The insurance industry provides a service that fulfils a central role in the global economy. It is essential that a proper accounting standard for insurers exist given the central role that insurance plays to the economy. The existing standard, International Financial Reporting Standard 4 (IFRS 4) is however only an interim standard and allows insurers to use a wide variety of practices. However, it does not provide consistent or granular transparent information about the effect of insurance contracts on financial statements and therefore makes comparisons difficult between products, companies and jurisdictions.
The valuation of insurance contracts is a complex affair. This is a well- known problem and hence it has taken the International Accounting Standards Board (IASB) close to 20 years to develop an accounting standard that will cater for the valuation of insurance contracts across over 100 countries that will apply IFRS 17. The IASB first issued a final IFRS 17 standard in May 2017, which is aimed at promoting uniformity in insurance accounting. Following significant debate with the global industry in the subsequent three years, a revised standard was released with a deferred effective date of 1 January 2023.
What are the implications?
Users of financial statements will have a whole new perspective. Volume will no longer be determined via a premium measure. A revenue-based approach is used. The ways in which analysts interpret and compare companies internationally will change. Increased transparency, as a result of the increased requirements in relation to the granularity of reporting about the profitability of new and in-force business, will give users more insight into an insurer’s financial health than ever before. For example the separate presentation of underwriting and finance results will provide added transparency about the sources of profits and quality of earnings.
At the same time, there will be a number of other significant changes that IFRS 17 will bring, for example:
- Insurers will no longer recognise profits as day one gains and instead they will be required to recognise profits as they deliver insurance services (the revenue based approach).
- Requirement for cashflow projections.
- Losses incurred on loss making contracts will be accounted for immediately in the Profit & Loss, as soon as the company determines the loss is expected.
- Use of current market discount rates and the removal of the clear link between the return on assets and the discount rate may lead to increased volatility in financial results and equity.
Greater transparency and comparability could facilitate merger and acquisition activity; encouraging greater competition for investment capital and help gain the trust of investors. For consumers this increased transparency about profitability of insurance contracts may lead to insurers either changing the range of products it offers, or re-pricing products. If implementation costs are significant, they may be passed on to consumers through increased premiums.
For insurers the impacts will be felt far beyond accounting and will touch on most areas within the business including finance, actuarial and IT. Implementation of the new standard will potentially require a substantial effort in relation to new systems, or system upgrades, processes and controls quite apart from any technical changes in approach. The magnitude of the implementation costs will depend on the extent to which IFRS 17 differs to current approaches applied by the company, the number, age and type of insurance contracts the company has and the existing systems (including specifically the number of any historic systems) used by the company for reporting.
Coupled with new risk-based capital regimes appearing in our region, insurers will need to assess the impact to their available capital, which in turn will impact the ability to support new growth opportunities and dividend paying capacity.
How is East Africa fairing in this journey?
All insurance companies in the region are required to comply with the local regulations in reporting and adherence with the sector’s policies.
Just like in other countries, insurance reporting in East Africa has mainly been driven by regulation and this will continue to be a significant requirement for compliance with IFRS 17. The complexities of the insurance sector in Kenya are also compounded by the diverse business models which are frequently revised, the systems the companies use, trust deficit, and generally the business environment dynamics in Kenya.
Implementation of IFRS 17 is non-negotiable and when the due date knocks in, the insurance sector in East Africa, just like elsewhere in the world will need to adopt the new standard. While 2023 may seem far, the road to implementation is not easy, and the risks of delay are significant in terms of a shrinking talent pool, a more limited runway for systems integration, and forgoing the opportunity to be strategic in operationalising the new standards to achieve greater efficiency.