Hello, and welcome again to the New Age of Risk Analytics, where we discuss the evolution of risk and finance integration into the new digital era. The new Insurance Accounting Standard, IFRS-17, has broader implications than some of our risk managers might realize. David Anderson, Advisory Director of Risk Consulting at KPMGUS, and Bryce Erhart, Director of Accounting Advisory Services at KPMGUS, discuss the standard and its implications for you. So we're here today to talk about IFRS-17.
Now, for our listeners who are not insurance based, can you illuminate for us exactly what that is? Yeah, so IFRS-17 is a standard, and the purpose of the standard was to bring about consistency and transparency within the financial reporting space globally. So historically, IFRS-4 is a primary reporting basis for insurance. IFRS-4 is not a specific standard, it allows much more broader interpretation context for local gap.
So insurers are able to report on a local reporting basis that's not consistent or unified across the globe. So IFRS-17, the primary objective is to bring that consistency and transparency within the financial reporting process and how it works across organizations, across geographies, really trying to tie everything together. If I am a user of the financial statements, whether I'm an investor or a regulator looking at how those financial statements work, I want to be able to understand the consistency and the difference between products across different geographies around the globe without having to put in some kind of understanding of what the differences within that local gap might be. So can you tell us how it differs specifically from local gap and how it differs from IFRS-4?
What are the advancements that are leading to that consistency? So IFRS-4 is a standard that basically tells you, as the preparer of the financial statements, to do whatever you used to do. So it's almost grandfiring in any old local gap. So what that leads you with is a global insurance accounting industry where everyone is doing something different for accounting.
So there isn't much comparability and that's why. So you can't go and compare a US company to a UK company because they're both maybe under IFRS-4 for reporting purposes, however, one IFRS-4 is different from another IFRS-4. IFRS-17 is a very comprehensive standard that now will take everyone that's under IFRS-4 reporting and put them on a same accounting basis. That's very well clarified.
Thank you. It certainly makes sense that we would need to do that as we become a more global interconnected world. What do you think that this addresses in terms of getting to that goal that was the biggest deficit? Is there an element of the standard that is most on point or is going to be the biggest driver of consistency among organizations worldwide?
Comparability. That's one of the biggest ones. Another one's transparency. Within the insurance industry today, there's a lack of transparency into insurance companies profitability.
So what that means is offsetting of gains and losses within a portfolio maybe. And what this standard tries to do is separate out profitable contracts from unprofitable contracts and then it tells you within disclosures, hey, these are the problem areas of this insurance company. And one of the other, one of the pieces of that is within the new disclosures, you kind of paint the picture of how management is actually creating their contracts and how they are handling the different products that they have. So there's kind of a play there of trying to achieve the objective of the requirement while not basically giving away the secret sauce of how management is actually managing their running business.
But the transparency aspect does provide a lot more granularity and level of detail in terms of how management is operating their portfolios, how they're pressing certain products, and how they're ultimately achieving profitability or lack of profitability. And that's what the disclosure is going to achieve. So that gives you, again, the element of transparency that the regulators are really looking for. It's just a question of how far you actually have to go.
Do you think the standard is really getting at what it needs to achieve the goal of comparability? Are there gaps? Are there other elements that could be tackled or might be missing? On the surface of it, it achieves what it wants to achieve.
And that is comparability, transparency, and consistency. But to be honest, it's going to be the user of the financial statements that decide how successful it is. And the same goes on the USGAP side. USGAP has targeted changes for life insurance accounting as well going on.
And users, again, they're going to have to judge whether or not they're getting out of it, what they want to get out of it. So TBD at this stage. But I would say, personally, that, yes, it achieves what it's set out to achieve. I know that there are probably a wide variety of concerns around implementation for people who are facing the standard.
That's an understatement. Well, please feel free to fill in that perspective. What do you think are the challenges that people are about to face? Our risk managers certainly want to know that as they try to balance what is going to be a fundamental restructuring of this perspective with the way that they've done business.
So the way the standard works is it requires you to group your policies in a specific way. And to do that effectively, you have to have data at a policy level. And it's a lot more data than we've ever had to have in the industry before. So there's challenges all the way from a data sourcing side through the calculation and all the way through to financial reporting and getting to the disclosure.
So the whole process is being re-engineered. And that's the approach that we've taken with a lot of the clients we've worked with is to develop this process of how do you build out an IFRS 17 infrastructure from data sourcing all the way through the calculation and get to the financial reporting and the disclosure piece of it. That whole engineering architecture, it gets a completely different view than what's historically that. And you've got to kind of change your mindset and how you build it out and work through the process.
