28 January 2019
The IASB presented a paper at its technical meeting earlier this week, which proposed changes to the approach to accounting for reinsurance under IFRS 17.
In my view, the proposed change is a victory for common sense that removes one of the weaknesses emerging from the new proposed accounting standard.
Under the current draft, IFRS 17 requires losses from onerous (ie loss-making) contracts to be recognised immediately in an insurer’s financial statements. On the other hand, the benefit of reinsurance cover must be recognised over the lifetime of the reinsurance contract. This creates inappropriate distortions in profit under certain situations. For example, where loss-making contracts are covered by quota share reinsurance, the insurer would need to recognise the full gross loss (which would then effectively reverse as the quota share recoveries emerge), even if it is perfectly matched from the outset.
This issue may be more commonplace than you might expect. This is because IFRS 17 places more emphasis on identifying loss-making contracts by requiring firms to consider smaller groupings of contracts. This reduces the possibility for offsetting of profits and losses that would occur when considering groups of policies higher aggregations. As a result, firms should consider their loss making policies separately from other policies (eg new business vs renewal business).
The proposed amendment at least now allows firms to recognise the benefit of reinsurance to offset these losses upfront, and paragraph 55 of the paper includes some calculations showing the possible impacts.
The IASB’s rationale for not considering this earlier was that it thought that these situations would be rare. Unfortunately not in current market conditions!