The goal of the International Financial Reporting Standard (IFRS) is to provide a global framework for how organisations should prepare and disclose their financial statements. It forms a control to encourage comparability of financial information and promote transparency.
IFRS 4 allowed companies to use national standards when accounting for insurance contracts which impeded comparability from one country to another. However, financial assets and liabilities within the scope were exempted from IFRS 4 coverage.
In January 2023, IFRS 17 came into effect to ensure all IFRS jurisdictions apply consistent accounting treatment for all insurance contracts. This latest standard aims to harmonise accounting treatment for all insurance contracts and improve the comparability of insurance and non-insurance companies across countries. Critically, it requires the separation of income by either an underwriting source or an investment source.
With IFRS 17, insurance contracts are reported on the balance sheet using the following criteria:
a. best estimate liabilities by present valuing cashflow using the market yield curve
b. risk adjustment for the uncertainty of insurance contracts and
c. provision of unearned profit known as contractual service margin.
So, IFRS 17 brings additional discipline and transparency to balance sheet reporting hitherto overlooked by IFRS 4. It, however, comes with a catch. Compliance with IFRS 17 requires complementary compliance with another standard – IFRS 9.
IFRS 9 was implemented in 2018, partly on the back of the perceived weakness in reporting and disclosure that led to the financial crisis of 2008. It focused on improving the disclosure of financial instruments such as treasury bills, bonds and derivatives.
Application of these standards creates new challenges for CFOs.
● Organizations that deal with multiple complex instruments and transactions would need significant knowledge and robust software to ensure compliance with the standards.
● Decision-making on whether the changes in insurance contracts and financial asset valuations will go through a statement of profit or loss or Other Comprehensive Income (OCI).
● Earnings volatility which must be mitigated by balance sheet management through Asset and Liability Management.
RMBN Asset Management has an asset-liability solution designed to minimise balance sheet risk and earnings volatility. It is an innovative risk management solution, that recommends the type and percentage of financial instruments to buy or sell at each rebalancing frequency to achieve the best asset and liability match.
For example, an unhedged liability is exposed to a risk of 13.50% (13.5% increase in liability) when there is a 1.0% decline in interest rate across the yield curve, whereas, for a hedged portfolio and a similar 1.0% decline in interest rate across the yield curve, liabilities will increase by 13.5% and financial assets will also increase by 13.5%, leading to minimal volatility in earnings and a risk optimized balance sheet.
In summary, the implementation of IFRS 17 and 9 marks a pivotal moment for the insurance industry emphasizing hedging strategies. RMBN Asset Management can provide you with the knowledge and support you need to minimise balance sheet risk and earnings volatility. Let us work with you to harness the full potential of IFRS 17 and 9 to foster resilience, innovation and value creation.
Author
Kike Mesubi, CFA
MD, RMBN Asset Management
Email:[email protected]
