Most public companies have already switched to the new revenue recognition standards and have moved on to the implementation of new lease accounting rules. Private companies, which were given a year longer to prepare, are close on their heels. Financial institutions are working out the kinks in complying with new rules on current expected credit losses (CECL). And now insurance companies, which were largely exempted from the revenue recognition changes due to the unique nature of insurance contracts, have received their marching orders, separately, from the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB).
The overarching goal of these changes has been to move away from the prescriptive table- and rules-based accounting methodologies common in the United States and toward the more risk-weighted and interpretive style of accounting favored in other developed economies. We’ve written about this principles-based direction and covered each round of changes as it occurred. This post deals specifically with the latest guidance on long duration insurance contracts, and what insurers should be doing now to ensure a smooth and efficient transition.
Two Standards, One Transition
In the United States, accounting standards, known as Generally Accepted Accounting Principles (GAAP), are defined by the FASB. International accounting conventions are defined by the IASB and are known as International Financial Reporting Standards (IFRS).
The first of the new insurance standards—FASB ASU 2018-12, addressing insurance contracts in the United States—won’t go into effect until January 1, 2021. The other two—IFRS 9 (for accounting for financial instruments) and IFRS 17 (which guides insurance contracts and replaces the existing IFRS 4)—apply to global insurers, and were recently postponed until January 1, 2022. However, look-back provisions requiring two full years of comparable prior-years’ data make compliance with these standards an immediate priority. That means creating and preserving the relevant data, or at least being able to find the data as needed to comply.
Large insurers, for the most part, have already begun the laborious and time-consuming process of adapting to the new standards, which includes collecting and realigning their data now in order to present the required two years of comparative financial results. Our purpose here is to encourage mid-size and small insurers to follow suit, and to recommend that companies approach the transition in one piece, rather than maintaining two, or even three, separate workflows for compliance with these rule changes.
A Road Map for Implementing the Changes
The changes insurers must make affect everything from the amortization of agent commissions to future benefit liability, risk calculations, and quantitative and qualitative disclosures on items affecting cash flow. We’re not going to discuss specific changes in detail here. They are available from the FASB and IFRS websites.
We do, however, want to point out that while specific applications and reports may vary by standard, the data, data architecture, data quality, accounting systems, control frameworks, governance, testing and training required are similar for these standards, and insurers can leverage the same road map for implementation:
- Gap Analysis and Impact Assessment. The first step in any change management process is a comprehensive assessment to determine the maturity of an organization’s current state and the full scope of required changes, risk exposures and infrastructure (people, processes and technology) required to get to the desired future state.
- Methodology. Insurers will need to develop new policies—around interest rate sensitivity and risk, for example—along with guidelines for adoption, internal controls and operational changes.
- Operationalization. Organizations will need to implement changes—from data/systems/process redesign to project management, education, and quality assurance. These changes will need to be tested via dry runs and debugged.
- Integrated Solutions. Finally, organizations could centralize governance of the new processes and systems and integrate them efficiently and effectively into the enterprise environment. It is also important, as part of the integration process, to determine whether capital reserves are adequate after all of the changes have been taken into account.
It won’t be easy, but by starting now and following good change management practices, insurers can minimize disruption and ensure an orderly transition to the new accounting standards in time to meet the deadlines and be compliant with the look-back periods as well.