within and across jurisdictions.

52. Views of supervisors are mixed on the potential impact of IFRS 17 on policyholders, ranging from no material impact to higher premiums and withdrawal of certain product types. Some supervisors expect insurers to change their product range due to the technicalities of IFRS 17. For example, IFRS 17 requires insurers to separately identify portfolios of insurance contracts that are managed together and bearing similar risks. Within each portfolio, insurers should group contracts according to their expected level of profitability. The valuation is then conducted on each group of contracts. Crucially, contracts issued more than a year apart should not be included in the same group. This could require a significant change to the way insurers design and price their products. For example, life insurers typically price their products by spreading fixed expenses across different generations of policyholders to be able to offer competitively priced policies. They may need to change such a pricing approach to reflect the constraints imposed by IFRS 17. Products that rely heavily on cross-subsidization between different generations of policyholders (e.g., participating or with-profits contracts) may need to be re-designed or re-priced to fit within IFRS 17 framework. The Figure 5 shows an industry study on business areas of an insurer that are expected to be most impacted by IFRS 17.

Figure 5.
Figure 5.

Potential Impact of IFRS 17 on Business Areas—Proportion that Selected the Top Four

Citation: IMF Working Papers 2020, 146; 10.5089/9781513551807.001.A001

Source: KPMG—In it to win – feedback from insurers on the journey to IFRS 17 and IFRS 9 implementation one year in.

53. Supervisors may need to revise their supervisory reporting requirements due to IFRS 17 and, correspondingly, the financial indicators or ratios derived from those reports. This is due to the new performance and profitability measures introduced through IFRS 17, which will no longer provide explicit information on premium income that is prevalent in existing financial indicators used by supervisors. One of the surveyed supervisors plans to review the expected values of insurance contracts as reported under IFRS 17 against actual materialization of profit or loss. Most of the surveyed supervisors are still in the process of reviewing which new financial indicators to introduce or existing indicators that need to be revised, for example see APRA 2019. Besides supervisory reporting, a few of the surveyed jurisdictions expect changes to requirements on own risk and solvency assessment, and stress testing, as well as supervisory risk rating frameworks.

54. IFRS 17 disclosure is expected to provide new sets of information that will be useful for supervisory monitoring of insurers. The Table 5 provides examples of new indicators that will be available through IFRS 17 disclosure. IASB (2017c) outlines a mapping of current indicators to new indicators that will reported under IFRS 17

Table 5.

Examples of New Indicators or Indicators Modified by Revised Inputs from IFRS 17 Reporting

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55. To alleviate the complexities of IFRS 17, a small number of the surveyed supervisors are planning to allow a proportionate application of the standard by certain insurers. The PAA under IFRS 17 is cited as an example of a possible simplification as it removes the complexity arising from discounting future cash flows and the calculation of the CSM. Although under IFRS 17 the PAA is only allowed for certain short-term contracts, supervisors in a small number of jurisdictions may widen the scope and allow this approach for smaller insurers with less risky business models and simpler products.

VIII. Concluding Remarks

56. IFRS 17 is expected to bring positive benefits to the insurance industry in the long-term as well as to financial stability. However, there will be significant implementation and upfront costs. Improved transparency will contribute positively to financial stability by making available useful information so that the relevant parties, including insurance supervisors, can take appropriate actions in a timely manner. Implementation of the standard can also enhance insurers’ ERM frameworks and better align insurers’ financial reporting with policyholders’ interest by ensuring profit recognition matches insurance service provision. While the positive aspects of IFRS 17 quoted in this paper are the broad conclusions of the survey conducted, it must be noted not all supervisors share these views and some either do not see benefits or see more muted benefits due to the range of different practices within the application of IFRS 17.

57. More work needs to be done to fully understand the potential impact of IFRS 17, the most significant development in the insurance industry in recent years. This standard may well be a game-changer in the insurance industry, affecting a range of business activities from product offerings and pricing to solvency of insurers. Without undertaking quantitative impact studies of the standard, it will be impossible for supervisors to understand how the financials of their insurers may change and the corresponding impact on their measured solvency.

58. The prudential implications of IFRS 17 need to be fully appreciated, regardless of whether regulatory frameworks use the accounting standard to assess the solvency of insurers. Independently of whether a regulatory regime relies (or plans to rely) on the standard for solvency purposes, insurers and policyholders will be affected by the standard. Failure to understand its potential implications could limit the ability of supervisors to react effectively.

