IFRS17 overcomes following IFRS4 limitations- 1. the sensitivity of profits to reserving assumptions 2. the lack of comparability of different life insurance companies 3. the early recognition of premiums and profits for long-term contracts Explanation for #3 is very clear when we consider how CSM is defined in IFRS17. How does IFRS17 overcome #1 and #2 above?
Also, how is #3 a problem for regulator (hence the need for IFRS17)? I understand that recognizing full profit for long term contract at inception is not ideal. However, how will balance sheet be affected if insurer does so/adopts to IFRS17? Is there anything which is detrimental for policyholders/regulators/shareholders if full recognition is done at inception?
IFRS 4 permitted companies to continue using their local GAAP (provided it met certain conditions). This could use a prudent reserving approach with each insurer able to choose its own level of prudence - so there is lack of comparability in terms of different insurers having different degrees of prudence (#2). Also, relating to #1, changing prudence margins could lead to profit variation - which is now removed. And IFRS 17 now smooths profit emergence through the use of the CSM, which is not a feature that would typically be found under local GAAPs.
Remember that IFRS accounts are not prepared for the regulator (which is interested in solvency), they are part of statutory reporting (emphasis on profit emergence). Full profit recognition at inception is not deemed appropriate from an accounting perspective as it leads to 'lumpy' profit emergence (depending on volumes of business being sold) and it recognises profits before they have actually been earned - which goes against standard accounting principles.
Yes alright. Anything to add with respect to whether IFRS4 was more beneficial for insurers or not? If actual profit was higher than actually earned, it must have been misleading for stakeholders of insurance companies surely. For insurance companies, lower profit now for IFRS17 would reduce their tax liability. Few more quick wins of IFRS4 vs IFRS17? Keen to know.
IFRS 17 addresses the limitations of IFRS 4 by introducing a new approach to accounting for insurance contracts that is based on the principles of the economic substance of the contract rather than its legal form. This new approach is intended to provide more relevant and reliable information to financial statement users by better reflecting the economics of the contract and the risks inherent in it. To overcome the sensitivity of profits to reserving assumptions, IFRS 17 requires companies to use a consistent, principles-based approach to determining the amount of the contractual service margin (CSM) for each insurance contract. The CSM represents the difference between the premiums collected and the estimated future cash flows to be paid under the contract, and is intended to reflect the profits expected from the contract over its term. By using a consistent approach to determining the CSM, companies can provide more reliable information about the expected profitability of their insurance contracts. To overcome the lack of comparability of different life insurance companies, IFRS 17 requires companies to use a consistent approach to measuring and presenting the CSM for each insurance contract. This includes specifying how the CSM should be measured, how it should be allocated to periods of coverage, and how it should be presented in the financial statements. By using a consistent approach to measuring and presenting the CSM, companies can provide financial statement users with more comparable information about the profitability of their insurance contracts.
