Insurance companies, including captives, are at different phases in their journey toward adopting the new International Financial Reporting Standard 17 (IFRS 17), which took effect across many markets around the world for reporting periods starting 1 January 2023. Despite this progress, many jurisdictions have delayed the implementation of IFRS 17 and will adopt the new accounting standard between 2024 and 2026.
What Is IFRS 17?
After over twenty years of development, the International Accounting Standards Board (IASB) issued IFRS 17 Insurance Contracts in May 2017, entailing a comprehensive new accounting standard for insurance contracts. In June 2020, the IASB issued amendments to IFRS 17, including changing the implementation date to 2023. Once effective, IFRS 17 replaces IFRS 4 Insurance Contracts; most companies are also adopting IFRS 9 on a parallel basis, which involves recognition of assets.
IFRS 17 is a market value-focused accounting standard for insurance contracts based on discounting future cash flows. Additionally, the standard recognizes profit over the period that services are provided under the contract. The new reporting standard brings material changes to accounting principles, rules, presentations and financial disclosures for insurance companies on how they should value and report insurance contracts. It also aims to bring greater transparency and comparability, especially with non-insurance sectors.
For the universe of captive (re)insurance companies, whose main role is to cover insurance risks arising from a parent company or specific related entities, those who publish financial statements in accordance with IFRS accounting standards will be impacted by IFRS 17 implementation.
Captive insurance is typically used by commercial or industrial groups. The benefits from this ‘intra-group’ insurance operation include effective risk management through a better assessment of group-wide risks, access to reinsurers, and negotiating power to transact with third-party reinsurers. Other key advantages of captives are the ability to enable better intra-group cash management and profit retention from good insurance risks, which otherwise would have been ceded to third-party (re)insurers.
In general, IFRS 17 is applicable to all entities that issue insurance contracts and are reporting under IFRS accounting standards. While the changes introduced by IFRS 17 will affect insurance companies operating in most jurisdictions, some significant markets such as the United States and Japan are not IFRS reporting jurisdictions. While Bermuda, Cayman Islands, Vermont, Utah and Delaware are the top five captive domiciles, these jurisdictions do not require the compulsory adoption of IFRS 17. (IFRS is not required but permitted in Bermuda and Cayman Islands.)
However, captive insurers are not completely off the hook. If a captive does not report under IFRS, but its parent company does, the captive may still be required to perform IFRS 17 valuations for consolidation purposes.
For those who need to adopt IFRS 17, there is a varying level of readiness for IFRS implementation among captives. Some started implementing the project early with the support of their parent companies and have reported quarterly numbers to their parent under IFRS 17 since the first quarter of 2023.
Some others started later and depend on external consultants’ or captive managers’ one-size-fit-all solutions, which are developed for smaller insurers/captives. This group of captives is working toward being ready for the financial year-end 2023 reporting deadline.
Operational Impact On Captives
Compared with current accounting standards under IFRS 4, IFRS 17 requires more granular data. This might be a headwind for captives as the required data (especially legacy data) might not be available or need additional work to prepare.
In addition, captives may run on outdated legacy data systems. They might need to invest in new data systems and processes to ensure successful implementation of IFRS 17, which could add pressure to their operating performance.
IFRS 17 is a complex and resource intensive change to insurers in general. This change requires different departments to work collaboratively with the finance team. For many captives operating in IFRS 17 environment, the standard change will have significant implications on IT systems, business processes and strategic management. Many captives might count on their captive managers for providing support and solution. In addition, the implementation of IFRS 17 also requires a lot of training for stakeholders, including:
A key risk under the IFRS 17 regime is a heavy reliance on third parties for some captives, including external consultants, actuarial firms and captive managers, to drive IFRS 17 development and implementation projects. This presents the risk of concentrating knowledge outside of the operating captives, and creates a potential disconnect between internal management engagement and external consultant experience on the subject.
High Implementation Cost For Captives
As captive insurers typically have smaller, less diversified portfolios relative to commercial insurers, it might be a burden for them to absorb such a large, fixed cost on the aforementioned expenses. Hence it is expected that the parent would provide support to ensure compliance.
