Authors: David Brunsveld, Servaas Houben
Publisher, publication date: The European Actuary, 2020-07
In light of the potential audience of this article, we sometimes deviate from specific IFRS accounting terms.
IFRS 17 principles behind transition
IFRS 17 is the new accounting standard for insurance contracts, with an objective to provide users with relevant information about the financial performance of insurance contracts. Users can assess the effect of those on an entity’s financial position, performance and cash flows, and between entities globally.
To comply with IFRS 17, a transition is needed from current accounting (e.g. from IFRS 4) to IFRS 17, for all existing contracts. This is to account as if IFRS 17 had always applied and to derecognize balances that would not exist with IFRS 17 (with net differences booked in equity).
One outcome is an opening balance of expected future profits, the “Contractual Service Margin” (CSM). This CSM will gradually release into the P&L over time (in potentially many years). To determine the opening CSM one needs to use historical data about insurance policies and assumptions.
To transition, it is required to apply the “full retrospectively approach” unless this is “impracticable”. When “impracticable”, there is an option to choose between (a mix of) the “fair value approach” and a “modified retrospective approach”. We will call this the transition option. This option has potential value, as each insurer can make choices that fit more or less to their business context and value perspectives.
Transition approaches and options
IFRS 17 distinguishes three transition approaches:
- (Full) retrospective approach: the standard approach, unless “impracticable”. Past contracts are accounted for as if IFRS 17 had always applied. Requiring the use of historical data on policies, assumptions (setting), actual cash flows and at least annual (actuarial) measurements.
- Fair value approach: a choice if the full retrospective approach is “impracticable”. The CSM is the difference between the IFRS 13 fair value and the IFRS 17 estimate of insurance contract(s). IFRS 13 allows a buyer’s valuation and can result in different assumptions (e.g. discount curve, expenses), contract boundaries and risk assessments (risk margin, non-performance risk).
- Modified retrospective approach: another choice if the full retrospective approach is “impracticable”. This approach is to mimic the full retrospective approach as much as possible, allowing various modifications. It includes using all available information that would be used in the full retrospective approach, such as data about risk assumption changes since issuance or cash flow such as amounts charged to the policyholder.
Only the fair value and modified retrospective approach allow to combine contracts issued more than a year apart.
The table below indicates the relative business value contribution, for each combination of value factor and transition approach:
|Value factor||Fully retrospective||Fair value||Modified retrospective|
|Accuracy of estimates||++||+/-||+|
|Management information (e.g. trends)||++||–||+|
|Flexibility (tailoring potential)||—||+/-||++|
Table 1: assessment of relative value
There is an overarching consideration in the operational efforts and complexities from choosing to apply some mix of the fair value and modified retrospective approach.
The opportunity to optimize the transition option value lies in comparing the fair value and the modified retrospective approach, when tailored to the specific business context and value perspectives. A specific differentiator can be the business value from more (detailed, historical) management information.
Perspectives on value with the transition option
As the transition option allows for a transition approach per group of contracts, insurers can choose to vary approaches for example by product line. The following characteristics could be considered also:
- Closed or open books: for open book business information on trends is more relevant (to change its pricing, reinsurance contracts, claims management or acceptance). For closed books, less instruments are available and less historical information might suffice;
- Level of materiality: when lines of business or product groups are less material, the value from historical data could be less and a fair value approach might suffice. For material blocks, a detailed analysis might be more valuable;
- Company specific or industry pricing: when pricing is based on an own risk assessment, more detailed and historical information could be valuable. And lesser so when pricing (policies) are prescribed by a regulatory body;
- Type of profit sharing: profit sharing products are more complicated (e.g. to fulfil the criteria for fair treatment) and more nuanced or granular information might be valuable;
- Vanilla or non-vanilla: more complicated products may benefit from more detailed information over time;
- Product duration: products like lifelong annuities can’t be repriced, and less rich information might suffice. For pricing shorter term products it might be valuable to distill trends in performance.
- Portfolio transfers and M&A: for portfolio transfers or M&A activity, a potential buyer or seller could value a clear (audited) track record of past performance, impacting a deal or transfer price.
The fair value approach may seem the most practicable transition option, as it requires the least historical data. Nevertheless, the transition option could add more business value with more historical data. We think insurers will benefit from the transition option with taking broad perspectives on business value that align to their specific portfolio characteristics and context. We believe that doing so helps management to optimize business value while complying with IFRS 17.
 “Impracticable” depends on amongst others on costs and efforts needed to meet the requirement.
 E.g. on how to combine contracts or how to construct the discount rates,
 These factors are reasonable however indicative, assuming management’s perspectives on value for some insurer