Getting up to speed with IFRS 17 for insurance contracts. Implications for Malaysian insurers. Volume 5 - Issue 3-19 June 2017

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1 Volume 5 - Issue 3-19 June 2017 Getting up to speed with IFRS 17 for insurance contracts Implications for Malaysian insurers Take 5: Getting up to speed on IFRS 17 for insurance contracts 1

2 In the next four years, Malaysian insurers will need to implement significant technical and practical changes to meet the mandatory IFRS 17 Insurance Contracts effective date of 1 January IFRS 17 represents the most significant change to insurance accounting requirements in 20 years it demands a complete overhaul of insurers financial statements (including takaful operators). Asia-Pacific survey on IFRS 17 implementation: 78% 40% 48% of Asia-Pacific insurers have yet to start their IFRS 17 implementation intend to start implementing IFRS 17 in the next 3 to 6 months (2017) agree that IFRS 17 will bring greater comparability between insurers globally This major change program to implement IFRS 17 will extend beyond the finance and actuarial functions of insurers its business impacts need to be understood and communicated to a wide range of internal and external stakeholders. Given the complexity of the IFRS 17 implementation task, insurers should start formally assessing impacts and mobilise their organisations now. 21% 60% think that too many policy options will hinder greater comparability between insurers globally agree that IFRS 17 will bring: more transparency about the performance of insurers a more consistent basis of accounting and reporting a more relevant accounting model reflecting uncertainty and current estimates Source: EY Asia-Pacific IFRS 17 webcast for insurers, June 2017 Martyn van Wensveen EY Asia-Pacific IFRS 17 Implementation Leader Take 5: Getting up to speed with IFRS 17 for insurance contracts 1

3 Take action now IFRS 17 sets a new accounting and reporting landscape for insurers IFRS 17 has an international impact applying to all 125 jurisdictions which use IFRS and impacting over 500 insurance companies globally, including Malaysian conventional insurers and takaful operators. It is the biggest change to accounting standards for insurers in the past 20 years. It will affect multiple areas such as actuarial models, accounting systems, product design, financial statements, taxation and operations including agency channels. Within that 4-year implementation window ( ), insurers will also need to adapt to a wave of other accounting standard changes: IFRS 9 Financial Instruments effective 1 January 2018 IFRS 15 Revenue from Contracts with Customers effective 1 January 2018 IFRS 16 Leases effective 1 January 2019 Early investment and a structured planning approach are key to a smooth IFRS 17 implementation. Insurers that start earlier rather than later will be in a better position to take advantage of IFRS 17 market opportunities and be best placed to shape their business journey and financial performance going forward. IFRS 17 in a nutshell What? One accounting model for all insurance contracts in all IFRS jurisdictions Applies to all types of insurance contracts Why? Consistent framework for insurance contracts (including Malaysian takaful contracts) More useful and transparent disclosures Better information about profitability How? To be applied across all facets of accounting for insurance contracts including recognition, measurement, derecognition, presentation and disclosure. When? Effective 1 January Early application is permitted. Bank Negara Malaysia ( BNM ) has requested all locally-registered insurers to submit their IFRS 17 plans to BNM by the end of September Chart 1: Countdown to IFRS 17 (for December year-end) Disclosure of expected impacts of the standards issued, but not yet effective 1 Potential reassessment of IFRS 9 classification on IFRS 17 transition First IFRS 17 compliant financial statements to be published IFRS 17 issued on 18 May IFRS 9 effective date IFRS 17 start of comparative period IFRS 17 Effective date 1 Jan 2021 IFRS 4 IFRS 4 & IFRS17 (parallel run) IFRS 17 Note: 1 Early adoption of IFRS 17 is permitted provided insurers have also adopted IFRS 9 and IFRS 15. Take 5: Getting up to speed with IFRS 17 for insurance contracts 2

