The volatility of the profit or loss for insurance contracts: a comparison between the IFRS4 standard and the IFRS17 standard

Details

Supervisors

Courtois, Cindy

Faculty

Faculté des sciences

Degree label

Master [120] en sciences actuarielles, à finalité spécialisée

Abstract

This study aims to explore the expected effect and impact of the transition from the International Financial Reporting Standard 4 Insurance Contracts (IFRS4) to the International Financial Reporting Standard 17 Insurance Contracts (IFRS17) on the financial statement of an entity, and to identify how the volatility of the financial statement is impacted by the new standard. The current standard IFRS4 is set to be replaced by the new standard IFRS17. Where IFRS4 focuses on the enhancement of the information disclosure of insurance contracts, IFRS17 focuses on the enhancement of the quality, consistency and transparency of the reported amounts related to insurance contracts in the financial statement and statement of comprehensive income. Therefore, IFRS17 enforces precise and specific requirements. Moreover IFRS17 imposes the use of measurement models that are current. Whereas, IFRS4 allows a wide range of local accounting measurement practices. Those practices are detrimental for comparability of the information about the insurance contracts that a company issues and the reinsurance contracts that a company holds. IFRS17 allows to resolve the comparability issues. In what follows the scope, application and principles of the new standard, IFRS17, for insurance contracts are discussed and compared to those of the current standard IFRS4 in order to determine the effects of transitioning from IFRS4 to IFRS17. The extend of the transitioning impact that IFRS17 will have when first applied will mainly depend on which measurement approaches were used under IFRS4 and to which level those approaches were already aligned with the new standard. The change in standard is expect to principally affect the premiums, incurred claims and other expenses, the grouping of the insurance contracts, the accounting for the time value of money, the risk adjustment or margin and the requirement to regularly update the assumptions. The approaches of IFRS17 introduces a prospective view. The premiums, incurred claims and other expenses are expected to decrease due to the exclusion of the deposit component. The grouping of the insurance contracts is expected to be more granular. The accounting for the time value of money and the risk adjustment will change in computation. Plus, IFRS17 requires a regular update in the assumptions taken in order to be consistent with the current economic conditions. In particular this study finds that the total profit or loss recognized over the duration of the group of insurance contracts generally does not change between IFRS4 and IFRS17. Nonetheless differences occur within accounting practices in the amounts recognized in each reporting period and how aspects of the profitability of the group of insurance contracts are integrated in the statement of comprehensive income. The effect of applying IFRS17 on an entity’s equity will depend on a number of elements. When applied to short-term insurance contracts the equity will increase when transitioning to IFRS17. Since under IFRS4’s existing practices the liabilities for incurred claims are not discounted or the level of risk margin is higher than the level of risk adjustment. When applied to long-term insurance contracts, on the other hand, the equity increases when transitioning from IFRS4 to IFRS17 in case the historical rate is lower than the current rate, the risk margin is higher than the risk adjustment, or the acquisition costs are expensed as incurred under IFRS4. the equity decreases, however, in case the historical rate is higher than the current rate, the risk margin is lower than the risk adjustment, or the current value of minimum interest rates guarantees is not fully reflected in the measurement of insurance contracts. In addition, the influence of those effects on the key performance indicators - gross written premiums, insurance revenue, contractual service margin, return on equity and combined ratio - are examined. This study concludes that the volatility of the financial statement is likely to decrease under IFRS17 due to a lower amount of accounting mismatches and the requirement to reconcile accounting treatments of assets held as back-up of a portfolio of insurance contracts with the accounting treatment of the portfolio of insurance contracts itself.