Meeting the Challenge of IFRS 17
After all the attention and effort dedicated to Solvency II, RDR and GDPR, insurance organizations could be forgiven for putting IFRS 17 on the back burner. But the January 2021 transition date is fast approaching and with it a fundamental overhaul of the way insurers report their liabilities, associated revenue streams, and how profit is recognized.
Under the current IFRS requirements, the profit of a single contract is recognized at inception and reflected in the P&L accordingly. In the real world, however, the profit profile of a given policy (or set of policies) emerges over its lifetime. IFRS 17 is designed to take account of how profit actually emerges and how it is subsequently reflected in the P&L.
One of the key implications of IFRS 17 is that insurers will have to constantly analyze the profit profile and actual experience of each and every policy. This will impact their P&L statements, which will have to reflect current and revised estimates of the value of future profits. And if that wasn’t complicated enough, all the processes, controls, and data that are involved must be traceable, with full accountability and auditability.
The ability to meet the requirements of IFRS 17 will involve the complex interaction of an insurer’s existing actuarial, finance, and disclosure systems; new tracking and monitoring processes and controls; and new sets of granular policy data.
Managing constant evaluation, feedback and tracking
IFRS 17 introduces two new measures that are of significant importance: the contractual services margin (CSM) and risk adjustment (RA). These measures represent the value of future profits and a margin for uncertainty in modelled cash flows. Calculating these new measures will typically be undertaken in the insurers’ existing actuarial engines. Modelling these measures should not be a major challenge for most insurers, as it primarily involves revisions to existing actuarial models. Insurers might use the risk margin adopted for Solvency II as a starting point for the RA calculation, for example.
Tracking precisely how profit emerges, impacts on the cash flows into and out of CSM and RA, and subsequent interaction with the P&L is a significant challenge. It requires new processes and controls, as well as new data sets and sophisticated tracking between administration, actuarial and finance systems.
A good example of the complexities involved can be found in the calculation of the CSM and allocation to a cohort (see below). This requires a number of assumptions to be set. Over time, these assumption “sets” will change and each change will have to be time-coded, recorded, and stored for future reference – either for internal justification, or external auditing.
In an attempt to simplify matters, the IASB (the IFRS 17 Regulator) has suggested that rather than modelling at the individual policy level, modelling the management of the CSM and RA can be done at the “cohort” level. A cohort is in effect a group of policies that, by definition, ’have a similar inception date and profit profile‘. But this is open to interpretation: what exactly comprises a cohort? What are the rules related to the establishment and management of a cohort?
It is possible to envision a situation where the number of cohorts grows very quickly, and thus managing cohorts will become a major issue. This is illustrated by the fact that a cohort will continue until the last policy has expired and each accounting period, new cohorts will emerge.
Once the rules for the creation of cohorts have been established, insurers will need to generate a new set of processes to manage and control them.
Extensive changes required for implementing IFRS 17
The challenge posed by implementing IFRS 17 within the timeframe will require extensive changes to existing actuarial and finance systems, new tracking and monitoring processes, and a range of new data sets at a granular level. Whilst this can be done manually for all but the smallest insurers, a more automated and auditable approach is required.
Sapiens DECISION operates within the insurance system environment and can facilitate the development of the new tracking, monitoring and data interaction processes to support a successful IFRS 17 program in a fully compliant manner. DECISION is ideally suited for defining and controlling the new processes, setting the rules for cohort establishment and management, and allocating profit to the P&L.
Contact us now to arrange a meeting with one of our insurance consultants to see how DECISION can empower your change.Share this blog post