59. New accounting standards will not be the top priority for insurance supervisors or insurers during the COVID-19 pandemic. However, the 2023 implementation date is looming. Supervisors and insurers can only afford to give a lower priority to the implementation of IFRS 17 and IFRS 9 for a short period. Initial impact analysis should start no later than the end of 2020 or beginning of 2021.

60. There will likely be a wide range of regulatory approaches on the use of IFRS 17 or other accounting standards for insurance contracts for regulatory solvency purposes. There are reasons for the different regulatory approaches. Nevertheless, supervisors should satisfy themselves that the cost of a separate regulatory approach does indeed outweigh the benefits of using a single valuation basis for solvency assessment purposes and general purpose financial reporting. New or developing risk-based regulatory regimes have more scope to seize the opportunity of basing their solvency framework on accounting standards. If IFRS 17 will be used for regulatory solvency purposes, further consideration should be given to achieving the desired comparability of results and addressing unintended consequences that could arise from volatility of solvency results.

61. Those jurisdictions that are not currently intending to implement IFRS 17 for regulatory solvency purposes should reconsider this position, in the medium-term, after some experience with IFRS 17. Most solvency systems are reviewed periodically, and that may provide an opportunity for alignment between regulatory solvency valuation and general purpose financial reporting. This would have the benefit of reducing the number of accounting systems insurers need to maintain and any confusion between outcomes of regulatory solvency systems and general purpose financial reporting.

62. One way forward would be to specify aspects of IFRS 17 implementation where currently a wide-range of techniques and inputs may be used. The specification could be like what is provided in current regulatory valuation approaches (e.g., specified discount rate methodologies or published discount curves could be applied in the IFRS 17 context). This may also lead to a consistent implementation of IFRS 17 within jurisdictions to the benefit of all stakeholders.

63. Greater specification of the techniques and inputs to be used in IFRS 17 for regulatory solvency purposes should be developed through global coordination to avoid local versions of IFRS 17 being created. Significant regional and global consultation with the insurance industry, professional bodies, investor stakeholders, and consumer groups would be required to achieve this outcome. Jurisdictions with insurance groups that have considerable business outside their borders may find merit in coming together to work on such a project. Such jurisdictions would derive the most benefit from a globally consistent approach to regulatory solvency calculation within IFRS jurisdictions and more consistency of general purpose financial reporting.

IX. References

Appendix I. List of Supervisors that Participated in Survey and Abbreviations

1. Australian Prudential Regulation Authority (AUS)

2. Bermuda Monetary Authority (BMA)

3. Office of the Superintendent of Financial Institutions, Canada (CAN)

4. Comisión para el Mercado Financiero, Chile (CHL)

5. Dubai Financial Services Authority (DUB)

6. French Prudential Supervision and Resolution Authority (ACPR), France (FRA)

7. Federal Financial Supervisory Authority (BaFin), Germany (DEU)

8. Insurance Authority, Hong Kong SAR(HKG)

9. Istituto per la Vigilanza sulle Assicurazioni, Italy (ITA)

10. Financial Services Agency, Japan (JPN)

11. Financial Supervisory Service and Financial Services Commission, South Korea (KOR)

12. Bank Negara Malaysia (MYS)

13. Reserve Bank of New Zealand (NZL)

14. Monetary Authority of Singapore (SGP)

15. National Bank of Slovakia (SVK)

16. Insurance Supervision Agency, Slovenia (SVN)

17. Prudential Authority, South Africa (ZAF)

18. Swiss Financial Market Supervisory Authority

19. Prudential Regulation Authority, United Kingdom

20. National Association of Insurance Commissioners, United States (USA)

Appendix II. COMPARISON OF THE U.S. GAAP TARGETED IMPROVEMENTS (ASU 2018–12) WITH IFRS 1711

After a public consultation in 2007, the FASB pursued a joint project with the IASB to review the accounting for insurance contracts. In February 2014, rather than continuing to work with the IASB on a new accounting model, the FASB instead decided to focus its efforts on making targeted improvements to its U.S. GAAP insurance accounting model. On August 15, 2018, the FASB issued an Accounting Standards Update, ASU 2018–12, intended to address shortcomings in financial reporting for insurance companies that issue certain long duration contracts. Three of the main shortcomings of FASB’s current accounting model are:

  • The current use of locked-in assumptions about nonparticipating traditional and limited-payment long duration contracts;

  • Nonmarket-based approaches to valuation of market-based benefits of long duration contracts that expose the insurer to capital market risk; and

  • Under the existing FASB standard, there are limited requirements to disclose information about long duration contracts.

