In May 2017, the International Accounting Standards Board (IASB) issued the International Financial Reporting Standard for insurance contracts (IFRS 17). After several rounds of discussions by the Transition Resource Group (TRG) and consultation with various stakeholders, the relevant amendments to IFRS 17 were finalized and released in June 2020. The final standards (together with the amendments) will take effect starting Jan. 1, 2023.
Since the issuance of the standards, insurance companies worldwide have started work related to implementing IFRS 17. This article introduces the progress of IFRS 17-related implementation in mainland China and Hong Kong and considers the challenges and other factors that should be taken into account during the implementation process. We hope this article provides valuable insights for companies as they embark on their journey to IFRS 17 implementation.
Updates on IFRS 17 Implementation in Mainland China and Hong Kong
Many countries and regions around the world recognize and will adopt IFRS 17 to replace the current accounting standard IFRS 4. The Hong Kong Institute of Certified Public Accountants (HKICPA) announced the word-for-word adoption of IFRS 17 in January 2018 and issued the “Hong Kong Financial Reporting Standards No. 17.” In December 2018, the Ministry of Finance of the People’s Republic of China issued an Exposure Draft of the insurance contract standard, and it intends to officially release the Chinese version of the new insurance contract standards in the near future.
The Hong Kong insurance industry has been a pioneer in the implementation of IFRS 17, and many large multinational insurance groups with regional headquarters there have formulated a standard set of approaches and procedures in the implementation of this new accounting standard. As of December 2020, most insurance companies in Hong Kong have nearly completed the technical interpretation and design stage of implementation, and they have entered into the system implementation phase, carrying out the improvements to existing financial, actuarial and business-related systems and processes, as well as the construction of IFRS 17 sub-ledger systems and data platforms. System testing work also is being carried out simultaneously.
IFRS 17 implementation in mainland China is lagging behind Hong Kong, mainly because the Ministry of Finance has not officially released the new insurance contract standards and many insurers are taking a “wait-and-see” attitude toward IFRS 17. But notable progress has been made by large insurers or insurance groups listed in Hong Kong because they need to comply with Hong Kong’s regulatory requirements. These companies are in different stages of implementation, but most of them are initiating or in the process of the design stage. Unlisted companies, with the exception of a few large insurers, have not yet started the implementation process. In general, the insurance industry in China understands to a certain degree the potential impact and challenges of the new insurance contract standards and is actively involved in planning for the changes.
Challenges and Considerations for IFRS 17 Implementation
The IFRS 17 implementation project represents an opportunity for most companies in terms of financial transformation, and it more closely resembles an information technology (IT) system project rather than a technical project that considers accounting interpretations. The implementation process requires close communication and collaboration among finance, actuarial, and IT staff. From the initial planning stage to the system go-live, the overall commitment, skills and competency requirements of IT staff will continuously increase, and the roles of actuarial and finance staff will gradually shift from leading the work of standards interpretation and technical solutions to supporting and assisting with system implementation. Depending on the size of the company, the complexity of the business, the current state of data and systems, and whether there are multiple reporting requirements, the overall implementation efforts will vary—but it is expected that companies will continue to invest a considerable amount of resources in the implementation and testing of the systems.
In terms of the approach or focus of system implementation, there may be varying practices for different types of insurers. The business models for group companies, life insurance companies, general insurance companies and reinsurance companies are all different, and this will have an impact on the implementation approach. In the following sections, the main challenges and factors to be considered in the implementation of IFRS 17 for these types of insurers will be explored.
The main challenge for insurance groups in implementing IFRS 17 lies in the design of the financial reporting system at the group level and project organization across different subsidiaries. To implement the standards, the group company first needs to determine how to deploy the system—either centrally at the group level or in separate subsidiaries. The common approach is to design at the group level based on the core businesses and then roll it out to the subsidiaries and make necessary adjustments. Decentralized deployment in subsidiaries also exists if the business systems of the subsidiaries are highly differentiated or if the group’s management is not efficient.
In terms of project organization, effective project management and decision-making mechanisms are crucial for the successful implementation of IFRS 17 for insurance groups. The structures of the management group and working group play a pivotal role in the implementation of the group’s projects. For example, whether the working group has clearly defined roles and responsibilities, whether the communication and escalating mechanisms are smooth and effective, and whether core members of the team can provide continuous support throughout the design, implementation and testing phases are key to success.
The costs to implement IFRS 17 at different stages of the project are another important factor. Some large insurance groups invest a significant amount of manpower and financial resources in the early stages for the interpretation of standards and system design. However, as the project progresses to the implementation and testing phase, the company gradually realizes that more resources should be deployed at later stages of implementation and incurs pressure in its budgets. Therefore, we advise companies to consider carefully the allocation of project time and cost during initial planning. In the development and testing phase, iterative developments could be considered to reduce costs, and industry experience could be utilized to understand where potential risks lie and avoid the more costly choices.
