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Key features of IFRS 17

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On 18 May 2017, the International Accounting Standards Board (IASB) published IFRS 17 Insurance Contracts, twenty years after the IASB’s predecessor initiated the insurance contracts project. The new standard, which will replace IFRS 4 for accounting periods beginning on or after 1 January 2021, is a major milestone for the insurance industry as it represents the first ever near global accounting standard for insurance contracts. This is more than “just” an accounting change: IFRS 17 will have a wide and significant impact on insurers’ operations and implementation will be a major challenge. Some of the key impacts are considered in this report.

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Key features of IFRS 17

  1. 1. willistowerswatson.com IFRS 17 Insurance Contracts: the countdown to 2021 has begun! May 2017 © 2017 Willis Towers Watson. All rights reserved.
  2. 2. willistowerswatson.com IFRS 17 Insurance Contracts: the countdown to 2021 has begun! 2 © 2017 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. On 18 May 2017, the International Accounting Standards Board (IASB) published IFRS 17 Insurance Contracts, twenty years after the IASB’s predecessor initiated the insurance contracts project. The new standard, which will replace IFRS 4 for accounting periods beginning on or after 1 January 2021, is a major milestone for the insurance industry as it represents the first ever near global accounting standard for insurance contracts. The standard sets out a comprehensive methodology applicable to all insurance and reinsurance contracts, both long- and short-term, as well as investment contracts with discretionary participation features. IFRS 17 represents a major departure from current insurance accounting practices in many jurisdictions, which will fundamentally change both how and what insurance companies report to shareholders, policyholders and other stakeholders. This is more than “just” an accounting change: IFRS 17 will have a wide and significant impact on insurers’ operations and implementation will be a major challenge.
  3. 3. willistowerswatson.com Key features of IFRS 17 3 © 2017 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. The main feature of IFRS 17 is the building block approach, or General Measurement Model, for the insurance contract liability that includes (1) discounted cash flows, (2) a risk adjustment to reflect the uncertainty in the cash flows and (3) a contractual service margin to eliminate any gain at issue. The Insurance Contract Liability will consist of a fulfilment cash flow element and an unearned profit element (the Contractual Service Margin, or CSM, which cannot be negative). The value of the fulfilment cash flows will be a current amount at any point in time, reflecting economic conditions at and expectations of future experience from the time of the valuation. A simplified measurement, the Premium-Allocation Approach, is permitted for short-duration pre-claims liabilities and is similar to existing unearned premium approaches (i.e. using the premium less acquisition costs as the liability on day one, subject to an onerous contracts test, then running it off simply over time). This provides a simpler alternative for many A&H and P&C contracts and some Life contracts. Cash flows Time value of money Risk adjustment Contractual service margin Total Insurance Contract Liability Fulfilment cash flows: Component representing the risk- adjusted present value of future cash flows needed to fulfil the contract Component representing unearned profit the insurer expects to earn as it fulfils the contract IFRS 17 – The General Measurement Model
  4. 4. willistowerswatson.com Key Features of IFRS 17 (continued) 4 © 2017 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. A Variable Fee Approach will be applicable to contracts with direct participation features. The Variable Fee Approach has the same components as the General Measurement Model. The difference is that the CSM can be adjusted in response to variations in underlying items, most particularly investment returns, such that investment return and other relevant variations will not immediately affect profit or loss. This will be applicable to a range of product types, including UK style participating contracts and investment linked/variable life insurance and annuities. CSM T=0 Present Value of Cash Outflows Assets Risk adjustment T=1 Present Value of Cash Outflows Risk adjustment CSM Initial measurement CSM/ Variable Fee Subsequent measurement Example: CSM responds to movement in asset values, aligning the insurance contract liability with the value of assets underlying the participation feature. Contribution
  5. 5. willistowerswatson.com Key considerations for both life and general insurers Issue Why is it an issue? Disclosure There will be new line items for the income statement presentation and reconciliations which will take time to get used to, and also significant additional disclosure requirements, particularly to cover areas of significant judgement and the nature and extent of risk. Difference to approaches for other purposes, such as capital requirements Differences between IFRS 17 and approaches which are applied concurrently for other purposes, such as the determination of capital requirements under Solvency II and other regimes, are likely. For example, which contracts and which cash flows are to be included. Reinsurance There are potential differences in measurement approach between primary insurance and reinsurance, including that any net cost or net gain on origination of reinsurance contracts held is to be recognised as a CSM and the Variable Fee Approach may not be applied. Discount rates Discount rates are not prescribed, and either bottom-up or top-down approaches may be utilised. The extent to which the illiquidity of cash flows should be reflected in discount rates requires consideration. Risk adjustment Unlike the specified risk margin of Solvency II, for example, IFRS 17 is principles-based, allowing companies to set their own approach to determine the risk adjustment allowing for management’s views on the compensation required for bearing risk. Interaction with IFRS 9 How the insurance contract liability interacts with asset measurement will be key to understanding and managing volatility of profits. 5 © 2017 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only.
