Insurance Contracts: Why IFRS 17?

By Irene Peter Atolo

FCA, ACCA(DipIFRS) FCIIN.

To aid understanding, the essay is broken into the following sub-topics:

1. Introduction.

2. Definitions.

3. Why a Separate Standard for Insurance Companies?

4. What was the purpose of IFRS 4?

5. The defects of IFRS 4?

6. Why IFRS 17?

1.  Introduction

I entered the insurance industry in 1978 without much knowledge about insurance. I started with the reconciliation of brokers and insurance companies’ statements of account which was a hard job. Reasons why it was hard: the calculated premiums may be different from both sides, some brokers deliberately make payments on account so that when a claim is reported on an insurance contract for which money has been collected but not remitted the underwriter agents can ascribe some of the bulk payment to particular policies or policies; timing differences; a broker might have issued their cheques which have not been recorded in the books of the insurance company and an insurance company would have issued credit or debit notes not yet in the brokers’ books. Commission rates may be different. The most painful part was that these statements which were processed manually may not be mathematically correct and may cover more than a decade. It was a tough-tough job.

Insurance Companies’ reconciliation was worse. Many exchanges of businesses through facultative insurances or co-insurance businesses may never be paid for and some of them could exceed ten years still in the books. Overriding commissions was another difficult chore. There were numerous scenarios difficult to reconcile. NAICOM’s implementation of “no premium, no cover” changed everything.

As a newcomer to the department, my boss dumped many statements of long-abandon reconciliations on my table and gave me target-dates to complete them. Within three months I was able to make little progress but was contemplating resignation for full-time studies because of frustration. My employers suddenly allocated a new beetle car within three months of my tenure which forced me to abandon the idea and face job at hand. It made me realise my efforts were appreciated.

I moved through the ranks until I became the accountant in 1989 and later became the chief accountant in 1998. That same year, I moved to a new company where I was in charge of finance and administration for another decade. Phoenix Assurance, in particular, was where I hone my skills in preparing financial statements within insurance industry. A solid four decades has been poured into this practice.  So, I am qualified to say a word or two on the evolution of accounting practices, in pre-IFRS, during the introduction of IFRS 4 in 2004 and finally when IFRS was adopted legally in Nigeria in 2012. But was IFRS 4 used before 2012 in Nigeria? Arguably, yes. There were many changes introduced to improve the accounting practices in Insurance companies. Even though it has some limitations, it was far better -as we shall see later- than the Nigerian GAAP- Generally Accepted Accounting Practice.

2. Definitions

There are so many definitions of insurance. When I visited Guinea Insurance in 1969 in Investment House and asked my senior brother what was insurance, he told me that insurance is just when a group of people who are concerned that something bad or untoward may happen to them or their belongings; contribute money to Insurance companies so that if persons from that group suffer loses the insurance company will compensate them or attempt  to put them in the same position before the event/loss. When I was studying risk in financial management in my career I learned that insurance is a risk control mechanism whereby entities transfer the risk they would have borne to some organizations called insurance companies.

The definition when I started an Insurance professional examination was somehow similar to the above. For this article let me adopt the standard definition of insurance as per IFRS 17- Insurance contracts.

It defines an insurance contract as “ a contract under which one party (the issuer) accepts significant insurance risk from another party (the policyholder) by agreeing to compensate the policyholder if a specified uncertain future event (the insured event) adversely affects the policyholder.” The standard provides definitions to distinguish “insurance risk” from “financial risk.”

3.Why separate standards for Insurance?

The question is often asked why a separate standard is reserved for insurance companies. Banks and allied financial institutions including manufacturing have no special standards. The reason usually advanced for this is that IASB recognizes that the application of GAAP will not be appropriate as it would not reflect the view of an insurance contract. The main reason for this school of thought is that in an insurance contract the line between service and investment is relatively blurred. In the service part for instance, the recognition of the revenue is not easy to determine due to evaluation requirements of the attached risk which may vary very much throughout the policy which is the contract of Insurance. As regards the investment elements the main standard is IAS 39: Financial Instruments Recognition and Measurement now superseded by IFRS 9

Financial Instruments.

4. What was the purpose of IFRS 4

Because of the nature of insurance and the growing need to make insurance financial statements transparent and comparable across jurisdictions, the IASB started a project on insurance accounting. The project was in two phases. The first phase was IFRS 4 which was issued in March 2004 and the second and final phase which was issued in May 2017- IFRS 17.

Specifically, IFRS 4 was issued to guide accounting for insurance contracts: though very limited in scope and application. It was amended in 2005 to clarify that the standard covers most financial guarantee contracts. Paragraph 35 of IFRS 4 also applies the standard to financial instruments with discretionary participation features. These are the improvements introduced by IFRS 4:

i) Testing of insurance contract liabilities to ascertain their  adequacy— usually tested by actuary employed by the insurer.

ii) Testing of reinsurance assets to ensure they are  not impaired. The insurance company reinsurance assets are its securities known as  Reinsurance Companies where various insurance treaties such as facultative,  quota share, excess of loss or surplus treaties may be held. Some of these companies might go bankrupt or temporarily unable to settle their debts.

iii) It also prohibits the accruing of insurance claims that have not been incurred. This completely reverses section 20 (b) of insurance act 2003 which provides that outstanding claim at year-end should be grossed up by 10%, the 10% representing Claims Incurred But Not Reported (IBNR) as per section 20 (1b) of the act.

iv) It enhanced the disclosure requirement.

5. What are the defects of IFRS 4?

i) It was an incomplete standard and was designed only to provide limited improvements to insurance accounting pending the issue of a more comprehensive standard now known as IFRS 17.

ii) It permitted insurance companies to continue to use the previous accounting practices for insurance contracts.

iii) Out of the 14 members of IASB, only 8 supported the standard and the 6 dissenting voices gave various reasons for their actions either jointly or individually as follows:

•  Four Board members dissented with the temporary exemption of insurance contracts accounting from accounting policy changes as required by IAS 8—Accounting Policies, Changes in Accounting Estimates and Errors.

•  Four members dissented because IFRS 4 objected to the accounting for assets backing insurance companies-the so call shadow accounting.

•  Two members objected to the inclusion of financial instruments with discretionary participating features within IFRS 4 rather than IAS 39: Financial Instruments Recognition and Measurement now superseded by IFRS 9- Accounting Policies, Changes in Accounting Estimates and Errors.

•  One person dissented because IFRS 4 required to include the separate measurement of embedded derivatives that meet the definition of  insurance contract.

•  Tasumi Yanade a member of the Board dissented separately because he did not believe that IFRS 4 fully addressed mismatches between accounting for insurance contracts and assets backing the insurance contract.

•  Leisenring continued to criticize IFRS 4 after its issue; including a statement credited to him- “IFRS 4 is a gift of IASB to the insurance community that keeps giving. The exact way the incredible Warren Buffet described investment in listed equities.

6.Why IFRS 17?

In May 2017, the IASB issued IFRS 17 to replace IFRS 4, thus completing the second phase of the insurance accounting project and originally had an effective date of 1 January 2021. But in November 2018, the Board proposed an effective date of January 2022 with the year of transition of January 1st, 2021. Early adoption is permitted provided the entity has already simultaneously adopted IFRS 9: Financial Instruments and IFRS 15: Revenue from Contracts with Customers. Next week I will do a brief introduction of IFRS 17.