Authored by Michael Dubin
The business of insurance is unique in that the primary cost of the product is unknown at the time of sale, and it may take many years before that cost is certain. In most businesses, accountants and business professionals can apply accounting rules to determine results of the business and compare to similar entities. The insurance industry, in contrast, requires the application of actuarial science to determine results, and then to merge those results with accounting rules in order to produce a meaningful financial statement. Thus, the determination of financial results for the insurance business can be very complicated; whether the business is long duration, such as selling life insurance contracts that last for the policyholders’ lifetimes; or short duration with a long tail, such as selling workers compensation insurance to employers obligated to pay lifetime medical costs for employees suffering permanent injury.
For a business as complex as insurance, accounting rules should never be expected to provide a perfect picture of results. This is not to say accounting rules do not allow users of financial statements to compare results of similar entities – they indeed do. However, with stagnant accounting rules, accountants and actuaries can become complacent and forget that the true picture of results is more complex than any set of rules has the ability to portray.
IFRS 17, which the implementation was recently delayed from 2021 to 2023, is the most important accounting change for the insurance industry in at least 20 years, and it has been over 10 years in the making. IFRS 17 represents an opportunity for collaboration between the actuarial and accounting professions, that happens only once or twice in a career, to create standards for the next generation. The current transformation of the insurance industry toward using increasingly complex models and analytics, IT resources and data sources increases the opportunity for companies to benefit from IFRS implementation. While the text of IFRS 17 is virtually complete, it may take some time for a clear set of acceptable judgments, practices and documentation to evolve.
At its heart, IFRS 17 simply clarifies that contractual insurance liabilities are equal to a contractual service margin (CSM) that is amortized over the duration of the contract, plus the present value of the best estimate of future cash flows, adjusted for risk. The details are complicated by the immense variety of insurance contracts.
Below are seven areas, affecting both life and health and property/casualty (P&C) insurers, that will require actuarial judgment and documentation for IFRS 17 compliance:
Due to the risk inherent in insurance, many actuarial models and analytics are used to make business decisions. These models are increasingly complex and do not necessarily comply with accounting requirements (e.g., management may want to model the impact of various discount rates or risk adjustments without regard to whether those assumptions meet accounting guidelines). Actuaries are already working with IT departments to create more complex models for analytics and other business purposes. IFRS 17 presents an opportunity to modernize financial accounting systems at the same time. Some of the benefits include team collaboration, business insight, financial transparency, regulatory compliance, and a single source of financial and actuarial data. These benefits may help with adoption of predictive analytics, machine learning and robotic automation, as well as valuing mergers and acquisitions (M&A) and insurtech targets.
For more information on these topics, or to learn how Baker Tilly’s Value Architects™ can help, contact our team.