Coming Soon: New Accounting Requirements for International Business Operations

Insurance carrier CIOs routinely need to address an evolving array of regulatory compliance and governance issues as part of their “business-as-usual” operations. Changes in actuarial tables, addressing the specifics of CCPA, and a move to principle-based reserving are but three examples from the recent past.

Changes in accounting rules are also reasonably routine occurrences. American companies generally need to conform to the rules promulgated by the Financial Accounting Standards Board (FASB) in support of Generally Accepted Accounting Principles (GAAP) for public and private companies as well as nonprofit organizations. For companies domesticated in, and doing business in, the United States, FASB rules are considered the gold standard.

But FASB isn’t the only standard. For companies that are not domiciled in the United States, or which have operations in other countries, there is a semi-parallel universe to be aware of in the form of accounting standards managed by the International Financial Reporting Standards Foundation (IFRS). Similar in structure and scope to the FASB, the IFRS rules apply in many locations outside of the United States, including Canada and Mexico. For any company domesticated or domiciled in the 100+ countries that follow IFRS accounting rules, a new set of rules are rapidly approaching critical implementation dates. This is a proverbial “big deal,” so impacted insurer CIOs will surely be aware if their organization is in scope.

Timing

The International Accounting Standards Board (IASB) proposed the first draft of this change, which impacts how insurance contract liabilities are calculated for financial reporting, in 2017. Most recently, it delayed its implementation by a year, until January 2023, due to COVID-19. Most insurers haven’t changed their plans in response to the date change and still plan to begin reporting in January 2022. Internal deadlines may be even sooner.

Purpose

In contrast to regulatory accounting requirements, which are focused on consumer protection and thus solvency and claims paying ability, IFRS 17 is designed to provide more accurate and timely information on insurer profitability. Furthermore, previous insurance accounting guidance permitted significant accounting standards variability across national borders. IFRS 17 standardizes national accounting treatments and facilitates the comparison of insurer profitability regardless of domicile.

Time Value of Money

IFRS 17 requires that insurance contracts be recorded as obligations on insurers’ balance sheets, using current interest rates to discount the value of expected cash flows, an adjustment for risks to those cash flows and expected unearned profits. These cash flows will reflect the value of embedded interest rate guarantees and financial options. Existing accounting treatments, depending on the jurisdiction, permitted the use of historical or expected interest rates.

Revenue and Earnings

IFRS 17 distinguishes between insurance revenue and deposits. Deposits are excluded from revenue, and deposit repayments are reflected as the settlement of liabilities rather than insurance expenses. All in-force insurance contracts, including those with outstanding IBNR, will be re-valued at each financial reporting period to reflect current interest rates. Changes to the value of these insurance contracts will be reflected on the income statement as profit or loss for past insurance coverage or an adjustment to unearned profit for future insurance coverage. Similar contracts sold in a given year will be valued as a group and broken out in the financial reporting. The impact of grouping contracts is to improve the visibility of the profitability of new sales and influence of past sales on earnings.

Reporting Impact

Many will wonder how these changes will impact their insurer’s reported profitability. The answer to this question will depend on how IFRS 17 changes their current accounting policies (GAAP) and their business mix. The impact may extend beyond reporting and actually drive decisions about lines of business and product mix.

Technology Impact

The actuaries and accountants responsible for IFRS 17 reporting will require fine-grained transactional data in order to calculate risk factors and group like contracts. In many instances, the information currently fed into the general ledger will be insufficient. Impacted insurers will need to enhance their data environments to facilitate timely access to rich pools of high-quality, governed data, if they have not yet done so. Some companies have reportedly used the changes from IFRS 17 to justify the costs for upgrading or replacing key elements in the financial systems stack, including general ledger platforms.

The IFRS rules do not apply to the vast majority of American companies, but for those impacted, this is a notable drain on both financial and IT resources. Planning ahead, even with an implementation delay until 2023, may be critical for organizations now, despite concurrently grappling with the ongoing COVID-19 pandemic.

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