- Captives must understand what constitutes insurance contracts
- Captives should value direct risk and reinsurance separately
- Asia Pacific domiciles conforming most tightly to IFRS 17 reporting standards
- Singapore implementation increases bureaucracy with no added benefit
The implementation of IFRS 17, particularly in certain jurisdictions, has had significant implications on the way insurance contracts are valued with some commentators suggesting it is stifling experimentation and innovation.
IFRS 17 is an International Financial Reporting Standard (IFRS) that replaced IFRS 4 and has been implemented by the International Accounting Standards Board (IASB) and provides new insurance contract guidelines.
It applies to jurisdictions that require or permit IFRS, though some countries continue to use local Generally Accepted Accounting Principles (GAAP) instead.
In some domiciles, captives may be allowed to use IFRS 17 voluntarily or follow local GAAP standards, but this varies by country.
Those jurisdictions where implementation of IFRS 17 is most stringent, primarily in Asia Pacific, service providers and captive owners argue the new accounting standard is overly burdensome and costly for captives.
As in the case of other regulations such as Solvency II, IFRS 17 designed with larger insurers in mind, but captives are caught up in changes.
Bron Turner, partner and sub sector lead for captives at KMPG Bermuda, said that for most of his book across different regions, there were three main approaches taken.
Turner covers several regions, including Bermuda, the Caribbean, Crown Dependencies and Malta.
He said the first approach was to completely drop IFRS reporting, because there was no statutory requirement to produce GAAP financials.
“GAAP financials include IFRS, US GAAP, or UK GAAP, and instead, companies would just meet the local regulatory filing requirements,” he told Captive Intelligence.
Turner said that for jurisdictions where only local statutory financial statements are required, regulators allowed for the ‘grandfathering’ of IFRS 4, or the old regime for accounting for insurance contracts.
“The second approach was to convert to US GAAP, or UK GAAP for example, which simplified the transition to the new reporting framework,” he said.
“The third approach was a kind of dual exercise, where companies kept their old IFRS 4 accounting and made ‘top-up’ adjustments to bring in IFRS 17 numbers.”
Turner said this was often the case when companies were only writing one contract, for example.
“For filing purposes with the regulator, they continued using IFRS 4, but for parent consolidation reporting, they transitioned to IFRS 17,” he added.
Turned highlighted that less than 5% of his entire book have transitioned to IFRS 17.
“Most have transitioned to a different GAAP,” he said. “What will be interesting, though, is whether UK GAAP or other similar standards convert as well.”
Susan Dreksler, an actuary and partner at KPMG UK, believes the driver behind IFRS 17 was creating consistency across the globe, particularly for large multinationals that had entities reporting under different accounting standards.
“Especially life insurance companies, which often had huge variations in how they approached things,” she said.
“The purpose of IFRS 17 was to bring a more consistent framework for those large multinationals. For captives, they’re subject to the same rules, but it does not necessarily provide them with much of an advantage.”
Dreksler said we cannot rule out the possibility someone might question whether IFRS 17 is really adding value to captives.
“We’ve seen this with some of the Solvency II stuff,” she said. “They might start considering alternative approaches internationally.
“For example, with Solvency II in the UK, they’ve already eased some of the requirements for smaller entities.
“At some point, they might recognise that the requirements under IFRS 17 are a bit too onerous for smaller entities as well.”
Challenges
One of the main changes under IFRS 17 standards is how insurance contracts are valued.
“The standard does not apply to the company itself, but rather to the contract,” Dreksler said.
“A company does not have to be an insurance company for IFRS 17 to apply – it is the contract that matters.”
Dreksler said that if a client is engaging in activities that resemble insurance, those contracts may still be subject to IFRS 17, even if they are not legally an insurance company.
“This distinction is crucial, and I think many people have missed it,” she told Captive Intelligence.
“It’s about looking at it through an IFRS 17 lens, not a legal lens, to determine whether the contract qualifies as an insurance contract. If it does, then firms need to apply IFRS 17.”
Dreksler said IFRS 17 might capture things firms had not previously regarded as insurance.
“Second, it requires people to look at their contracts in a different way,” she said.
Dreksler noted that the key issue is that most captives take on the risk from the parent company and then reinsure it out.
