6 minute read
IFRS 9
A WAVE OF CHANGE
Scott Dietz considers the challenges of implementing IFRS 9 in a post-pandemic world.
Scott Dietz Director, Regulatory and Accounting Solutions, Moody’s Analytics
IFRS 9 presents several changes to those working in investment accounting. What will these changes mean for finance teams implementing the new standard in a post-pandemic world?
The Covid-19 pandemic has had a considerable impact on the global economy and the ripples will be felt across many industries and professions for years to come. And while recovery may be slow and arduous, organisations should be taking steps now to ready themselves for operating in a post-pandemic era.
Of course, those steps will look different across the board. If we look at the impact for finance professionals in the insurance sector specifically, those steps will undoubtedly include addressing the wave of change in accounting standards – such as the International Accounting Standard Board’s IFRS 17 and IFRS 9 standards – and their looming implementation deadlines. To address these standards efficiently while navigating the uncertain business environment brought on by Covid-19, insurers and their finance teams need to keep in mind that a return to “normal” could happen after or right at the time of implementation. This timing means that insurers will have to adopt these standards in an economy facing tremendous uncertainty.
With that in mind, let’s consider what insurers and their accounting teams can do, right now, to be in a better position to implement one particularly challenging aspect of these new standards: the new allowance framework within IFRS 9.
Author bio Scott Dietz is a Director at Moody’s Analytics, with over 15 years of experience leading auditing, consulting and accounting policy initiatives for financial institutions.
Current state of play
The international accounting standard IFRS 9 is changing investment accounting. It brings changes to the classification of investments, how hedging activities are determined and accounted for, and how a reserve or allowance for potential future losses of these investments should be determined.
As mentioned, we will focus on one of the key changes within IFRS 9: the allowance determination. From industry participants that have already adopted this accounting framework, we have learned that the process can take upwards of two years. There are many factors leading to this long runway, including significant data requirements that challenge nearly all adopters, and numerous management decisions that are required along the way.
Each of these decision points requires testing and analysis to determine the best methodology selections for your organisation. Examples of such selections include the following:
● What is a reasonable and supportable forecast period?
● What credit loss metrics are appropriate and how will they be determined?
● What criteria should be used to determine stage allocation logic?
These decisions represented challenges for organisations even before the pandemic and resulting economic downturn. Given the current state of the economy, and the belief that the recovery may extend beyond the implementation
date of this standard, it inevitably leads to the question of how the implementation of IFRS 9 in a post-pandemic world be different from a pre-Covid19 implementation?
Implementing in a future state
The impact of the pandemic is huge and far-reaching. Implementations that require significant collaboration between functions and lines of business – accounting and actuarial, for example – may experience additional stress and operational difficulties due to rapid and continuous change of how insurers conduct their day-to-day activities. IFRS 9 requires insurers to measure the expected credit losses of financial instruments based on the deterioration of each instrument’s credit risk since initial recognition – an operational concern for many insurers.
A typical insurer’s investment portfolio under IFRS 9 contains commercial real estate loans, whose changing credit ratings may inform how the instrument’s overall credit risk is measured. If an instrument’s credit risk increases significantly, the insurer is then required to calculate the expected credit losses over the expected life of the financial instrument rather than allowances based on 12 months of expected credit losses, which is what’s required if the credit risk of an instrument has not increased significantly.
In addition to the operational concerns, however, many of the conceptual questions which IFRS 9 presents may need to be revisited as a result of the pandemic.
Among the questions insurers need to consider:
● What is the impact of Covid-19 on their internal credit assessments?
● When should a loan be downgraded?
● What if there is a government assistance programme that defers the manifestation of loan non-performance while allowing the borrower to stop payments temporarily?
● How do you assess whether the credit risk has truly deteriorated and the borrower will not be able to repay the loan fully versus the borrower taking advantage of the government assistance?
Then there is the additional work that accounting teams may be doing to get comfortable with the IFRS 9 results given volatility. Expected credit loss estimates under IFRS 9 should be informed by history, current conditions and forecasts over the expected life of a financial instrument. The Covid-19 pandemic presents the challenge of finding relevant historical loss information, and injects uncertainty and volatility into economic forecasts. Lifetime projections may require more scenarios, running robust sensitivity assessments and detailed attribution analyses to be able to determine drivers of the changes in estimates and reasonableness of the results.
Benchmark assessments may be a good way for management to challenge the model-run outputs and inform the qualitative framework to capture significant drivers that are not part of the modeled approach.
Scenario analysis and accountants
Within the IFRS 9 standard’s guidance, accountants are required to estimate their expected loss reserves considering multiple hypothetical economic outcomes. In practice, this requirement has led to institutions considering multiple economic outcomes such as a mostlikely, upside, and downside; and then taking a weighted average with the weights reflecting the likelihood of each outcome. With this in mind, one way in which insurers can prepare for the uncertain economic outlook in the near to medium term is to have a robust process that considers multiple scenarios that reflect a range of possible future outcomes for the economy. These scenarios should incorporate the latest data, economic models and economists’ views, so that they give an accurate and internally consistent picture of how the economy would fare under different “what-if” narratives. Such scenario analysis forms the cornerstone of stress testing and budgetary planning.
Scenario analysis should not be limited to the IFRS 9 process. These efforts can add value to the asset liability sensitivity exercises and stochastic risk analysis performed by the actuarial teams to understand how key metrics – such as profit, liquidity and capital – are likely to change under various economic scenarios. Since these scenarios consider the comprehensive set of risks facing the different lines of businesses, and the interdependencies between them, their use can enhance collaboration between different groups within the company, building enterprise-wide process consistency and improving efficiency.
Beyond IFRS 9
There are many key decision points that IFRS 9 requires of companies adopting the standard. These include data management, the use of credit risk models, economic scenarios and stage allocation logic. However, as firms that have already adopted IFRS 9 – or current expected credit losses (CECL) in the US – know, one of the key considerations for insurers is the effect of the new standard on their balance sheet and how they will manage this change alongside IFRS 17. Understanding IFRS 9 classification of financial assets – including fair value (FV) through profit and loss, and FV through other comprehensive income (OCI) and amortised cost – and applying the standard in conjunction with IFRS 17 adoption may cause income statement volatility and balance sheet asset liability mismatches. Those insurers who have not yet implemented IFRS 9 should take advantage of the extension given by the International Accounting Standards Board and adopt a comprehensive approach for implementation of both standards. Furthermore, they may want to consider using deterministic economic scenarios not only for IFRS 9 but for actuarial projections as well to get a consistent view of their balance sheet forecast. ●