4 Implementing IFRS 17 For a smooth IFRS 17 implementation, some focus areas and key questions to consider: Is this an insurance contract? If so, what is its contract boundary? Insurance contract definition substantially unchanged but contracts which fail the augmented significant insurance risk definition test may fall under IFRS 9 Assessing derecognition timing and contract boundary are critical as they determine the: Appropriate valuation approach Periods over which profits are released Future cash flows to be included in the valuation process 1 Recognition Definition and scope Level of aggregation Separation of components To what extent can we group individual contracts? Are any of the contracts onerous? Contracts to be aggregated into respective portfolios defined by IFRS 17 as being: Subject to similar risks; and Managed together Portfolios to be then divided into at least three groups: Contracts that are onerous (loss-making) at inception; Contracts with no significant risk of becoming onerous at initial recognition; and Any remaining contracts in the portfolio IFRS 17 Ready, Set, Go! Contracts issued more than one year apart cannot be grouped together. IFRS 17 prohibits the offsetting of onerous contracts against profitable contracts. Which measurement model should we apply? 2 Measurement The General Model (Building Block Approach) ( GM ) Default measurement model Measured using fulfilment cash flows i.e. riskadjusted present value of future cash flows Offset by the Contractual Service Margin 1 ( CSM ) Variable Fee approach ( VFA ) Applicable to contracts with direct participation features The entity s interest in the contract would represent a variable fee for the service of managing the underlying items on behalf of a policyholder Measurement model Premium Allocation approach ( PAA ) Optional simplified model for short-term insurance contracts Measured as a liability for remaining coverage and an incurred claims liability Similar to existing non-life insurance contract measurement Reinsurance Are there additional requirements for reinsurance contracts held? Modified GM and PAA apply Measured separately from the underlying direct insurance contract Gain or loss recognised as reinsurance services received Notes: 1 CSM refers to the contractual service margin which is the unearned profit of the insurance contract to be recognised in profit or loss over the contract service period. Take 5: Getting up to speed with IFRS 17 for insurance contracts 3

5 Do we have non-insurance components which must be separated or disaggregated? Does a different standard apply for each component? Separation Embedded derivatives which are not closely related (IFRS 9) Distinct investment components 2 (IFRS 9) Distinct performance obligations to provide noninsurance goods and services (IFRS 15) Disaggregation 3 Non-distinct investment components (IFRS 17) 5 Interaction with IFRS 9 What are insurers options in implementing IFRS 9 and IFRS 17 simultaneously? Insurers (with significant activity related to insurance) have been allowed a temporary exemption from applying IFRS 9 until the mandatory IFRS 17 effective date of 1 January 2021 Recognition of impact of changes in market interest rates on insurance contract liabilities to match with measurement options taken under IFRS Transition Presentation and disclosure Which transition approach should we use? Full retrospective approach requires an insurer to: Determine the original fulfilment cash flows and CSM for each portfolio of insurance contracts; and Roll forward for each portfolio to the transition date If impracticable, insurers may opt for the: Modified retrospective approach; or Fair value approach Insurers may apply different approaches for different groups What additional data do we need for disclosure and presentation? Presentation Investment components to be separate from insurance revenue and service expenses To reduce volatility Insurers may choose to present the impact from changes in discount rates in profit or loss or other comprehensive income 4 Disclosure Increased granularity required Financial information to be disclosed to help users better understand how contracts affect financial position, financial performance and cash flows New disclosures are concerned with new business features and expected profitability Notes: 2 An investment component is distinct when (i) investment component and insurance component are not highly interrelated, and (ii) a contract with equivalent terms is sold, or could be sold, separately in the same market or same jurisdiction, either by entitites that issue insurance contracts or other parties 3 Disaggregation refers to the exclusion of an unseparated investment component from insurance contracts revenue for presentation in profit or loss 4 Other comprehensive income refers to items of income and expense (including reclassification adjustments) that are not recognised in profit or loss as required or permitted by other IFRSs Take 5: Getting up to speed with IFRS 17 for insurance contracts 4

