IFRS 17 Full retrospective approach – When insurers apply IFRS 17 for the first time, the transition provisions of IFRS 17 require full retrospective application. However, a modified retrospective approach or a fair value method are allowed under circumstances where the full retrospective approach is impracticable.
Applying the full retrospective approach for IFRS 17 means that the contractual service margin (CSM) at the date of transition to IFRS 17 will be based on an assessment of the CSM (unearned profits) for each group of contracts at inception of the group and a roll-forward of those amounts to the transition date. The CSM at transition will be an important aspect of the capital impact on transition and on future accounting earnings.
Accordingly, insurers are evaluating the transition requirements and assessing alternative transition strategies to mitigate the impact of IFRS 17 on their future accounting earnings. These strategies might include reinsurance or divestiture of onerous blocks of business or certain assets. In many instances, the feasibility of these strategies will depend upon the regulatory and tax environment post-transition.
Full retrospective transition
A reporting entity should apply the Standard retrospectively unless impracticable, with two exceptions:
- Exception 1: There is no requirement to disclose for the current period and each prior period presented the transitional impact on each financial statement line item or on the basic and diluted earnings per share (where applicable) IFRS 17 Full retrospective approach
- Exception 2: It applies to insurance contracts with direct participation features where entities have previously documented an objective and strategy to use derivatives in order to mitigate financial risks arising from insurance contracts. In such cases, entities should only apply prospectively the option not to adjust the contractual service margin for the changes in the entity’s share of the underlying items caused by financial risk or for changes in fulfilment cash flows attributable to guarantees.
To apply the Standard retrospectively, at the beginning of the period immediately preceding the date of initial application an entity should follow the steps outlined below:
- Step 1 – Recognise and measure each group of insurance contracts as if the Standard has always applied,
- Step 2 – Derecognise any existing balances, which would not exist had the Standard always applied (eg deferred acquisition costs (DAC) or acquired value of in-force business (AVIF) intangibles), and IFRS 17 Full retrospective approach
- Step 3 – Recognise any resulting net difference in equity. IFRS 17 Full retrospective approach
Required presentation on the transition date balance sheet following the full retrospective approach
Full retrospective approach
Best estimate of expected cash flows (BE)
Expected present value using the discount curve and BE assumptions as per the transition date.
Risk adjustment (RA)
Based on assumptions and entity’s view as per the transition date.
Contractual service margin (CSM)
Based on the calculations of the BE and RA at the initial recognition date and consideration of account developments to the transition date.
Discount rate effect
Difference in expected present value of the insurance portfolio using the yield curve and BE assumptions at the transition date minus the expected present value using the curve on the initial recognition date and the BE assumptions as per the transition date. Note that this effect can be reflected in the CSM (if the variable fee approach applies), in the OCI or in the statement of profit and loss.
Completeness of data is a major issue. The retrospective calculation of a CSM under IFRS 17 requires data that companies have often not needed to retain in the past – such as initial premiums on single premium products, acquisition cash flows, and historic assumption sets – and some companies are finding this data now does not exist.
The granularity of data required poses another challenge under IFRS 17. The definition of a unit of account means that the data for a fully retrospective calculation is required not just at a portfolio level (i.e. for policies facing similar risks that are managed together), but specifically for groups of contracts issued within the same year and in the same group of profitability (as defined by paragraph 16 of the standard). IFRS 17 Full retrospective approach
In many cases data was never stored at this level of granularity – particularly in the case of actual (cash) movements – and new assessments of historic data may be required.
Even if data is found to be available, there are often problems faced in the ability to use that data to calculate a CSM.
Significant level of actuarial model development across the industry means that companies are often finding that their existing valuation systems are now not able to process this data, unless they undertake extensive further development specifically for this purpose.
The issue of hindsight is another challenge of a fully retrospective approach. IFRS 17 Full retrospective approach
Retrospective application is impracticable if it is impossible to calculate estimates at historic dates without the use of hindsight.
As companies develop accounting policies on areas of significant judgement, such as the calculation of the risk adjustment or liquidity premium in the discount rate, they must then consider the ability to apply these retrospectively, based only on the circumstances that existed at the point of recognition.
In addition, there are a number of issues that could give rise to differences between group accounts and those for subsidiaries preparing IFRS 17 accounts for local purposes, including:
- The requirement to build up the retrospective calculation of the CSM at each interim reporting date (where this takes place at a group level). IFRS 17 Full retrospective approach
- Expenses may be different in the subsidiary and group accounts if there is a profit margin on intergroup transactions. IFRS 17 Full retrospective approach
- The implications of internal reinsurance – potentially resulting in a different CSM at group level than the aggregation of individual entities. IFRS 17 Full retrospective approach
See also: The IFRS Foundation