Within IFRS 17, there are three measurement models for valuing insurance contracts’ liabilities – the general measurement model (GMM), the premium allocation approach (PAA) and the variable fee approach (VFA). Among these, the GMM and PAA models would be applicable to captives.
The GMM is the default measurement model for evaluating insurance liabilities. This approach is more complex to be implemented and is typically being used for life insurance contracts or long-duration contracts. In comparison, the PAA is a simplified approach that could be applied for measuring liabilities for insurance contracts that have a coverage period of one year or less, or for short-term (longer than one-year) contracts in which PAA approach’s outcome is not expected to differ materially from the result that would be calculated when applying the GMM.
Given the generally small size of (re)insurance captives, the nature of their contracts, and the operational complexity of implementing IFRS 17 under the GMM, the simplified PAA is expected to be largely adopted by captives, particularly if they underwrite short-term insurance policies from the group or affiliates.
Discounting Of Insurance Liabilities
Unlike the usual practice under other accounting standards, IFRS 17 requires insurers to measure most insurance liabilities based on discounted cash flows. Although a risk adjustment buffer is applied as well, the overall insurance liabilities (under PAA model) are expected to be slightly lower under the IFRS 17 reporting framework in most cases.
Due to regulatory restrictions, many captives operate like a captive “reinsurer,” by underwriting groups’ insurance risks from fronting insurers.
The shift in reporting treatment of reinsurance commissions is one of the biggest conceptual changes in the transition to IFRS 17 for reinsurers, including for captive reinsurers.
Under the revised reporting treatment, reinsurance commissions (on both inwards and outwards reinsurance) will need to be split between commissions contingent on claims and those not contingent on claims. For the outward reinsurance commission not contingent on claims (eg flat ceding commission), it will now be deducted from premiums, reducing the captive reinsurers’ revenue.
Conversely, the outward reinsurance commissions contingent on claims (eg profit commission) will now be included in claims.
The new concept of reinsurance commission treatment alters the components of KPIs of many captive reinsurers (ie decrease in reported expenses due to reclassification of reinsurance commission and profit commission). This requires a significant educational effort to help management understand how to read and interpret KPIs going forward.
(Re)insurance Receivable And Payable
Insurance contract liabilities under IFRS 17 will incorporate the net effect of insurance receivables (an asset item) and insurance payables (a liability item), which used to be shown as separate items in assets and liabilities. This netting of receivables and payables within (re)insurance contract assets/liabilities would reduce total assets and total liabilities of a captive’s balance sheet.
AM Best, a global credit rating agency specialised in the insurance sector, does not expect the introduction of IFRS 17 to have a direct impact on the captives’ fundamentals. The change of accounting reporting standards is not expected to alter the captives’ business strategy and underlying economics, unless the lack of preparedness or failure of implementation leads to concerns in risk management and control, such as the accuracy of financial reporting and the availability of timely management information in the decision-making process.
AM Best views robust enterprise risk management practices as central to being able to successfully manage the transition.
IFRS 17 adoption is viewed as a positive step toward a more economic and uniform presentation of financial statements that will eventually enable non-insurance experts to better understand the company’s fundamentals.
The adoption of IFRS 17 is an ongoing journey, rather than viewed as a project to be completed in 2023. The board, the management and different stakeholders need to learn the new IFRS 17 concepts and language, in order to fully understand business fundamentals under the new reporting, evaluate financial performance and form appropriate strategies.
Christie is a senior director and head of analytics of AM Best Asia-Pacific Limited. She leads a team of rating analysts within AM Best that cover all types of rated insurance companies, including life, non-life, reinsurers and captive insurers, for Greater China, Japan and Korea. Founded in 1899, AM Best is the world’s first credit rating agency, and has grown to become the largest credit rating agency in the world specialising in the insurance industry. It is the oldest and most widely recognised provider of credit ratings, financial data and news with an exclusive insurance industry focus.