The supercomputer in Douglas Adams’ Hitchhiker’s Guide to the Galaxy took 7.5 million years to come up with 42 as the answer to the meaning of life. The accountants at the International Accounting Standards Board (IASB) may feel that they have been on a similarly mammoth quest.

For the past 20 years, the IASB — the peak global body for setting accounting standards — has laboured to shed light on the opaque world of risk, uncertainty and probability inhabited by the world’s US$13 trillion insurance industry.

Its lofty ambition has been to devise a set of accounting principles that will, for the first time, provide consistency and transparency in insurance contracts, enabling investors to meaningfully compare insurance products and peer into the books of providers wherever they operate.

The IFRS 17 solution

The ongoing lack of transparency and consistency in insurance financial reports has been costly. It has prevented the industry from fully participating in the global flows of capital and finance in the way that other sectors such as manufacturing and banking have been able to do.

It has discouraged investors, who have baulked at committing capital to companies and products they don’t fully understand. It has cost insurers ready access to cheaper capital to invest and expand. And it has cost policyholders, in terms of both narrower policy choices and higher premiums than they would otherwise face in a more competitive market.

To remedy this situation, the IASB has been analysing and dissecting thorny concepts arising from the nature and characteristics of insurance contracts. These contracts are complex, combining the features of service agreements and financial instruments, and generating cash flows that can be decidedly lumpy.

The standard it has developed, IFRS 17, extends to 116 pages and includes numerous details that insurers need to come to terms with. As Grant Thornton New Zealand national technical director Mark Hucklesby puts it: ‘The standard is in some dimensions deceptively simple but in other ways incredibly complex.’ 

Accounting for insurance

A fundamental aim of the standard is to unbundle the insurance contract and separate out any non-insurance components. These are then to be accounted for under other standards like IFRS 9, which covers financial instruments.

The IASB seeks to achieve this by combining the current measurement of future cash flow with the profit expected to be gained over the period services are provided. It requires insurance revenue to be presented separately from finance income and expenses.

Insurers are required to recognise profit as they deliver their services, rather than when premiums are received. Acquisition costs (such as commissions and bonuses) — while reflected in the year of the transaction as a deduction from the expected profit — are reported as an expense over the same period as revenue is recognised.

This process of disclosure is guided by a general measurement model. This model has three components — fulfilment cash flows (the risk-adjusted present value of future cash flows), past and current claims, and the contractual service margin.

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