Life Insurance Companies
Many life insurance companies operate over a long time span with relatively outdated systems, so meeting the IFRS 17 requirement on data granularity and quality has become a major challenge in implementation. They may need to rebuild their systems (e.g., policy administration systems, expense systems, investment systems), create a big data platform, develop ETLs (Extract-Transform-Load) for data collection and interaction with other systems, and use ETLs or other tools to allocate and integrate data at different levels (e.g., expense allocation).
Actuarial system development also is an important part of the implementation for life insurers, with the challenges mainly in measurement (e.g., risk adjustment, time value of options and guarantees, reinsurance). Actuarial modeling may require consideration of the linkage of assets and liabilities, simulation of management actions and stochastic calculations, which pose greater technical challenges for actuaries.
Determining the opening balance at the transition date is more complicated for life insurance companies compared to other types of insurers. There is no industry consensus on the most appropriate approach that should be adopted for transition, with some companies preferring the fair-value approach to save on implementation costs and others preferring the full-retrospective or modified-retrospective approaches to achieve desired financial results. The latter means more stringent requirements on the availability and accuracy of historical data and models, and correspondingly leads to higher implementation costs.
General Insurance Companies
The impact of IFRS 17 implementation on the financial reporting of general insurance companies is relatively small compared to life insurers. The majority of general insurers, especially small and medium-sized ones, tend to adopt simplified methods for IFRS 17 implementation. For example, general insurers are more inclined to adopt the premium allocation approach (PAA) as their measurement model, as this approach is largely similar to current accounting standards and the accounting treatment is relatively simple, which can save on costs and implementation efforts. Short-term business, which accounts for the majority of general insurance companies’ business, will immediately qualify for the PAA. For the rest of the very few long-term insurance businesses, the standards require companies to perform the PAA eligibility test to decide whether such contracts qualify for the simplified approach. Therefore, the criterion used in the PAA eligibility testing model requires careful consideration, as it will directly affect the complexity of both technical interpretation and implementation for general insurers.
Furthermore, the vast majority of general insurance companies still use spreadsheets as actuarial valuation tools, but spreadsheets have limitations in terms of calculation power and cannot perform policy-by-policy calculations for long-term products. Whether to introduce a new actuarial platform or to perform policy calculations in the sub-ledger system will become an important consideration for general insurance companies during the implementation process.
Compared to direct insurance, reinsurance contracts normally have different terms and conditions, and the policy data underlying reinsurance contracts (required for valuation) needs to be obtained from the ceding companies. The business and operating model of reinsurers implies that they need to invest more effort in sorting out basic contract information and underlying policy data, as well as establish the mapping between reinsurance contracts and underlying policy information.
For reinsurers, many accounting judgments need to be considered. This includes relevant reinsurance contract information, such as:
- The termination clause used for determining contract boundaries
- Risk types of ceded business used for contract grouping
- Contract signing date, which affects the determination of the initial recognition date of the insurance contract group
The complexities in sorting out the underlying data and establishing the mapping between the reinsurance contract and underlying data include:
- For the yearly renewable term reinsurance business that may be assessed with the general measurement model as a long-term product, it is necessary to process and analyze the underlying insurance policy data. If the volume of data is significant and has not been managed properly in the system for historical valuations, the amount of effort involved in such activities is considerable.
- The frequency, accuracy, consistency and sufficiency of data provided by ceding companies across periods vary significantly, and delays in providing such information further complicate the process.
- The data granularity of the inward reinsurance business is different from the direct insurance business, and the inward reinsurance contract needs to be matched with the underlying product information and policy data. If the inward reinsurance business is subsequently retroceded to other counterparties, then it is necessary to establish the mapping between the original insurance contract, the reinsurance contract and the retrocession contract, which will add to the complexity.
These activities are labor-intensive and require a large number of finance and actuarial professionals who are conversant with the standard requirements and features of the reinsurance business. As the number of technical staff (including finance and actuarial staff) in a reinsurance company is relatively limited, the potential impact from this shortage is a factor that cannot be ignored.
The requirements of the IFRS 17 standards present difficulties in terms of technical interpretations. At the early stage when the standards were just released, companies invested a significant amount of effort in interpreting the standards, but the industry gradually came to realize that the impact on data, systems, processes and people will be more significant and far-reaching than originally anticipated. With less than three years remaining until the date of first application, the planning and ultimate implementation of IFRS 17 to achieve regulatory compliance will be challenging for insurers.
Copyright © 2020 by the Society of Actuaries, Schaumburg, Illinois.