  6. 6. willistowerswatson.com Key considerations primarily for life insurers Issue Why is it an issue? Contractual Service Margin The CSM can significantly change the recognition of accounting profit:  Consistent with other industries there will be no day 1 profit from the writing of a new contract.  The impact of changes in demographic and expense assumptions will be spread over the lifetime of the contracts rather than posted immediately to profit in the income statement. Transition There will be a one-time transition exercise to the new standard, notably to determine the CSM applicable to existing business as at 1 January 2020 (as at least one year of comparatives is required). The default position is for full retrospective application to determine what the CSM would have been at the start and end of 2020 as if IFRS 17 had always applied, with simplified approaches available if full retrospective application is impracticable. Options and guarantees Incorporating allowance for any options and guarantees in the valuation of the fulfilment cash flows will potentially require more complex stochastic models relative to those currently in use. Participating business The Variable Fee Approach should allow investment and other gains and losses to be recognised over time through the CSM. The key considerations for any insurer will be to what extent and how the Variable Fee Approach can be applied. Investment components Reported insurance contract revenue is to exclude any investment component of the premium. 6 © 2017 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only.
  7. 7. willistowerswatson.com Key considerations primarily for general insurers Issue Why is it an issue? Applying the General Measurement Model If companies are not able to apply the Premium Allocation Approach for all their business, then the General Measurement Model and all its complexity will apply. Liability for incurred claims Liabilities for incurred claims must reflect a fulfilment cash flow measure, as per the General Measurement Model, including a risk adjustment. Onerous contract liability Where a portfolio of contracts is potentially onerous, companies will need to evaluate the value of the fulfilment cash as per the General Measurement Model, and immediately recognise a loss to the extent the portfolio is onerous. 7 © 2017 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only.
  8. 8. willistowerswatson.com It is now time for action 8 © 2017 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. Many insurers that are or are going to be subject IFRS accounting will already be somewhere along the road to adopting IFRS 17, some further than others. Now that the final standard is available, it is more imperative than ever to start activities to implement IFRS 17: likely business and reporting impacts. This helps to narrow down the implementation options into a clearly defined accounting policy – with the benefit of fewer surprises for all post implementation. Assess information and I.T. systems impact, gaps and solutions Starting from your current insurance contracts project status and using your existing actuarial IT reporting landscape, we will guide you through IFRS 17 system requirements. Throughout the project we will partner with your actuarial, IT, and reporting experts, to develop an initial, high-level blue print, with planning and budget estimates for the full IFRS 17 project. Analyse the business impact IFRS 17 is principles-based and as such comes with a range of options, each with different potential impacts on the business, as well as on the profit or loss statement. In advance of performing large-scale implementation, companies can first assess the After assessing the impact on your IT systems, we will work with you to identify and implement pragmatic steps to fill any gaps identified, leveraging any Solvency II synergies we can as effectively as possible. As the World’s largest supplier of actuarial software, we are able to offer a wide range of modular software solutions to help in your IFRS 17 implementation
  9. 9. willistowerswatson.com It is now time for action 9 © 2017 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. Design, implement and test IT and reporting processes As a result of the introduction of IFRS 17, there will be a significant change for insurance groups in the content and structure of data captured from business units to support group statutory and regulatory reporting. A key challenge will be to ensure that these different types of data are available and that systems have the flexibility to accommodate differences between Solvency II and IFRS 17. We are an integrated consulting and software provider, and our experts provide business advice, solutions and software. We will work with you to help specify the actuarial IFRS 17 requirements for your specific situation. We can then design, implement and automate your actuarial reporting processes, taking into account best practice processes, and the latest IT and software solutions. For many insurers, the optimisation of existing actuarial processes will already be underway. However, if you haven’t yet started to optimise your processes, there is still time and we can help you to undertake the necessary steps. And if you are already working towards optimising your systems, we can provide an independent view to help ensure you are on track to deliver the right processes, with the right specifications, at the right time – and crucially that it is suitable for IFRS 17. Finally, as experts in software development and implementation, we have developed an implementation process and standards guide that can be adapted to best meet our client’s needs for the IFRS implementation project. And a phased test process for predefined test cases assures the functionality and quality of the implementation.
