Riding the wave of accounting changes

Across the globe, one can hardly sit through an accounting update session without robust discussion about the unprecedented changes in insurance accounting. As a long-duration/life reinsurer, one will most likely have to contend with IFRS 17: Insurance Contracts, or Accounting Standard Update 2018-12: Targeted Improvements to the Accounting for Long Duration Contracts (LDTI), or for some, both.

IFRS 17 is scheduled to be applied for annual periods beginning on or after January 1, 2022; LDTI is effective for public business entities on January 1, 2021 (on July 17, 2019 the FASB tentatively decided to delay the effective dates of ASU 2018-12 by one additional year for public business entities and stagger the effective date for all other entities). These standards have been referred to as “transformative”, “significant”, “a comprehensive overhaul”, etc, due to the impact the implementation of these accounting standards can have on all aspects of the business. These range from operations to systems, administration, governance, and certainly, the financial results of a company. This is because both standards seek to significantly shift the measurement and financial reporting of insurance contracts.

In the discussion that follows, we will explore some of the biggest challenges reinsurers will have to contend with as they navigate implementing insurance accounting changes.

The challenge: it’s all about the data
Data requirements stemming from the new accounting rules will significantly impact how reinsurance companies manage their data today. Various aspects of the new accounting rules will put pressure on reinsurers who might not have historically collected, retained or managed the data needed to comply with the new insurance accounting requirements.

Under today’s practice, most reinsurers rely on ceding companies to provide the administrative policy data (eg, claims, billing, etc) to prepare their financial statements. Due to new requirements, reinsurers can expect to face challenges around data quality and availability.

The challenges around data availability will come to bear depending on certain accounting decisions (eg, transition approach in the year of adoption). For example, one of the key changes introduced under LDTI is market risk benefit (MRB), which represents a
new classification for certain benefit features that are required to be measured at fair value at the transition date under a full retrospective approach. In order to determine the fair value, reinsurers need to maximise the use of relevant observable data and information for applicable assumptions as of the contract inception date. As a result, reinsurers might face situations whereby the necessary data may not be available, or historical data from contract inception will need to be re-collected/requested from the ceding companies.

It’s expected that additional data will need to be stored locally or made easily accessible to generate disclosure reports on a consistent and timely basis as part of implementing the new accounting rules.

Reinsurers can expect to spend significant time and effort communicating and coordinating with ceding companies to fulfil the data needs stemming from the new insurance accounting standards.

Judgement around the unit of account
The two standards require similar decisions around how companies apply each respective standard. From an IFRS 17 perspective, one such decision is how the portfolio of contracts is defined and grouped. From an LDTI perspective, this is understood as what level of aggregation shall be considered for measurement. Either way, both represent the universal concept around the unit of account.

While IFRS 17 is more prescriptive in how one determines the portfolio and groups of contracts, the LDTI guidance is not as prescriptive, other than prohibiting companies from grouping contracts together from different original contract issue years for the purpose of calculating the liability for future policy benefits.

Reinsurers who are actively assuming insurance contracts may have grouped treaties with different product lines and benefit levels within one reinsurance treaty. Under today’s practice, such treaties may have been measured as one unit of account. For assumed treaties with different product groups and benefit levels, reinsurers are required to understand the original contract issue years and potentially regroup the policies into distinctive unit of accounts under the new accounting rule.

Further, while the LDTI accounting rules are silent on grouping contracts from different product lines, it may not be appropriate to group contracts at a level higher than the product line. For example, a reinsurer may assume/acquire a treaty that includes both whole life and term life. Grouping both product lines into the same cohort (assuming the original contract issue year is the same) requires significant judgement.

Depending on the unit of account, there will be data and system implications that will have to be considered. The business will have to assess whether the current system infrastructure supports the level of detail required and if needed, what actions should be taken to ensure that the future needs will be met.

The appropriate level of data will have to be sourced and made available to actuarial models; the models in return will have to be updated to accommodate cohort calculations.

The solution: what now?
There are various solution options to meet the objectives of the new accounting rules, but it is recommended that reinsurers take a comprehensive and strategic approach on their journey to compliance.

This typically starts with (i) developing and setting up a cross-functional governance structure; (ii) carrying out high-level impact assessments which span financial, operational, data, and system; and (iii) designing a future state implementation roadmap which defines key initiatives, milestones, dependencies and priorities.

Generally speaking, companies are taking one to two years to fully implement the new accounting rules, depending on the size of the organisation, the product mix and management’s strategy outlook.

Considering potential significant data challenges reinsurers may be faced with, it is recommended that reinsurers take a comprehensive data management approach to improve data and analytics capabilities.

To start, reinsurers should work with their internal and external stakeholders to assess the current data flows and identify potential gaps. In doing so, it’s vital to have the future state in mind to identify data requirements across the existing data and technology landscape.

A single consistent source of data for finance and actuarial may need to be implemented to store and feed data for subsequent consumption by general ledger and actuarial systems, potentially with required reconciliations in place.

In addition, it’s important for reinsurers to refine/rethink their data governance strategies; implement an integrated finance and actuarial data approach; and develop/update the existing data quality framework, including data retention, data archival, data lineage along with the related process and controls, etc.

This exercise will contribute to defining the target state data architecture in meeting the new accounting rules and other strategic initiatives that involve data management.

Cordelia Davis is a partner in the financial services department of EY Bermuda. She can be contacted at:  cordelia.g.davis@bm.ey.com