Augmenting your accounting change, transformation projects

Different accounting policies applied to different insurance contracts, incomparable financial statements, and outdated guidelines on estimates – these are just some of the issues prominently seen under International Financial Reporting Standard (IFRS) 4, Insurance Contracts. While accounting standards were meant to establish a common accounting language for comparability, IFRS 4 lacked specific guidance, allowing insurance companies to apply their own interpretations, and subsequently gave way to the incomparability issues.

The objective of IFRS 4 is to specify financial reporting for insurance contracts by any entity that issues such contracts until the board completes the second phase of its project on insurance contracts. It is very clear that it is not meant to be the standard that will answer all the problems in insurance accounting. In addition, the standard itself specified that it only provided limited improvements to accounting by insurers for insurance contracts.

These problems created the need for a consistent framework, leading to the issuance in May 2017 of IFRS 17, Insurance Contracts. When this new standard takes effect in the Philippines beginning Jan. 1, 2025, as set in the Insurance Commission Circular Letter 2020-62, companies are required to measure insurance contracts using more updated estimates and assumptions that better reflect the timing of cash flows and any uncertainty relating to insurance contracts. These are evident in the initial recognition and subsequent recognition requirements of the standard.

On initial recognition, all insurance contracts must be measured as the sum of the following:

(a)   Fulfillment cash flows - risk adjusted present value of entity’s rights and obligations to the policyholders

(b)   Contractual service margin - the unearned profit that the entity will recognize as it provides services over the coverage period

Subsequently, entities must remeasure the fulfillment cash flows at each reporting date to reflect current estimates. These changes would then be reflected in the profit or loss, other comprehensive income or as an adjustment to the CSM, depending on the cause of the change.

IFRS 17 definitely brings new levels of transparency, giving users better insight into an insurer’s financial position and performance than IFRS 4. Investors will also be able to get more information on the profitability of the business, which would help them make more informed investing decisions. Additionally, since the new standard has more specific requirements in measuring insurance contracts, there is less room for interpretation, driving greater consistency globally and allowing for increased comparability between insurers.

Digital transformation

Knowing the facts and differences between IFRS 4 and IFRS 17, however, does not mean we can already face the changes. The biggest question is how the insurance organizations can adapt to the changes. Based on the new requirements of the amended IFRS 17 last June 2020, the new effective date of the standard is on Jan. 1, 2023. Early adoption is permitted if IFRS 9 financial instruments are also applied on the date of adoption or earlier. So the question now is – will companies retain existing processes and manually adjust their financial statements to comply with the standard? We don’t think this should be the case. Manual accounting tends to be time consuming, labor intensive, and inefficient. Moreover, manual processing is more challenging now as several organizations are working remotely during the pandemic.

Clearly, digital transformation is the way to go given the changing business landscape. Embracing innovation and staying up-to-date with the latest technologies are essential to remain relevant and competitive.

Of course, implementing a new standard through digital transformation comes with challenges too. For insurers, they need to install and test new or upgraded systems, processes and controls, and coordinate with various functions, such as finance, actuarial, and information technology.

In a study by the Institute of Management Accountants (IMA) last February 2021, they summarized the key challenges organizations experience as they work towards digitally transforming their finance departments. Based on the study, companies view capturing reliable data, hiring, and retaining finance professionals with the right skill set, and creating a data-driven decision culture as the significant challenges of digital transformation in finance.

Based on this study, the transformation appears to be held back mainly by practical and operational challenges, such as a lack of reliable data and a lack of skilled finance professionals. On the other hand, digital transformation provides opportunities to develop fresh perspectives, gain better insights from data analytics, and streamline their processes.

Organizations that seek to maximize the benefits from technology to cater to IFRS 17 (or possibly even other future accounting system changes) should lay out a few key strategies:

(a)   Let finance drive the initiative: Make sure the finance team plays a big role in the digital strategic venture. Since the main user and the expertise would come from finance, organizations should empower them to lead the digital transformation journey while working closely with IT professionals and actuaries.

(b)   Focus on value-adding technologies: Ensure that the digital solution the company will invest in will create value. It is important to strike a balance between upgrading the current system and implementing new technologies as this may lead to savings and less changes in the current processes.

(c)   Close the skills gap: Focus on upskilling your people and hire subject matter experts. SMEs could greatly increase the capability of the team and help decrease possibilities of errors.

(d)   Manage the team: It is unlikely that one individual possesses all the required new skills and competencies. Organizations should focus on building a team of individuals who jointly have all the required skills and competencies and work in harmony.

(e)   Develop a data-driven decision culture: Senior finance professionals, IT leads, and actuarial heads can promote a data-driven decision culture by letting the employees, as well as the business, focus on data and insights rather than opinions.

The journey in implementing changes and adapting new standards will be challenging, but with passion for innovation and the right eye for technology, organizations can grow, thrive and succeed.

Matthew P. Mendoza is an assistant manager of the technology consulting group of KPMG R.G. Manabat & Co. (RGM&Co.), the Philippine member firm of KPMG International.

This article is for general information purposes only and should not be considered as professional advice to a specific issue or entity. The views and opinions expressed herein are those of the author and do not necessarily represent KPMG International or KPMG RGM&Co.

For questions and inquiries, feel free to send a message through social media or [email protected].