6 Malaysian insights Some IFRS 17 considerations for takaful operators Under the concept of takaful, participants make contributions to a pool which is managed by a third party (the takaful operator) with the overall aim of aiding other fellow participants in times of need. IFRS 17 will also be applicable to takaful operators in Malaysia and there will be certain key decisions that will need to be considered throughout its implementation. Measurement of fulfilment cash flows IFRS 17 requires all cash flows related to fulfillment of contract to be included in the measurement of takaful contract liabilities. Although the underwriting surplus from the Participants Risk Fund ( PRF ) is not guaranteed, the takaful operator may have created a constructive obligation over past surplus distributions. In this regard, the underwriting surplus may need to be included in the cash flow projections when determining the takaful contract liabilities. Hence, a review assessment of Shareholder s Fund, PRF and Participants Investment Fund ( PIA ) will need to be considered, in terms of the applicability of IFRS 17. Onerous contracts assessment IFRS 17 requires the loss arising from onerous contracts to be recognised in profit or loss upon inception. Currently, the onerous contracts are not assessed and recognised in profit or loss upon inception. They are recognised as and when the losses arise. Chart 2: Aggregation of takaful contracts By expected resilience to becoming onerous as at initial recognition Applicability of variable fee approach The investment returns and surplus sharing features of takaful products may qualify the takaful contracts for VFA, as the participants may receive a substantial share of the returns. The takaful operators will need to conduct the necessary applicability assessment, to ascertain if its products meet the criteria for application of the VFA. IFRS 17 s impact on Malaysian insurers (including takaful operators) Investment-linked contracts The IFRS 17 measurement approach on investment-linked contracts differs significantly from the current Risk-based Capital ( RBC ) basis. Given the significance of investmentlinked products in Malaysia, insurers (including takaful operators) will need to assess the extent of the financial impact of IFRS 17. Contract boundaries The IFRS 17 measurement approach alters the recognition of cash flows as it focuses on the insurer s or takaful operator s ability to reprice contracts. Malaysian insurers presently determine contract boundaries based on its renewability. Expected to be onerous at initial recognition >> No significant possibility of being onerous as at initial recognition >> Other expected resilience at initial recognition >> Portfolio A Portfolio B Portfolio C By portfolio By annual cohorts << Contracts issued in 20x2 << Contracts issued in 20x1 Take 5: Getting up to speed with IFRS 17 for insurance contracts 5

7 actions to kick-start your 5IFRS 17 implementation 1 2 Conduct a gap analysis to understand key differences against your current accounting, actuarial and reporting practices. Understand the interpretative issues and analyse the financial, operational and system implications of IFRS 17 (and other new accounting standards) on your organisation. The new IFRS 17 will have a major impact on profit and total equity for insurance companies. In particular, the requirement to restate the opening balance sheet as if the standard has always applied to existing in-force business on the implementation date will require significant effort. 3 4 Determine a realistic implementation roadmap with draft budget and resourcing plan. Assess the strategic and product implications on other current or planned programs of activity including new product launches, in the next 3 to 4 years. As such, planning early and allowing sufficient time to test the results and perform pilot runs are critical to the successful implementation of IFRS Educate the executive management team and Board on the new requirements and implications. Brandon Bruce EY Malaysia Insurance and Takaful Leader Take 5: Getting up to speed with IFRS 17 for insurance contracts 6

8 Proactive approaches to IFRS 17 Getting the different teams onboard to manage the significant changes impacting various functions in your organisation CFO Financial controllers Communicate early to key stakeholders on expected impacts to financial statements and profit profiles Analyse current management reporting, KPIs and incentive frameworks for ongoing applicability and incorporate necessary changes for analysing margins and volatility Update volatility and Asset-Liability Management ( ALM ) frameworks for liability measurement changes under IFRS 17 and assets under IFRS 9 Re-evaluate capital requirements and compliance Identify which measurement approach to apply to each product Update: Chart of Accounts and account mappings Proforma financial statements current Balance Sheet and P&L formats Accounting policies and reporting manuals Process and controls documentation and opening procedures Design: Specific controls to drive new process quality, robustness and integration into existing control frameworks New or revised existing internal and external reporting templates Analyse: Closing and reporting processes (including updated timelines and responsibilities) For each reporting period, complete additional disclosures Auditability of reported figures Engage with regulators and external auditors to discuss implications, transition and implementation approaches. Appointed actuary Allocate time and resources to projects to design, build and test new data, modelling and systems capability Update methodology guidance for discount rate and risk adjustment assumption setting Help create a new or revise existing calculation engine for amortising and adjusting the CSM Work with the finance team to estimate impacts on transition date Assist in confirming the reported figures are auditable Operations Product development Investments Assess current data availability against new data requirements for both model inputs and outputs Change the: Content and structure of data captured from business units to support group reporting Process for reporting the additional data to the group reporting team Enhance the: Scrutiny of data quality, storage and archiving ahead of implementation date Data reconciliation based on new data needs Attention to data governance and management Review in detail your product offerings and pricing strategies to adapt to expected changes in profit profiles Review investment policies and ALM strategies to assess the impact of the new measurement models on insurance contracts and financial instruments Take 5: Getting up to speed with IFRS 17 for insurance contracts 7

