insurance standards framework

The build-up to the change took almost two decades to complete. However, when the IFRS 17 global reporting standard was made effective from January 1, 2023, there was a general sense of acceptance for the new set of standards that replaced the 2004 IFRS 4 clearly established principles for profitability recognition, liability measurement, presentation, and disclosure of insurance contracts. The objectives were simple – that insurance companies provide relevant data that transparently represented their contracts and allowed consumers to assess the impact of such contracts on a company’s overall financials, including cash flows. 

The International Accounting Standards Board (IASB), the independent accounting standard-setting body, introduced the IFRS 17 in 2017 and decided to implement it from January 2021. However, multiple postponements over concerns from insurers resulted in its eventual launch only from January 2023, a date that necessitated changes from mid-2022 itself.  That the new set of standards wasn’t just a discrete set of accounting tweaks but required complex end-to-end change had been known much earlier: it required multiple functions from across the business to work closely to create a solution that started from shifts in policy administration systems and ended with publicly disclosed financial statements. The new standard establishes principles for recognizing profits, liability measurement, presentation, and disclosure of insurance contracts.

What does IFRS 17 compliance actually mean?

Before getting into the challenges, let us take a brief look at what it means to become IFRS 17-compliant. For starters, insurers need to consider factors ranging from data and system architecture to staffing, besides also remembering that the new standards essentially apply to a handful of scenarios. These include (a) insurance or reinsurance contracts issued (b) reinsurance contracts currently held, and (c) investment contracts with discretionary participation features that get issued, subject to the provider also issuing insurance contracts. However, the standards are not applicable to product warranties, financial guarantee contracts, retirement benefit obligations, residual value guarantees, and fixed-fee service contracts.

Though the new standards came into effect in January, comparative income statements and an opening balance sheet for IFRS 17 were required in 2022 itself. This meant that insurers required parallel runs for a 12-month period to test functionalities while still operating under the IFRS 4 standards. Given the criticality of these test cycles, companies required additional reporting and testing resources to verify solutions, operational readiness, and for mitigation of any cut-over-related risks. In fact, the European Financial Reporting Advisory Group came out with a cost-to-benefit analysis of applying IFRS 17 with close to half of the respondents agreeing that the benefits far outweighed the costs.

Graph on components of total costs from EFRAG study

As the above graph suggests, the biggest challenges in the IFRS 17 transformation are in non-IT-related activities which require maximum investments, ostensibly in training of resources. Most of the respondents felt that accounting and reporting systems would require the most substantive upgrade while the actuarial system itself may require much lesser effort. 

Challenges galore from a changing landscape

Before plunging headlong into the transformation exercise, the C-suite at insurance companies should spend time recognizing that IFRS 17 represents a major change in the accounting of insurance contracts. And when there is such a change, one can expect considerable challenges around both the processes and the mindsets of people who would be running them. Presented below are a few pitfalls that insurers may do well to recognize early:

  • Managing Complexities: The IFRS 17 standards are complex and require a thorough review of the insurance contracts and their underlying financial and actuarial concepts. Several insurers have begun investing time and resources for this purpose, especially given the data-intensive nature of the new regulations. The need for granular data means that the scope for digitizing also increases, as there could be reporting frameworks in place locally with IFRS 17 becoming a layer on top, thus adding additional complexity.
  • Systems and processes: The new guidelines require companies to make changes to their systems and processes such as developing new actuarial models or adapting existing ones. New software systems could be required to capture and analyze data where automation and AI-led financial reporting processes could become the norm rather than the exception. 
  • Data and Information: The data gathering efforts would present a growing challenge as IFRS 17 requires a substantial amount of information from a granular level. Companies may have to upgrade or bring in new information systems and processes to collect and store data, as well as  report the analytics accurately in the future. 
  • Modeling challenges: The new set of standards requires enterprises to use actuarial models to estimate cash flows from insurance contracts. This automatically poses a risk to the models as accuracy of the results depend on accuracy of the models. For the models to be accurate, data accuracy is a must as a robust and transparent system would become non-negotiable going forward.
  • Time and costs: Implementation is proving to be a costly exercise for insurers, though most do agree that it is worth the money spent. Significant investments are required in new technology, processes, and people. Though companies confirm that implementation efforts began some months ago, a significant volume of the work remains undone. 