There's introducing a lot of new complexity within the standard, not just in the business of the environment but also in the implementation process and throughout the design and build as well. So there's a lot of new challenges the companies are trying to deal with and they're trying to figure out how to handle all that and tackle all that at the same time. Well as people look at implementation, are you seeing challenges already? Is it the mindset that's the most challenging?
Is it the data that's the most challenging? What is causing people the most, for like the better word, agita and the ramp up to this? I think from an industry perspective, it's not just the data, it's the full picture. Understanding the full impact that the standard is going to have on an organization is challenging.
And seeing how much of an impact that's going to have across across the globe for these multinational organizations is creating a lot of angst internally. So you've got companies within the US that are US domiciled filers and this is just a compliance exercise for them and they have to file statutory financial statements in 30, 40, 50 different countries and they have to comply with the standard. You have other international organizations that are primary IFRS filers and it's their primary filing basis. It's a completely different way of looking at the standard and how you apply it.
Some companies are managing their business on it, some companies are again using it as a compliance-based exercise. But as you evaluate the way that you're going to comply with the standard and you think through all the different complexities of actually building out the process for beginning to end, it creates a huge, huge lift on organization in terms of the people and capacity they have to be able to do it. It creates a lift on them in terms of how they're actually going to maintain it in a business as usual environment. And it creates a lot of challenges trying to get budgeting improved for it.
And we've seen that throughout the industry and it's still good seeing that as a constraint now. And bringing that to the forefront for executives to understand the level of work that's involved to get the standard done right. There's also a bit of a shift in culture. In the past, you kind of have your accountants and your actuaries and your IT people working in silos.
And under this new framework, you need to be working in a more collaborative and communicative way across all three of those groups. And part of the operational complexity is how do you get these groups talking to each other. And it's not just how verbally right, but it's the systems. All of them are using different systems.
So there needs to be some way to take the systems that they're using to talk and incorporate those into one cohesive operating model. Is there anything that you've witnessed that you've found is helpful in people in that process? You're really talking about changing not just one culture in the organization, but you know, and when you're dealing with several silos, that's three. One option that some companies use is creating implementation projects that are based on each of those different silos.
There's an increased risk that runs there because those groups are not necessarily running in tandem. Running in parallel, but there's not as many communication overlaps. Another way, and this is what I would recommend, is going to the table together and speaking to the IT people, the actuaries, the accountants, all in unison. And when it comes to creating an implementation program, they all would come together at the outset and throughout the entire process, there is a level of communication and dependency amongst the groups that really helps to build out that culture.
And once it gets to the implementation phase, i.e. when you're putting together these new models, these new programs, processes, controls, you have outlined these different dependencies that exist, and by identifying them, you work in ways to accommodate them. That makes a lot of sense in terms of planning, and certainly starting from the same page is a big part of any long-term project like that. Can you speak a little bit about the recent delay and the deadline, what that was, what that means?
Is this a process of them re-evaluating the project on such a level that people should hold off until the dust settles before they begin planning an implementation? Or should they go like they're going to run out of time? So just to be clear, my personal view, no one should be holding off. You know, you have an extra year, everyone should be thankful that we have the extra year.
The extra year came to be through a lot of discussion with the ISV, which is the authority that essentially issued the standard, and there's a resource group, a transition resource group, and that group has brought a variety of questions and potential concerns to the ISV. And through that process, there's been amendments that have been made to the standard tentative amendments. And one of those amendments is the deferral. And what the deferral did is it said, okay, my transition date, 5 for 17, is first of January 21.
Now it's going to be first of January 22. So we almost reset the clock a bit. And you know, in this process, the ISV re-deliberated 25 or so issues. So the dust is settling.
It's almost completely settled, really. There may be a few additional things that come up here and there as we go through the implementation process, but that doesn't mean that we should be slowing the projects. What it does mean, though, is that we should take a breath, look at our implementation project, look at it as compared to 2021 versus 2022, and see where there's opportunities to do a little bit of additional work or cut back in areas. One of the important parts of this project is that there's a lot of companies that are using it as a value-add exercise as well, not just compliance.
So compliance is just taking the dots and crossing your T's on IFRS 17, but a lot of companies want to use it for actual transformation, finance transformation, operation, modernization, and they built in that. Now, realistically, with the 2021 date for transition, most companies were really going to be running up against that. Even the first movers, the first movers, which are the large multinational insurers that have a lot of people working for them obviously, weren't necessarily going to be able to hit that date. Now they have 2022, they have an extra year, they have the ability to move along and build into that process what they always wanted to, whether it is a transformation of your actuarial systems or for finance systems as an example.