“Under the previous regime, they could net down much of that transaction,” she said.
“For example, if they had a 100% quota share agreement, they’d end up with no liability, because the risk would come in and go out.”
Under IFRS 17, captives need to value their own writing and reinsurance separately, and this can create challenges for captives because the values will not quite match.
“They need to account for the risk of default on the reinsurance, so they will not align perfectly,” Dreksler explained.
“It may not be a huge difference, but it does mean they will need to do an additional calculation to comply with the rules and doing that reinsurance calculation can actually be a lot of work.”
For example, Dreksler highlighted that a company must also project their future cash flows under IFRS 17.
“They have got to discount them back to the present and got to come up with a discount rate to do that,” she said.
“If the business is not eligible for PAA (Premium Allocation Approach), they need to do that for the unexpired risk as well as the risk that they’ve already written, and they have to hold a CSM, which is a balancing item to make sure they do not recognise profit before it’s actually earned.”
Global impact of IFRS 17
The impact of IFRS 17 is being felt differently in each jurisdiction dependent on how IFRS 17 is being implemented.
Kelvin Wu, president of the Captive Insurance Association Singapore (CISA), and treasurer of PARIMA, said that the long-term impact of IFRS 17 is not yet fully understood by all the stakeholders in the jurisdiction.
“In the short term, IFRS 17 clearly affects the initial years of reserving, but we’re still unsure how it will play out in the long run and how it will impact the release of profits back into a captive’s balance sheet,” he said.
Wu said that full understanding is crucial for long-term strategic planning for a captive.
“It also affects the viability of smaller, niche insurance contracts that captives were ideal for,” he said.
Wu said the cost of acquisition for each new contract has increased, and now clients must factor in the added audit and actuarial fees.
“This means the minimum premium for each new line of business has risen, which affects the long-term viability of the captive and the types of risks it can write.”
Steve Tunstall, captive director and general secretary at CISA, said the way IFRS 17 is being applied in Singapore is “very disappointing”.
“It feels like a sledgehammer trying to crack a nut,” he said. “While it has some relevance for large insurers, it has zero relevance for single-client captive insurance companies.
“The challenge is that it significantly increases bureaucracy without providing any real benefit.”
Tunstall said service providers are often confused about how to apply these regulations to such small entities.
“As a result, they tend to overprice their submissions because they do not fully understand the requirements,” he said.
“This creates a chilling effect on captives’ willingness to experiment, which I believe is quite dangerous.”
Joyce Chua, regional managing director of captive & insurance management solutions in APAC at WTW, said IFRS 17 implementation has been a significant challenge for most insurers including captives, and she has observed a notable increase in operating costs particularly stemming from the actuarial and auditing functions.
“Those fees can vary in accordance with the size, scale and complexity of the captive operations,” she told Captive Intelligence.
“For example, large and complex captives writing multi-year construction risks may be subject to rigorous testing procedures by the auditors when determining the Premium Allocation Approach (PAA) eligibility.”
Lawrence Bird, captive consulting leader at Marsh, said FRS 17 implementation has been a difficult process for all Asia Pacific domiciles.
“It has been challenging for clients, captive managers, and auditors alike,” he told Captive Intelligence.
“Although most captive domiciles outside of Asia Pacific have not adopted IFRS 17 as a standard, it is hoped that after the implementation challenges, matters will settle down significantly.
“In addition, effectively there is a requirement now for actuarial assessments to be completed, which did not exist under the previous accounting standard in the region, IFRS 4, although many of the non-Asia Pacific domiciles had some form of actuarial requirement already so from a cost-perspective, this will likely be similar amongst domiciles.”
Turner believes when it comes to jurisdictions he is working with, the regulators have been very accommodating in terms of companies transitioning to IFRS 17.
“I also have a client that has operations in Singapore, where they’ve had to prepare two sets of financial statements – an IFRS 17 set and local regulatory reporting (MAS reporting) which is more aligned with IFRS 4,” he said.
He added the client adopted IFRS 17 purely for the business in Singapore as required, which has become quite expensive.
“Their systems are not designed to provide the granular level of detail required for IFRS 17 financial statements,” he said.
“As a result, they’re having to make manual adjustments and top-ups, extracting data from their systems to generate the necessary information. It’s become a very onerous exercise.”