Opportunities to overhaul financial reporting systems

During our discussions with Chief Financial Officers (CFOs), a theme that surfaced repeatedly around the IFRS 17 was the opportunity that it provided to overhaul existing financial reporting systems in the insurance companies. There was unanimity among insurers that the new standards create an opportunity to reassess products, channels, market strategies, and pricing. By using IFRS 17 financial impact assessments, both the finance and actuarial services will be able to associate at a deeper level with the business to adopt a forward-looking approach. Why so? Because the requirements around transparency would bring in greater levels of detail in data captured, which provides for better insights and more exhaustive analysis. Let’s take a look: 

  • A more collaborative approach between various departments and stakeholders such as actuaries, finance, IT, and risk management would break down the existing silo approach and enhance communication and coordination within the company. This will help businesses take more informed decisions, manage risks better, and achieve better outcomes for their customers.
  • Existing processes may not be good enough for future business needs and the new standards could help insurers find and fix some of them, especially in the realm of data collection, analysis, and reporting. Per IFRS 17 guidelines, insurers need to separate the components of their contracts, specifically the metrics around cash flows. By doing so, companies can identify areas where existing processes may be missing the mark. Also, since the standards require regular reassessment of insurance contracts, insurers may be able to find inconsistencies and fix them in the process. 
  • An opportunity to implement AI-led digital transformation presents itself to the industry as the need for more granular data from across different systems grows. The process can be rendered simpler with automation tools that standardize data templates, streamline its collection, perform better analyses, and develop deeper insights for the company and the overall industry. 
  • A tactical solution with strategic benefits is how we can summarize the IFRS 17 implementation process. Insurers may spend time and money on the entire digital transformation process but once done, stakeholders can draw highly reliable insights into the business with a keen eye on profitability. The granular data enables better analysis of risks and opportunities in the future, which can assist strategic decision-making. 

The new standard and its far-reaching consequences

Having delved into the immediate challenges and the opportunities they present, one must also broaden the horizons to understand the far-reaching implications of IFRS 17 implementation. For starters, it is well worth noting that the entire insurance organization will be affected by a change which may be targeting just the finance function within a company. Stakeholders have been hard at work, reviewing their strategies to ensure that they adapt to this new world where the focus includes product and investment portfolios, asset and liability management, key performance indicators, and strategy. 

A benchmarking survey conducted by McKinsey & Co suggests that most respondents were prepared for the transition but weren’t completely clear about the overall strategic implications of the shift. Others had made elaborate plans to address the challenges while a few had gone ahead with the implementation itself. The bigger challenge is that the gap between market leaders and laggards in preparation only got starker as the changeover dates approached. This is especially true with the smaller companies attempting to get clarity on the need for enhanced balance-sheet volatility that IFRS 17 guidelines insist upon. 

graph of insurer preparedness from a McKinsey survey

For most insurers, the key to a painless transition would be a strong core data architecture that enables them to meet the stringent data requirements. Since compliance requires  bigger and broader data sets across multiple use cases, insurers would need to invest in data storage and integrity. Accounting numbers ranging from cash flows, discount rates, cohort CSM measurements, and risk adjustments need to be error-free and clean. Moreover, since IFRS 17 necessitates repeat calculations to account for evolving conditions and financial risks, companies would need a data architecture that can handle the frequent changes. 

In conclusion…

The transition to the new sets of IFRS 17 standards requires balancing business transformations in tandem with running the day-to-day insurance operations. Towards this end, insurers would require finance and accounting professionals that can think strategically while also possessing the requisite skills for the business. Skills related to financial modeling, performance analysis, and statistical insights will become mission-critical for enterprises preparing for the digital transformation exercise around the new standards. Which is why it is worth reiterating that IFRS 17 is not just a discrete accounting change but comprises a complex end-to-end shift for the industry as a whole. And this journey could be a tough one without external expertise that straddles both accounting as well as knowledge around the domain.