Another place that some companies are going to be thinking through using this extra year is cost cutting within their implementation program. IFRS 17 is quite costly and that's because of the fundamental change in how you do your accounting and arguably some of your actuarial valuations right now. So some companies are thinking, maybe I don't need to do three dry runs, I only have to do two dry runs and because of that extra year, I have a bit of buffer in between them to be able to do the tweaks that I need to so I don't need three dry runs. So there's a variety of different things to think about there, but needless to say, there shouldn't be any pausing at this point and if you haven't started yet with your implementation, you should.
That's always a good message to have and it's never bad to be prepared for those insurers which are smaller and are non multinational and don't have this excess capital to build out a whole new infrastructure. What kind of time frame should they be looking at? Can they still approach seeing this as an opportunity and not just a limitation? Is all of that due to financial resources in terms of implementing this optimally?
Are there approaches that are advantageous for that level as well? I think there are approaches that are advantageous for the smaller insurers, especially with the additional year, you do have that ability. The place that's going to be the most challenging for them is obviously getting the budget but getting the resource as well. The insurance industry's job market is very tight right now.
There's a lot of accounting change happening in the US and internationally and I think one thing that a lot of people insurance companies are realizing is that I don't have the resource and I can't find the appropriate resource within the marketplace. Where do I get it? That's one of the reasons that it's critically important to start now if you have it because the longer you wait, the harder it is going to be to secure those resources. If you don't secure those resources, then the project may just fall down to a compliance exercise rather than having the opportunity to use any value add.
You may want it to just be a compliance exercise and that's completely fine and acceptable. Without the resources, you have a large risk of non-compliance or issues with the transition as VAU. A great example is IFRS-9 accounting change, so IFRS-9, a similar implementation program, a big lift in how you account for your financial instruments. Most companies were able to get to the finish line and adopt the standard as needed to be by the end of the transition period.
They got to the end, but they didn't have enough resource and time to be able to put in place the appropriate processes and controls. Because of that, now they're in a process to remediate a lot of these control failures in lack of controls that they just didn't have the time to put in place. So when you move that over into our insurance world, another place that you need to be thinking about is how are you going to be able to adapt your implementation program to not just think about getting across the line with the numbers, but getting across the line with the appropriate process and controls. A lot of our audience, sounds from the baking sector, why should our banking people care about IFRS-17?
How does that relate? That's a really good question because IFRS-17 is named insurance contracts, so if you don't issue insurance contracts, why should you care about it? One of the most fundamental things about IFRS-17 is that its scope is determined on a contract by contract basis. So if you were to compare that with US GAAP, US GAAP's scope for their insurance standard is on an entity basis.
So if I'm an insurance company in the US, I apply the insurance company standard for US GAAP. However, in the IFRS world, if I issue anything that is an insurance contract, then I have to apply for a 17 to that contract. And believe it or not, there's a lot of companies out there that may issue insurance contracts and they don't even know it, and that's because of what the definition says. I won't get into the definition, but the point of this is that entities, whether an insurance company or not, need to think through whether or not you are issuing any insurance contracts.
Now, within just the aura of business, most of the areas outside of insurance companies that are going to be affected by this are banks. And within the banking sector, there could be some types of contracts that are considered insurance. And that would be essentially contracts that are issued that have some form of non-financial risk tag to them, non-financial risk being any sort of mortality risk, for example. So one example could be some sort of loan, whether that be a mortgage or a student loan that has a waiver of principle upon death.
That in and of itself could be an insurance contract. Now one part of these amendments that we were talking about earlier is how to deal with those types of contracts. And there is a tentative amendment that would say that there's a choice as to how you would deal with that, you either count forward under the financial instruments standards or under the insurance contract standard at UIFRS 17. But what's important here is that from the accounting perspective, that's an insurance contract.
So the working assumption is that it would be an insurance contract and you have to make a choice as to whether or not to pull it out and count for under IIFRS 9, which is the financial instruments standard. So the important thing to take away from this is that if you are a bank, there is at least some sort of assessment that needs to be had as to determine whether or not you do have any insurance contracts that you are issuing. Can you talk a little bit about the intersectionality between all of these different compliance standards and as the financial world becomes more interconnected, not just in terms of geographical, also business lines merge together. What do insurers need to know about CISO, what do banks need to know about, if you could address that?