  10. 10. willistowerswatson.com It is now time for action 10 © 2017 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. Employee and management training The processes developed to report under the new insurance accounting standard will need to be auditable. To successfully implement and embed all the changes required under IFRS 17 insurers will need a proper understanding and buy in across their teams. Monitor developments While IFRS 17 is final, there is still possibility of further development. The IASB is establishing a Transition Resource Group later this year that will advise the IASB on implementation issues. Actuarial staff need to be in a position to specify necessary cash-flow modelling changes and amendments for IFRS 17. This requires investment of time and resources into educating and training staff and management. Whether or not this leads to any specific changes to IFRS 17, it is likely that further clarification from and guidance will result from this feedback process. Companies will need to be aware of and adapt their implementation for such developments.
  11. 11. willistowerswatson.com About Willis Towers Watson Willis Towers Watson (NASDAQ: WLTW) is a leading global advisory, broking and solutions company that helps clients around the world turn risk into a path for growth. With roots dating to 1828, Willis Towers Watson has 40,000 employees serving more than 140 countries. We design and deliver solutions that manage risk, optimize benefits, cultivate talent, and expand the power of capital to protect and strengthen institutions and individuals. Our unique perspective allows us to see the critical intersections between talent, assets and ideas — the dynamic formula that drives business performance. Together, we unlock potential. Willis Towers Watson 71 High Holborn London WC1V 6TP Towers Watson Limited (trading as Willis Towers Watson) is authorised and regulated by the Financial Conduct Authority in the UK. The information in this publication is of general interest and guidance. Action should not be taken on the basis of any article without seeking specific advice. To unsubscribe, email eu.unsubscribe@towerswatson.com with the publication name as the subject and include your name, title and company address. 11 Willis Towers Watson is uniquely placed to help both Life and P&C insurers interpret and implement the new standard developed by the IASB. We:  Advise more than three-quarters of the world's leading insurers  Are the industry's leading risk specialist and a leader in financial modelling  Are the largest provider of actuarial software in the world  Have more actuaries and chartered enterprise risk analysts (CERAs) serving the insurance industry than any other professional services company Willis Towers Watson and IFRS17 © 2017 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only.
  12. 12. willistowerswatson.com More on IFRS 17 12 © 2017 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. From our website • IASB issues IFRS 17 Insurance Contracts, starting the countdown to 2021 • International Financial Reporting Standards • How we can help you turn IFRS 17 into a success story • Software Solutions for Life Insurers • Software Solutions for Property & Casualty Insurers • Solvency II One Year On For more information about how we can help you turn IFRS 17 into a success story, please contact your Willis Towers Watson consultant or Richard Bulmer +44 1737 274135 richard.bulmer@willistowerswatson.com Kamran Foroughi +44 20 7170 2743 kamran.foroughi@willistowerswatson.com Roger Gascoigne +420 226 294 449 roger.gascoigne@willistowerswatson.com Andreas Schröder +49 221 80003460 andreas.schroeder@willistowerswatson.com

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