The introduction of the new Insurance Accounting regime (AASB 17) is more involved than it may seem. Here are some issues to consider:
The assumption is often made that little will change with accounting for general insurance, as the new requirements for liabilities pre-claim are similar to the current arrangements under the unearned premium approach, and requirements for liabilities post claim are virtually unchanged. However, the new requirements might still require substantial change to systems because:
- Not all contracts will be eligible to use the simplified ‘unearned premium’ approach;
- The test for liability adequacy will be different;
- There is no longer a separate ‘Premiums Receivable’ asset – it is wrapped into the liability for insurance contracts;
- Reinsurance analysis is conducted gross, rather than net;
- On an acquisition, contracts where a claim has occurred are to be treated as insurance against adverse development rather than against the original claim event;
- Grouping is more granular than currently (potentially exacerbated by any changes to APRA reporting requirements); and
- Presentation and disclosures is more complex than currently.
Life Insurance Risk Business
There has been a lengthy debate about whether acquisition costs for stepped premium risk business in life insurance should be all recognised in the first year or spread over the future for what is effectively a multi-year contract. A recent decision by the IASB looks to have resolved that debate. However:
- The IASB’s tentative decision requires companies to defer some acquisition costs to future renewals – so those companies who would have preferred to recognise all acquisition costs in the first year cannot;
- Only acquisition costs directly attributable to newly issued contracts can be deferred – not all of them;
- The company will need to determine the basis on which any deferral is determined;
- There may be adverse tax consequences of not being able to recognise acquisition costs immediately;
- Even if some acquisition costs can be deferred, the profit signature won’t be the same as currently; and
- It is not clear what this means for other essentially ‘one-year’ contracts if some part of acquisition costs in the first year are incurred in anticipation of future renewals.
Friendly Societies are not specifically mentioned in AASB 17, and there is only one question in relation to them in the Information Note produced by the Actuaries Institute. The application of AASB 17 to Friendly Societies is therefore not clear, and there are particular issues for Friendly Societies that are mutuals.
There is thus a lot of work that needs to be done on what AASB 17 means for Friendly Societies, and how it is to be applied to them – for example, mutualisation is particularly relevant for Friendly Societies that write participating business.
There is the big question of what APRA will require, which will impact what you have to do.
APRA is keeping companies informed of its thinking – on 16 November 2018 it issued a letter to all life and general insurers providing an update on its planned approach to integrating AASB 17 into capital and reporting frameworks. But, at the moment, only intended principles, proposed process and indicative timelines, have been published – not detailed requirements – and the timeframe could be altered by the proposed deferral of IFRS 17.
While APRA may intend to minimise the operational risk faced by entities, the continued uncertainty hampers implementation.
The tax consequences of the changes to insurance accounting are also uncertain.
One major issue is the tax treatment of acquisition costs for stepped premium risk business in life insurance. Initially, the concern was that companies would gain a substantial tax benefit by recognising acquisition costs in the first year, compared with the current arrangements. However, the recent decision by the IASB reverses some of that (see above). Of course, it partly depends on what APRA does, and how the ATO responds, as life insurance tax is currently linked to regulatory profit (see below). But there is also uncertainty about:
- Whether tax should be based on accounting profit or profit in regulatory returns (tax on general insurers is based on accounting profit, while tax on life insurers is based on profit in regulatory returns);
- If tax is based on profit in regulatory returns, APRA decisions will be important; and
- If tax is based on accounting profit, is it appropriate for that profit (and the associated tax) to be dependent on assumptions chosen by the company?
And that’s not all …
There are subtle, but significant, differences in relation to:
- The discount rate at which the effect of assumption changes is determined;
- The pattern by which profit is recognised;
- The treatment of losses once recognised;
- Reinsurance, which must be measured and presented on a gross basis, whereas currently the underlying insurance is analysed net of reinsurance;
- The treatment of some contract modifications, which is much more complex than currently;
- The derecognition of contracts – in future the release of much of the liability will be deferred to future periods, and so will not be available to meet any payments;
- Recognition of changes in the fair value of assets – currently these are immediately recognised, whereas in future deferral through Other Comprehensive Income (OCI) might be an option. Subsidiaries of overseas conglomerates, which are used to such presentation for their group accounts, may be required by their parent to use OCI, and if that has to be done, then the calculations are very complex; and
- Components of contracts which clearly do not transfer insurance risk – at the moment, insurance accounting is not applied to these, but this unbundling may not be possible in the future.
Fundamentally this is about insurance accounting going forward, but there is a big exercise required to determine the starting amounts on transition to the new regime. Transition is an issue for both accounting and regulatory purposes.
The decisions required, and issues to be considered, depend on the specific circumstances and details of your business. You will need to make changes to your systems and processes, as well as ensure that actuaries, accountants and auditors work with each other.
The whole implementation needs to be carefully planned and managed. With our deep expertise in the interpretation and implementation issues involved with the new standard, PFS Consulting can help design and manage your implementation in a way that best suits your circumstances and business.