On May 18, 2017, something significant, whose real impact is yet to be felt, happened in the Insurance industry.
The International Accounting Standards Board (IASB) issued its new insurance contracts Standard IFRS 17 (formerly known as IFRS 4 Phase II) effective for annual periods beginning on or after 1 January 2023.
IASB is an independent private-sector body that develops and approves International Financial Reporting Standards (IFRSs), IFRS 17 supersedes IFRS 4.
Why does this matter so much to the Insurance industry?
Under IFRS 17, there will be one accounting policy for all insurance contracts, similar accounting methods for insurance and noninsurance companies, and a discount rate based on the cash flows of the contract rather than on the investment as was the case under IFRS 4. Also, to note is that estimates will be updated each reporting period.
The net impact of IFRS 17 is that the key drivers of profit (investment vs underwriting) are made transparent.
Under IFRS 4, there were different accounting policies per insurance contract hence a lack of comparability of insurance companies across countries and of insurance vs non-insurance companies. Estimates were not required to be updated and it was difficult to see key drivers of profit.
The idea behind the IFRS 17, therefore, is to ensure that insurance companies provide relevant information that faithfully represents insurance contracts. This allows users of financial information to assess the impact that insurance contracts have on the financial position, financial performance, and cash flows of an insurance entity.
Insurance companies are taxed as per the provision of sec 19 of the Income Tax Act. The Act provides for the taxation of short-term/general insurance companies and long-term/ life insurance entities.
The current Income Tax Act on taxation of insurance business in Kenya is premised on the guidelines of IFRS 4. With the adoption of IFRS 17, the Act will have to be amended to adopt the new standard.
In the meantime, insurance businesses in Kenya will have to maintain two books, one prepared under IFRS 4 and the other one under IFRS 17 to comply with the current insurance taxation provision.
The changes that the Act must factor in include the gross written premium (GWP), Insurance service expense, and finance expenses from the insurance contracts issued.
Gross Written Premium is being replaced by insurance contract revenue which will generally be measured by the premium allocation approach (PAA).
The gross written premium should be the same as the insurance contract revenue if all the insurance contracts are within one year.
Where the insurance contracts are more than a year such as engineering insurance contracts which at time runs more than a year, the insurance contract revenues will be discounted to net present value hence reporting a different amount as compared to Gross Written Premium (GWP).
Insurance service expenses comprise actual claims paid, movement of liabilities of the incurred claims (LIC), actual attributable expenses incurred, and the loss component of the loss-making insurance contracts (onerous contracts). The cost should be discounted to reflect net present value.
Fundamentally if the short-term contracts are within one year, there will be no significant difference in the cost under IFRS 4.
However, for the contracts that are more than a year, the cost allocated to those contracts will be adjusted to net present value which will create some differences between IFRS 4 and IFRS 17 hence the differences in taxable profit.
Finance expenses from the insurance contracts issued will factor in the unwinding of discount rate/interest accretion which is a change in the expense number on contracts that are more than a year.
From the above analysis, the IFRS 17 has introduced several fundamental concepts that will necessitate the changes in the income tax act on short-term business to incorporate the following:-
The new definition of gross earned premiums to insurance revenue discounting of both revenues earned, and cost incurred to the net present value on both the premium earned and cost incurred running beyond one year.
Recognition of the loss component on the loss-making insurance contracts and unwinding of discount rate/ interest accretion which is a change in the expense number on the financial expense of the contracts that are more than a year.
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