IFRS 17 for Actuaries: Examining the differences between this Standard and IFRS 4 with special consideration for takaful

IFRS 17 is an accounting standard but, for actuaries, the calculations and application of the Standard to accounting are not totally alien. If we were to discount the nuances that apply to all accounting standards, we can easily say that this is also an actuarial “standard”. In writing this paper I have approached the topic from an actuarial perspective and leaned heavily on one aspect of actuarial work: the need to approach any problem in a methodical and consistent manner. Also our training as actuaries has emphasized the need to go to first principles and not to accept “approximations” without understanding the assumptions under which such approximations hold true.

There are two sections to this paper. In the first section I compare the differences in the application of IFRS 4 and IFRS 17 in the Income Statement of insurance companies in Malaysia and dwell briefly on any special considerations for takaful. In the second section I explore certain aspects in the application of the Standard at subsequent re-measurements as it affects takaful.

It may come to a surprise to many actuaries in Malaysia (as it did to me) that, under the current IFRS 4 accounting for takaful, the accounting at the Takaful Entity level in the Income Statement is practically the same as for insurance. When perusing a set of multi columnar Takaful accounts I tend to concentrate on only the first two columns in the three columns of Financial Statements, namely the Operator Fund Column and the Takaful Funds Column. The Takaful Entity Column was not of much interest to me as I saw it as purely a consolidation of the first two columns. To put it bluntly, under current accounting for takaful, the Takaful Entity Column effectively reports the takaful business as risk transfer rather than risk sharing, though this would not be obvious to the reader unless a Qard arose in the year. Where Qard remains outstanding from the Takaful Funds, Qard when incurred would have been treated as a loss while any subsequent Qard repayment would appear as a profit at the Takaful Entity level in the year of repayment. This practice exactly mirrors the accounting for risk transfer in insurance. This is perhaps the reason why the audit fraternity in Malaysia is reluctant to move away from the current accounting practice of depicting risk transfer at the Takaful Entity level even though under IFRS 17 there is the option to account for takaful as risk sharing.

Where the takaful industry is currently at, in its approach to IFRS 17, is to go for a two-column approach: one for the takaful funds and one for the takaful entity. Should the industry or an individual player instead opt for a three-column approach (which then includes a column for the takaful operator) the Operator Fund Column will need to be accounted under IFRS 15, a different set of accounting standards. The reader will appreciate that, where an Operator Fund Column is shown in addition to the Takaful Funds Column, the risk sharing nature of takaful would be more apparent. Under such an approach, the only issue outstanding is how the Takaful Entity Column should be presented.

In Table 1 below we first consider the differences in approach for certain key new requirements introduced for the Income Statement under IFRS 17 and compare this against what is currently practiced under IFRS 4. The table assumes a two-column approach (Takaful Funds Column and Takaful Entity Column) for the Financial Statements as this is currently the expected approach to be adopted in Malaysia.

We next turn to takaful-specific issues which require our further attention when applying IFRS 17 to takaful. In Table 2 we consider what Qard means and how to allow for changes of assumptions at re-measurements. The reader would need to be aware that the current thinking among account preparers in Malaysia is that there is a need to establish a temporary “virtual” Operator fund column where IFRS 17 is assumed to apply to this column instead of IFRS 15 (thus, the term “virtual” is used). This is necessary in order to construct the Takaful Entity column of the Income Statement which would be a consolidation of this virtual column with the Takaful funds column. As any representation of the Operator fund in the Financial Statements has to comply with IFRS 15, but in this case, does not since this virtual column is IFRS 17 compliant instead, this virtual column cannot be shown in the Financial Statements.

Whilst the final accounting for takaful under IFRS 17 has yet to be finalized, time is quickly running out. The intelligence we have from the market is that consultants are recommending the application of the Variable Fee Approach (VFA) at the Takaful Entity level when the criteria enabling this approach are satisfied. This means applying the Standard at the policy level notwithstanding the complications highlighted above. I would urge actuaries to look deeper into the applicability of the VFA at the Takaful Entity level even if the criteria set by the Standard are met. As actuaries, we need to be satisfied that the use of this approximation is justified by the maths. We especially need to think carefully of the implications of our accounting approach at re-measurement. Would our accounting approach result in reported profits at re-measurement which are faithful to the economics of takaful? Specifically how would changes in discount rate and non-financial assumptions affect the reported profits of the Operator? Truth be told there are actually two contracts in takaful and, arguing that legally there is only one and therefore the lowest unit of account is the one “whole” policy, will inevitably distort the reporting of takaful to its stakeholders, maybe not immediately but certainly at subsequent re-measurements. I end this paper by quoting a line from BC3.26 of the IASB Conceptual Framework for Financial Reporting 2010 which says, “Representing a legal form that differs from the economic substance of the underlying economic phenomenon could not result in a faithful representation”. This quote I believe refers to the need that ultimately the Financial Accounts should faithfully represent the economics of the business of the Entity, legal form notwithstanding.

Note to the reader: If you are actively involved in applying IFRS 17 to takaful please fill in the questionnaire at the following link: https://learnatap.com/ifrs-17-for-takaful-questionnaire/

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