Yeah, no worries. So I touched on what the banks need to know about IIFRS 17, so let me take it the other way. Insurance companies make a lot of their money through investments, right? So they have a very heavy portfolio, investment portfolio, that investment portfolio is achieving two things.
You're trying to achieve spreads to make money, but you're also there. It's there to support your liabilities, and that's what helps to make up your surplus. So naturally, there's a left side and right side of the balance sheet. What we've been discussing a lot today is the rights of the liabilities, the insurance contract liabilities.
The left side, you have the investments, and so there's a lot of change happening there as well, right? You have IIFRS 9 from the IIFRS space, and you have CISO from the US gap space. So insurance companies are in a unique position where they have some very important changes that are happening to them right now, and there's a very important interaction that exists between the assets and liabilities within an insurance company, where they're essentially trying to match the assets and liabilities in the recognition patterns, et cetera. So it's not just accounting change, but it is truly the interaction and how that volatility from recognition of assets and liabilities flows through to the income statement, and how the interaction of those two could actually impact the profitability of the company.
So because of that natural interaction, there's a lot of work that is done and needs to be done around how to help mitigate any sort of unnecessary volatility, how to use accounting policy choices to help you achieve the accounting that best reflects the economics of the assets and liabilities. Oh, there's actually been, I've been reading some concerns around the standard contributing to volatility. Do you want to speak to that at all? Sure, and I think that comes up because naturally with IIFRS 17, it's the best estimate liability.
So what that means is that each period, the assumptions are essentially updated. So part of the assumptions that are updated are financial assumptions, so that includes things like discount rates. In the past with insurance companies, depending on which jurisdiction you were in, of course, some of those financial risk assumptions were not updated. They were locked in.
Therefore, there was usually no volatility that was coming through the P&L. Under this new world of insurance accounting, there's going to be volatility that comes through the P&L as a result of changes in financial risk. Now, there's a variety of aspects of IIFRS 17 that are there to help an entity manage that volatility, such that you could take changes in risk for certain portfolios, and instead of putting them in the P&L, you put that change in the OCI, OCI being other comprehensive income. So, and there's a variety of other choices that exist to ensure is to help them manage that volatility.
Now, that's on the liability side. Of course, the best way to identify what the volatility is going to be is by looking at the asset side and matching up your recognition for the asset's liabilities. So for example, if I were an insurance company and I have an asset portfolio that's primarily recognizing changes in fair value going through my P&L, most likely I'm going to want my changes in financial risk associated with the liability to also go through the P&L. That way, it's matching.
If I were to use one of those OCI option to take the financial risk changes in the liability to OCI, that would create volatility that wouldn't necessarily have been there under previous accounting standards. That's very well explained. Thank you. Very much for that.
You know, obviously our audience is risk managers across the financial spectrum and also on other industries. Is there anything you can identify that you think our audience needs to know and understand whether they're insurers or not about this new standard? Can you speak on an analyst level? What are some of the challenges that our listeners and audience who are in that role might be finding in the upcoming few years?
Yeah, absolutely. I think from an analyst perspective, there's a lot to think through with IFRS 17 and it specifically goes to the heart of what are these new financial statements going to look like and what is an analyst going to use them for and how is their job going to change when they are looking at them? And part of that education, right, understanding what the standard is, interacting with the key insurance companies that you're analyzing. One thing that analysts could do is reach out to those companies and simply ask them, hey, what are you doing for IFRS 17?
Do you have a feel for how it's going to change your financial statements? Can you just help me understand what I should be expecting? Now, the onus is on the insurance companies here, though, and one of their big tasks is educating the marketplace with regards to what their results are going to look like and essentially how to tell their story. And that's something they're thinking through right now.
It's a big, big effort within the insurance industry right now, especially those that have to address IFRS 17 and also US GAP's long duration target improvement standard. And that is, how do I tell my story? The sort of even starting to tell your story is building an expectation for the users of your financial statements, including your analysts. But what I would suggest is that those analysts also take a bit of directive and try and reach out to those specific insurance companies and simply ask them, how's it going?
And do you have any ideas to what I'm going to be seeing in three years' time? I think that's an incredibly helpful. I thank you so much for your time today, and I know you have a lot of work to get done in the next few years. So we wish you the best for that.
We thank you for taking the time to speak to you. Well, I really appreciate that opportunity. Thank you. Thank you.
Thank you to Bryce and David for speaking with us, and thank you for joining us on the New Age of Risk Analytics. Please subscribe on your favorite podcast platform to be notified of future episodes. And visit sass.com slash risk for information on these and other risk topics.