Earlier this year, the IASB indicated that the effective date of the forthcoming insurance contracts standard could no longer be aligned with the effective date of IFRS 9 Financial instruments. In response to industry concerns – in particular, temporary accounting mismatches and volatility, and increased costs and complexity – the IASB proposed amendments to IFRS 4 Insurance Contracts.
The IASB now proposes two optional approaches to assist insurance companies until the new insurance contracts standard is issued:
1. Deferral Approach: Temporary exemption from applying IFRS 9
Under the “deferral approach” some entities would be permitted to defer the effective date of IFRS 9 until 1 January 2021 at the latest if their predominant activity is issuing insurance contracts.
The predominance criterion is assessed on a reporting entity level. For the consolidated financial statements of a group, the predominance criterion is assessed for the group as a whole. A subsidiary is only eligible for temporary exemption in its stand-alone financial statements.
The IASB does not provide users with a quantitative threshold for the predominance criterion. However, an example in the Exposure Draft indicates that an entity’s insurance activities may not be considered predominant if 75% of its liabilities are in the scope of IFRS 4. Also, no guidance exists on how to determine liabilities from insurance contracts, but the IASB mentions that other types of liabilities, like tax liabilities or pension liabilities, cannot be excluded from the calculation total liabilities even if they relate to insurance contract liabilities (and are included in other liabilities). Unit-linked contracts are not in scope of IFRS 4 and can therefore not be added to the liabilities from insurance contracts.
According to our analysis of the 2014 financial statements of Swiss insurance companies, the predominance criterion would appear to exclude the majority of entities that are commonly referred to as “insurers” from the deferral of IFRS 9. In our view, it is essential that preparers request the IASB to further explore different criteria that support the application of the “deferral approach” to as many insurers as possible.
The exposure draft requires that insurers applying the deferral approach are to disclose the fair value and fair value changes of financial assets that fail the SPPI test and therefore do not qualify for the “held-to-collect” or “held-to-collect-and-sale” business models applying IFRS 9. For financial assets held in the above-mentioned business models, irrespective whether the fair value through profit or loss option is used, insurers are to disclose the gross carrying amounts by credit risk rating grades, information about the credit risk exposure and credit risk concentration. In our view, an insurer therefore still needs to go through the classification criteria and the consequential measurement of its financial assets. Also, in order to be able to disclose meaningful information on credit risk, insurers will have to have started their assessment on impairment already now. Additional considerations need to be made in order to determine whether the disclosure requirements will cause system changes and other challenges.
2. Overlay approach
All entities that issue insurance contracts are allowed to apply the “overlay approach” to qualifying financial assets when the entity first applies IFRS 9. Eligible financial assets would relate to contracts that: (1) are in the scope of IFRS 4; (2) are classified at fair value through profit or loss (FVTPL) in their entirety under IFRS 9; and (3) were not classified at FVTPL in their entirety under IAS 39.
Under the overlay approach, an entity removes the incremental volatility in profit or loss which results from certain financial assets relating to insurance contracts that are measured at fair value through profit or loss under IFRS 9 into OCI, but not so under IAS 39.
The “overlay approach” might be used as a possible remedy when Swiss insurers do not meet the predominance criterion (based on our analysis). Whilst this approach may resolve the issue of temporary volatility and accounting mismatches, it may cause additional costs and complexity: Swiss insurers would have to develop methods to calculate the differences between IFRS 9 and IAS 39. We have heard that both IFRS 9 and IAS 39 would need to be run in parallel for financial assets to which the “overlay approach” is applied. This would also require adjustments to or new processing systems, as well as additional internal controls.
Insurers applying the overlay approach will have to disclose additional information about the amounts reclassified from profit or loss to other comprehensive income.
3. Responses and further development
Without a doubt, most (Swiss) insurer were hoping for a deferral of IFRS 9. The not further specified but intended high threshold may not be the solution Swiss insurers expected. Today, many insurance groups are diversified which leads to non-insurance contract linked liabilities. Therefore, it is questionable if they can meet the predominance criterion. Such insurers or groups still may apply the overlay approach which eliminates profit or loss volatilities from insurance contract linked financial assets. However, this is both costly and complex. It will therefore continue to be interesting to observe the comment letters IASB will receive in response to its exposure draft. We will continue to closely monitor these. Be sure to stay tuned.