IFRS 4 Phase II – major changes for Australia. More to prepare for than expected
The Insurance Accounting Newsletter – Issue 28 provides an overview of the IASB's June 2013 revised exposure draft ED/2013/7 on Insurance Contracts. This edition focuses on the five key areas of the exposure draft (ED) on which the IASB is seeking comments, and describes the considerable business challenges facing the insurance industry in addressing these areas.
Insurance Contracts ED will have a major impact on the Life Insurance industry in Australia
There are two major impacts on Australian life insurers that are facing a fundamental change to profit recognition and reporting in Australia.
Yearly renewable business
The majority of Australian life insurance products still being sold, yearly renewable term and disability income insurance, will be considered one year contracts. So, while the rest of the world moves to treating life insurance contracts as long term and recognising profits accordingly, Australian will be heading in the opposite direction, with most insurance in Australia now being considered short duration.
This will have a major impact for life insurance profit reporting. The most significant change will be the removal of deferred acquisition costs. All upfront costs will be recognised over first year of the contract, resulting in losses in the first year. Companies with growing portfolios will face new business losses, which will distort profit reporting and risks misleading managers and owners of life insurers in Australia. This is of particular importance to listed companies, who will need to communicate impacts to market analysts and shareholders.
On the plus side, the reporting will be much simpler and easier to explain.
In another significant change the requirement to unbundle investment and insurance contracts will have a significant exception. Risk riders on investment contracts will be considered highly related to the host investment contract, resulting in both being treated as an insurance contract. Changing the treatment of these investment contracts to being insurance contracts adds complexity for life insurers.
Despite further guidance in the revised ED, uncertainty remains around the mirroring approach for participating business, and how this will be applied in practice. This presents another significant change for the industry.
The above changes, are in addition to the modifications to the presentation of insurance profit, which will impact all insurers.
General and Private Health Insurers to face lesser impacts
The General and Private Health Insurance Industries appear to be less impacted by the changes. The main changes are the introduction of the risk adjustment, and the use of the building block approach for long term contracts and during the post claim period.
While we expected there will be implications for systems, data and models, we don't expect a fundamental change in the overall business reporting.
A more detailed article on the impacts for the Australian insurance industry will be released shortly.