9 Let s talk about IFRS 17 support EY service offerings EY tools and accelerators Mobilise, analyse and evaluate Trainings, webcasts and workshops Assistance on key technical questions Perform operational impact assessment Conduct financial impact analysis Estimate of resources and costs Roadmap of activities for implementation IFRS 17 Operational Impact Analyser IFRS 17 / IFRS 9 training materials Gap assessment approach Roadmap and Costing template Design smart tailored implementation program Design Target Operating Model ( TOM ) and KPIs Run system impact assessment Prepare data analysis for transition IFRS 17 Prophet Prototype Tool ( GM ) Financial impact analysis tool Data and system impact analysis tool System architecture examples Program Implementation Investor and stakeholders education Project management and PMO support Model accounts, data model and chart of accounts IFRS 17 / IFRS 9 training materials Dry run Prepare transition data Re-design of control frameworks and processes Model accounts, data model and chart of accounts IFRS 17 / IFRS 9 training materials Implement TOM Pilot testing Conduct Board awareness sessions Live reporting Investor and stakeholders education Technical support IFRS 17 Chart of accounts ( COA ) IFRS 17 / IFRS 9 training materials Quality assurance Take 5: Getting up to speed with IFRS 17 for insurance contracts 8

10 EY tools and accelerators IFRS 17 Operational Impact Analyser A web-based tool to identify operational gaps from a micro and macro perspective in the insurer s existing processes, systems, data, models and policies, compared to the new requirements of IFRS 17. Gaps by dimension Systems 20 Processes 11 Policies 16 Models 22 Data 4 Gaps by topic Presentation and Disclosure 13 Variable fee approach 8 Level of aggregation 21 Discounting 9 CSM 22 IFRS 17 Financial Impact Analysis Tools Our Financial Impact Analysis tools help insurers gain insight into the valuation principles of the General Model (Building Block Approach) compared to existing cashflow projection models. They identify the inputs from actuarial models needed to support IFRS 17 reporting. The tools include: New business earnings generator CSM generator Balance sheet convertor Assets 50,760 Investment Amount arising from reinsurance contracts held - Insurance contracts - Investment with DPF - Investment contracts Other Assets - Other assets - Deferred tax 50, Insurance and other liabilities (41,700) IFRS 17 Prophet Prototype tool An actuarial model in Prophet to identify the inputs needed from actuarial models to support IFRS 17 reporting. The tool demonstrates the impacts of changing assumptions and cash flows on reported results. It can also perform multiple model runs to produce Analyses of Surplus and separate the impact of different assumption and experience changes. The tool is capable of calculating IFRS 17 insurance liabilities for a contract or a portfolio at inception and subsequent measurement dates Initial measurement Subsequent measurement (11) CSM RA BEL IFRS 17 Data Model and Chart of Accounts Supports insurers in understanding the data necessary to comply with the IFRS 17 disclosure requirements, including: Posting rules under the new IFRS 17 standard Model of a non-participating product The tool also includes a chart of accounts for primary statements and notes under IFRS 17 Input on assumptions Liability assumptions (i.e. cash flows, discount rate etc.) Asset Assumptions (i.e. initial EIR, credit spread, duration, ECL) Acquisition expenses assumptions Output SAP IFRS 17 Chart of Accounts We have built an IFRS 17 and IFRS 9 compliant Chart of Accounts in a beta version of SAP S/4 HANA. The system allows insurers to accelerate implementation of the new accounting standards. Better, faster, simpler, cheaper S/4 BETA 1.0 Take 5: Getting up to speed with IFRS 17 for insurance contracts 9

11 EY Contacts Martyn van Wensveen Partner, EY Asia-Pacific IFRS 17 Implementation Leader Ernst & Young Advisory Services Sdn. Bhd. Tel: Brandon Bruce Partner, Assurance Malaysia Insurance and Takaful Leader Ernst & Young Tel: Christina Low Partner, Advisory Performance Improvement Ernst & Young Advisory Services Sdn. Bhd. Tel: Jeremy Lim Jern Director, Advisory Risk Actuarial Services Ernst & Young Advisory Services Sdn. Bhd. Tel: Harun Kannan Rajagopal Director, Assurance Financial Services Ernst & Young Tel: T E A M Take 5: Getting up to speed with IFRS 17 for insurance contracts 10

12 EY Assurance Tax Transactions Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organisation, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organisation, please visit ey.com Ernst & Young Advisory Services Sdn. Bhd. All Rights Reserved. APAC no ED None This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax or other professional advice. Please refer to your advisors for specific advice. ey.com/my