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Regulatory insight: Major impact IFRS-9 on insurance companies

April 4, 2017

The International Financial Reporting Standards (IFRS) is the set of accounting principles for listed European companies. Consequently, IFRS is also the leading accounting framework for many insurance companies in Europe.

A major change in these accounting rules will take place in 2018 as IFRS-9 will then replace the current reporting rules for financial instruments (IAS-39). The impact of these changes will be profound for insurance companies and already leads to much discussion. Here, we analyze the impact of the new IFRS-9. In particular, we will focus on the consequences for investment funds and mandates.

Classification scheme IFRS-9

Under IFRS-9, all financial instruments should be classified according to the following scheme (source: EY):

IFRS-9

This flowchart shows which aspects are important to properly classify a financial instrument under IFRS-9. We start with the specific financial instrument (at the top) and arrive at an IFRS-9 classification (at the bottom) by following the arrows in the flowchart. Four different classifications are possible:

  1. Amortised cost (AC). In this case the initial (cost) value of the instrument increases or decreases to the nominal value at the maturity date. AC can be applied for 'plain vanilla' fixed income instruments - with only payments of interest and principal - where the objective is to collect the cash flows of the instrument over time.
  2. Fair value other comprehensive income (FVOCI). The valuation is based on market value, but fluctuations of the market value do not have an impact on the profit and loss statement (P&L). Realizations go through the P&L, however. This classification can be used for fixed income portfolios which are possibly traded over time.
  3. Fair value through profit and loss (FVTPL). In this case fluctuations of the market value do affect the P&L. This classification is mandatory for derivatives and stock portfolios which are held for trading.
  4. Fair value other comprehensive income, no recycling (FVOCI). The valuation is based on market value but fluctuations of the market value do not affect the P&L. The term 'no recycling' means that realized gains or losses are not visible in the P&L either. This classification is appropriate for passively-managed stock portfolios.

Investment funds are treated differently than discretionary mandates

Investment funds are always treated as equity instruments, with a classification of FVTPL or FVOCI (no recycling). This also applies for fixed income funds, where the underlying instruments could be classified as AC. In a discretionary mandate (so not via a fund structure) a static bond portfolio could be classified based on AC, however. Such a discretionary mandate will thus offer more flexibility under IFRS.

Later expected starting date

IFRS-9 will come into force for listed European companies on January 1, 2018. However, for listed insurance companies IFRS-9 will probably come into force later (in 2021). The main reason for this delay are planned changes to IFRS-4, the accounting rules for insurance contracts. Phase 1 of IFRS-4 is currently in effect and gives insurance companies the possibility to value their insurance liabilities at book value. In phase 2 of IFRS-4, with an expected starting date of 2021, the valuation will be based more on market value. The valuation under IFRS-4 will, however, not be identical to an economic valuation (or a Solvency II valuation), so valuation differences will remain between the economic, IFRS and Solvency II balance sheet. Aligning IFRS-9 with IFRS-4 and aligning the IFRS, economic and Solvency II balance sheet thus remains a major challenge for listed insurance companies in the coming years.

Insurance companies that need more flexibility under IFRS should consider a discretionary investment mandate instead of an investment fund.

Conclusions

The accounting rules for financial instruments (IFRS-9) will change, but for insurance companies the expected starting date is 2021, together with expected changes of the reporting standards for insurance contracts (IFRS-4). For investment funds, the classification under IFRS-9 is not flexible and will be based on market value, like for equity instruments. Insurance companies that need more flexibility under IFRS should thus consider a discretionary investment mandate instead of an investment fund. A consequence of IFRS-9 could thus well be that listed insurance companies will focus their attention on discretionary mandates in the coming years.

 


This is the first issue of our Regulatory insights. In this series we will keep you updated on the impact of regulatory developments on investments and capital management.

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