The 2018 update from the FASB addresses these shortcomings. It does so by incorporating updated current cash flow assumptions and discount rates in measuring insurance liabilities for certain long duration contracts; a market-based approach to determining the value of options and guarantees; and more extensive note disclosures. Insurers’ financial statements prepared under IFRS 17 and those under the updated requirements of ASU 2018–12 are expected to better reflect economic reality and more faithfully represent the true underlying financial position and performance of insurance contracts. The Table 1 compares key features of the U.S. GAAP targeted improvements for long duration contracts with the requirements of IFRS 17.

Table 6.

Comparison of Key Features of the U.S. GAAP Targeted Improvements for Long Duration Contracts with the Requirements of IFRS 17

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Source: IMF staff.

Appendix III. Differences Between IFRS 17 and IFRS 4

Following are key differences that the surveyed jurisdictions expect between the current accounting standard for insurance contacts, IFRS 4 compared to IFRS 17.

Level of Aggregation

This is one of the most significant changes between the two standards. This is because currently, in most of the surveyed jurisdictions, there is no such requirement and the valuation is mostly undertaken at the individual contract level. In some jurisdictions, current accounting standards require insurers to group policies based on their risk profiles rather than profitability as required under IFRS 17. It is expected that insurers will need to segment their insurance contracts into more categories than currently.

Use of Premium Allocation Approach for Contracts of One-Year or Less

Some life insurers are expected to use the premium allocation approach for their short-term business, but it is not expected to result in significantly different valuation than the current approach. The main difference is that, under IFRS 17, insurers need to fulfil the specified criteria before they can use this approach to value eligible insurance contracts. Only one of the surveyed jurisdictions stated that none of their life insurers will use the premium allocation approach. Most of the surveyed jurisdictions expect non-lifenon-life insurers to use the premium allocation approach for the majority of contracts that they underwrite. They do not expect material differences in the accounting results compared to the existing approach.

Scope of Application

In most jurisdictions, the definition of an insurance contract is largely the same under IFRS 17 and IFRS 4. As such, the scope of application of IFRS 17 is not expected to be significantly different. Examples of contracts underwritten by life insurers currently accounted for under IFRS 4 but will not be included under IFRS 17 are fixed fee service contracts, unbundled service contracts, pension contracts. In one jurisdiction, it is likely that more unit-linked contracts will be captured under IFRS 17. For non-lifenon-life insurers, the scope of application is expected to remain broadly the same.

Current Estimates—General

There is currently some form of current estimate component in most jurisdictions. For life insurers, differences include existing prescription of discount rates and mortality rates (effectively requiring historical, instead of current, information to be used), treatment of discretionary benefits, implicit risk margins and mechanism to smooth release of future profits. The way current estimate is disclosed under IFRS 17 may be different, mainly due to the introduction of the contractual service margin. For non-lifenon-life insurers, the liability adequacy test currently required in a few jurisdictions effectively introduces the concept of current estimate in the valuation of non-lifenon-life contracts.

Current Estimates—Future Cash Flows

No major differences expected. For life insurers, differences arise from timing of revenue recognition, explicit allowance for surrenders, future attribution of discretionary benefits, explicit allowance for expenses and allowance of tax treatment. For non-lifenon-life insurers, differences are mainly due to a wider range of cash flows that will be captured under IFRS 17, for example, future expense cash flows.

Current Estimates—Discount Rate

There could be significant differences as some jurisdictions currently require life insurers to use risk-free rates or place limits in reference to risk-free rates. At the other extreme, in certain jurisdictions, life insurers currently use yields of their existing assets to determine the discount rates without adjusting for characteristics that are not reflective of the insurance obligations. In a few of the surveyed jurisdictions, non-lifenon-life insurers currently do not apply discounting. In several other jurisdictions, similar requirements for life insurers using risk-free rates also apply to non-lifenon-life insurers.

Current Estimates—Other Material Differences

Other material differences include different ways to assess loss recognition, disallowance of negative technical provision, minimum value based on contractual surrender value, recognition of acquisition costs and treatment of reinsurance.

