The insurance industry experienced a substantial transformation in 2024. This new standard has brought about new complexities, notably in areas such as data management, model risk and accounting estimates, despite the fact that it has improved financial transparency and comparability. As a result, insurance companies are currently experiencing increased regulatory and auditor scrutiny. This article delves deeper into the common audit findings that have emerged in the aftermath of IFRS 17, analysing the obstacles that insurers encounter, as well as the primary areas of focus for regulators and auditors.
Key audit observations subsequent to the implementation of IFRS 17
Data quality and consistency
It is the auditor's primary responsibility to ascertain reasonableness over the accuracy and completeness of historical and current data, with a particular emphasis on long-tail contracts. This encompasses historical data on premiums, claims, claims conversion / handling costs and historical loss ratios.
Auditors and regulators have highlighted that data governance frameworks - which cover data ownership, data quality standards and data management policies - are generally inadequate, resulting in data integrity and quality concerns.
Risk management model
Model validation is a critical phase in assuring the model's adequacy. In many instances, inadequate model validation processes are identified, which results in unreliable models and inaccurate provisioning. The most frequently encountered issues during the validation process are as follows:
Judgements and estimates
Insurers can encounter difficulties in generating reasonable estimates for future cash flows, complex insurance products and estimating liabilities for long-tail insurance contracts. Some examples of common pitfalls are outlined below.
Market and economic factors: these can include failing to assess the appropriate discount rate for discounting the cash flows, as well as inadequate inflationary adjustments, whereby inflation is not accounted for in forecasting cashflows, which can result in an underestimation of provisions. For cross border policies, it’s important to factor in currency fluctuations, as a failure to incorporate foreign exchange risks can impact the accuracy of the reserving estimates.
Operational risks: these may include inefficiencies in claims handling, where inaccurate assessments or delays in claims processing can result in unnecessary delay in the timing and quantity of payments, which in turn impact the related time value adjustments. Likewise, when there is uncertainty in the timing and amount of reinsurance recoveries, these can be incorporated inappropriately in the reserves estimation. Inaccurate assumptions about mortality and morbidity rates, meanwhile, may impact life and health insurance provisions, while insufficient sensitivity analysis will limit the understanding of the impact of changes in key assumptions on financial results.
Disclosure: ensuring clarity & consistency
Disclosures may lack clarity, consistency and relevance, hindering an understanding of the financial impact of IFRS 17. This occurs when insurers do not provide complete disclosures, including those related to contractual cash flows, risk margins and significant judgements. The resulting difficulties encountered may include a lack of high-quality disclosures, especially for complex or subjective areas e.g. sensitivity analysis. It’s also important to avoid overly generic company-specific accounting policies that are not tailored to the specific circumstances of the company and to be sure to provide a sufficiently detailed disclosure of significant judgements and estimates for the rationale for significant judgements and estimates.
In instances where there is insufficient disclosure around the management of macroeconomic risks, insurers should effectively manage risks related to interest rate fluctuations, credit risk and liquidity risk. Last but not least, there should not be an insufficient - or no - disclosure of the potential impact of geopolitical risk events on the insurance sector.
Conclusion
Increased regulatory focus plays an important part. Regulators are closely monitoring the continued impact of IFRS 17, leading to increased scrutiny and potential enforcement actions. Insurers may need to re-evaluate their business strategies, product portfolios and operational processes to align with the requirements of IFRS 17.
Insurance companies can improve the quality of their financial reporting, mitigate risks and establish trust with stakeholders by addressing these critical audit observations and making use of the insights from the regulators' reports.
How BDO can help
BDO’s expert audit teams apply the practical experience and knowledge gained from working with clients locally and worldwide and can actively assist insurers in managing the above-listed risks.
Please reach out to the relevant partner in your local BDO firm for further information.
Author: Hasnain Ejaz
Director - Assurance Services, BDO UAE
Key audit observations subsequent to the implementation of IFRS 17
Data quality and consistency
It is the auditor's primary responsibility to ascertain reasonableness over the accuracy and completeness of historical and current data, with a particular emphasis on long-tail contracts. This encompasses historical data on premiums, claims, claims conversion / handling costs and historical loss ratios.
Auditors and regulators have highlighted that data governance frameworks - which cover data ownership, data quality standards and data management policies - are generally inadequate, resulting in data integrity and quality concerns.
Risk management model
Model validation is a critical phase in assuring the model's adequacy. In many instances, inadequate model validation processes are identified, which results in unreliable models and inaccurate provisioning. The most frequently encountered issues during the validation process are as follows:
- No controls over model versions, meaning that incorrect models have been used in reserves assessment
- Inaccurate data input due to lack of familiarity with the model
- The absence of a data integrity evaluation prior to the data's input into the system
- No audit trail of the input data into the model.
- Incorrect formulae in the model not having been rectified.
Judgements and estimates
Insurers can encounter difficulties in generating reasonable estimates for future cash flows, complex insurance products and estimating liabilities for long-tail insurance contracts. Some examples of common pitfalls are outlined below.
Market and economic factors: these can include failing to assess the appropriate discount rate for discounting the cash flows, as well as inadequate inflationary adjustments, whereby inflation is not accounted for in forecasting cashflows, which can result in an underestimation of provisions. For cross border policies, it’s important to factor in currency fluctuations, as a failure to incorporate foreign exchange risks can impact the accuracy of the reserving estimates.
Operational risks: these may include inefficiencies in claims handling, where inaccurate assessments or delays in claims processing can result in unnecessary delay in the timing and quantity of payments, which in turn impact the related time value adjustments. Likewise, when there is uncertainty in the timing and amount of reinsurance recoveries, these can be incorporated inappropriately in the reserves estimation. Inaccurate assumptions about mortality and morbidity rates, meanwhile, may impact life and health insurance provisions, while insufficient sensitivity analysis will limit the understanding of the impact of changes in key assumptions on financial results.
Disclosure: ensuring clarity & consistency
Disclosures may lack clarity, consistency and relevance, hindering an understanding of the financial impact of IFRS 17. This occurs when insurers do not provide complete disclosures, including those related to contractual cash flows, risk margins and significant judgements. The resulting difficulties encountered may include a lack of high-quality disclosures, especially for complex or subjective areas e.g. sensitivity analysis. It’s also important to avoid overly generic company-specific accounting policies that are not tailored to the specific circumstances of the company and to be sure to provide a sufficiently detailed disclosure of significant judgements and estimates for the rationale for significant judgements and estimates.
In instances where there is insufficient disclosure around the management of macroeconomic risks, insurers should effectively manage risks related to interest rate fluctuations, credit risk and liquidity risk. Last but not least, there should not be an insufficient - or no - disclosure of the potential impact of geopolitical risk events on the insurance sector.
Conclusion
Increased regulatory focus plays an important part. Regulators are closely monitoring the continued impact of IFRS 17, leading to increased scrutiny and potential enforcement actions. Insurers may need to re-evaluate their business strategies, product portfolios and operational processes to align with the requirements of IFRS 17.
Insurance companies can improve the quality of their financial reporting, mitigate risks and establish trust with stakeholders by addressing these critical audit observations and making use of the insights from the regulators' reports.
How BDO can help
BDO’s expert audit teams apply the practical experience and knowledge gained from working with clients locally and worldwide and can actively assist insurers in managing the above-listed risks.
Please reach out to the relevant partner in your local BDO firm for further information.
Author: Hasnain Ejaz
Director - Assurance Services, BDO UAE