On 1 January 2023, the global insurance sector entered a new era of transparency and accounting realism. With the application of International Financial Reporting Standard 17 (IFRS 17), the age of the “phantom profits” that used to be recorded as soon as an insurance contract was issued came to an end, and the stage of spreading real profits gradually, as the actual service is provided, began.
The previous standard (IFRS 4) allowed wide diversity in accounting methods between companies, which made comparing them almost impossible. IFRS 17, by contrast, came to lay down unified and strict rules, with the aim of showing the true picture of insurance companies’ performance, preventing the inflation of profits, and increasing the confidence of investors and regulatory bodies.
Why did the world need this standard?
Before IFRS 17 was issued in 2017, every insurance company used different accounting methods to measure insurance contracts. This disparity led to great difficulty in comparing financial results between companies, locally and internationally.
The new standard came to achieve several fundamental objectives:
- Unifying the accounting treatment of insurance contracts globally.
- Increasing transparency and credibility in financial reports.
- Showing real profits gradually.
- Preventing the recording of phantom profits in the early periods.
- Improving the quality of the information provided to investors and regulators.
The core idea: profits are earned over time
The philosophy of IFRS 17 can be summed up in a single sentence: “An insurance company does not recognise the full profits as soon as the contract is issued; rather, it spreads them over the period in which the insurance service is provided.”
The standard defines an insurance contract as a contract under which the company accepts significant insurance risk in exchange for compensating the customer when an uncertain event occurs. This includes health, motor, life, fire and marine insurance, among others.
How are insurance contracts measured?
The standard relies on four main components for measuring the insurance liability:
- Future cash flows (expected premiums, expected claims, and expenses).
- The time value of money (discounting the cash flows at an appropriate discount rate).
- The risk adjustment (an additional amount reflecting the uncertainty in future risks).
- The contractual service margin (CSM) – the heart of the standard.
The contractual service margin (CSM) is the unearned profit that is deferred and recognised gradually over the contract period. If the company expects to make a profit on a particular contract, it does not record it immediately; instead, it places it in this account and releases it as time passes.
The three measurement models
- The general model (General Measurement Model – GMM): the basic model for most long-term contracts.
- The variable fee model (Variable Fee Approach – VFA): used when the customer shares in investment returns (particularly in some life insurance contracts).
- The premium allocation model (Premium Allocation Approach – PAA): a simplified model for short-term contracts (such as annual motor insurance).
Revenue and losses under IFRS 17
One of the most important changes: revenue does not equal premiums collected. Revenue is recognised only in return for the insurance service provided during the accounting period. In the case of onerous contracts, however, the loss must be recognised immediately, without deferral.
Disclosures: unprecedented transparency
The standard has required companies to make detailed disclosures that include:
- The nature of insurance risks.
- The measurement methods and assumptions used.
- The sensitivity of results to changes in key variables.
- Changes in the contractual service margin and profits.
The impact on insurance companies
IFRS 17 has brought about radical changes, which included:
- Developing new accounting and technology systems.
- Strengthening the capabilities of actuaries.
- Improving data quality.
- Changing the timing of profit recognition, which affects key performance indicators.
A simplified example:
A company issued an insurance contract for a term of 5 years with an expected profit of $50,000.
- Under the old system: the profit might appear in full, or most of it, in the first year.
- Under IFRS 17: the profit is spread gradually over the five years according to the service provided.
Conclusion
In conclusion, IFRS 17 is more than just an accounting standard; it is a strategic and cultural transformation in the insurance industry. By deferring the recognition of profits until the service is actually provided, and by requiring companies to make detailed disclosures about risks and assumptions, financial statements have become more credible and transparent.
Companies that were able to adapt to this standard early will gain a clear competitive advantage, while the latecomers will find themselves facing major challenges. In the end, IFRS 17 affirms a clear message: real profit lies not in signing the contract, but in fulfilling its obligations over the life of the contract.