Risk Adjustment for Nonfinancial Risk

Although this is not currently an explicit requirement in most jurisdictions, it is not expected to have significant impact because of hidden conservativism in current valuation approaches that effectively achieves the same result as a risk adjustment. In some jurisdictions, no difference is expected as the concept currently applies.

Contractual Service Margin

This is a new concept in most jurisdictions and could have significant impact, especially during transition and in terms of profit emergence patterns. However, existing hidden conservatism may already partially achieve similar effects, which may lessen the impact of the introduction of a contractual service margin. Moreover, in certain jurisdictions, day one profit is currently not recognised, which achieves a similar effect at initial recognition.

Subsequent Measurement and Profit Recognition

Not a concept in current accounting approaches. Currently, in most jurisdictions, any profit or loss due to valuation assumption changes is recognised immediately, instead of the more controlled way profit emerges under IFRS 17.

Contract Boundary

The criteria will most likely differ, which could have significant impact due to different capture of future cash flows. In some jurisdictions, expected future premiums currently excluded may be captured under IFRS 17.

Appendix IV. Transposition Approaches of IFRS Into Local Standards

Table 7.

Regulatory Approaches to the Use of Accounting Standards for Prudential Purposes

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Source: Financial Stability Institute and IMF staff based on survey responses.

Appendix V. Regulatory Approaches on the use of Accounting Standards for Prudential Purposes

Table 8.

Regulatory Approaches on the Use of Accounting Standards for Prudential Purposes

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Source: Financial Stability Institute and IMF staff based on survey responses.
1

The authors are grateful to Raihan Zamil and Esther Künzi for their valuable support with this paper. The views expressed in this paper are those of the authors and not necessarily those of the BIS, IMF, or the Basel-based standard setters.

2

In this paper, unless otherwise specified, the term ‘solvency’ refers to ability of an insurer to meet its obligations to policyholders when they fall due based on measures as specified by the insurance supervisor.

3

In this paper, ‘standards’ refers to standards issued by international or national standard setters.

4

Some jurisdictional specificities are not fully reflected in the figure.

5

In practice, insurance liabilities based on accounting standards could be higher than those calculated on regulatory basis.

6

Regulatory intervention should be designed to occur prior to triggering corporate insolvency laws

7

For more information on how low interest rates could impact insurers and possible supervisory responses to address the problem, see FSI (2017).

8

The proposed amendments to the IFRS 17 are expected to minimize any such accounting mismatch by allowing insurers to recognize income arising from the reinsurance contracts held to cover losses of the underlying insurance contracts.

9

At the time of publication, the IASB is consulting on a limited number of targeted amendments to the IFRS 17, which are not expected to change fundamental aspects of the standard.

10

In general, a bottom-up approach involves starting with the risk-free yield curve and adjusting the rates to reflect differences between the liquidity characteristics of the insurance contracts and the financial instruments underlying the rates. Alternatively, a top-down approach uses the yield curve that reflects market rates of return implicit in a fair value measurement of a reference portfolio of assets.

12

Risk adjustment for nonfinancial risk aims to reflect the compensation that the entity requires for bearing the uncertainty about the amount and timing of the cash flows that arises from nonfinancial risk.

13

Includes derivatives that have not been separated from the host insurance contract (after applying IFRS 9).

14

A proposed amendment would allow an insurer to allocate, on a systematic and rational basis, insurance acquisition cash flows that are directly attributable to a group of insurance contracts: (i) to that group; and (ii) to any groups that include contracts that are expected to arise from renewals of the contracts in that group.

15

Allocation of the CSM based on a unit of service determines the year-by-year pattern of recognition of profits. No day one gains. The allocation is revised for remaining CSM as the expectations for the pattern of service are updated.

16

‘Yes’ may include prudential adjustments application. ‘No’ means not permitted or not required.

17

Solvency II, implemented in 2016 before finalization of IFRS 17, is mandatory under EU law and is not within the remit of individual prudential regulators to change. Any changes will depend upon the review of the regulation.

Accounting Standards and Insurer Solvency Assessment
Author: Peter Windsor, Jeffery Yong, and Michelle Chong-Tai Bell
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    Applicability of IFRS for Public Financial Reporting and Prudential Solvency Reporting

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    Objectives of Accounting and Regulatory Standards

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    Components5 of Accounting and Regulatory Balance Sheet

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    Illustrative Example of Different Insolvency Signals from Different Balance Sheets

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    Potential Impact of IFRS 17 on Business Areas—Proportion that Selected the Top Four