Two directives that will soon change the face of the insurance industry in the European Economic Area are Solvency II and IFRS 4 Phase II. While Solvency II focuses on establishing a single common regulatory framework to maintain capital adequacy and risk management standards, the International Accounting Standards Board (IASB) aims to “develop a single set of high quality, understandable, enforceable and globally accepted financial reporting standards based upon clearly articulated principles”, with IFRS 4.
Currently, reporting standards followed by the insurance industry are divergent, and this leads to discrepancies and confusion when accounting results from different geographies are compared. Solvency II and IFRS 4 aim to improve transparency and comparability from a regulatory and accounting perspective, respectively.
One directive (Solvency II) is a regulation and the other (IFRS 4) a financial reporting standard; but there is considerable overlap between the two and although implementation of both Solvency II and IFRS 4 could occur within a gap of a year anda- half or two, it would make great business sense for European insurers to take a coordinated approach in preparing to meet both directives.
Creating synergies and taking a coordinated approach will help reduce implementation costs; improve governance; and lend confidence to insurers currently concerned about meeting Solvency II and IFRS 4 within a short period of time. From an organizational perspective, the impact of both Solvency II and IFRS 4 (Phase II) are likely to be felt on the data and systems; reporting and disclosure mechanism; governance policies and protocols; and finally the people in the organization.
The multi-level impact that Solvency II and IFRS 4 are likely to have on European insurers calls for initiating change and more importantly creating synergies between the overlaps (in Solvency II & IFRS 4) in equipping organizational resources (reporting mechanisms, systems and data, policies and protocols and people) in meeting these two directives.
Both the differences and similarities are important for the insurer, from an implementation perspective. First, a look at the differences:
While there are differences between Solvency II and IFRS 4, there are certain similarities between the two frameworks that insurers will need to carefully consider while developing an approach for implementation of both the directives. A look at the similarities:
The real ‘time’ convergence of Solvency II and IFRS 4 Phase II seems unlikely. Solvency is likely to be implemented at least a couple of years ahead of IFRS 4 Phase II. However, for insurers, it makes complete business sense to take a coordinated approach for the implementation of both directives, given the significant overlaps in the requirements for Solvency II and IFRS 4 Phase II.
Solvency II and IFRS 4 Phase II have similar data requirements. Both require insurers to invest in data quality, control and management. However there will be differences in definition of portfolio and contract boundaries. A major requirement will be to ensure that the organization’s systems are flexible enough to factor in these differences in inputs to cash flows between Solvency II and IFRS 4 Phase II.
Under IFRS 4 Phase II, accounting policies will need to be standardized and insurers will need to ensure that the processes developed to comply with IFRS 4 Phase II, are auditable. On the other hand, insurers will need to conform to the governance and control framework promulgated in the Pillar 2 of Solvency II, in terms of policies, assumptions and calculation methods.
Insurers will need to take care when planning a common approach to reporting and regulatory disclosure standards for both sets of requirements. In spite of similarities between IFRS 4 Phase II and the Pillar 3 of Solvency II, there will be challenges in implementation. There could be inconsistencies in the way an organization’s risk profile is reported under IFRS 4 vis-à-vis Solvency II. It will require a mature understanding of the insurance business as well as accounting, reporting and disclosures for a smooth implementation.
With the European insurance industry, heading towards meeting two crucial regulatory / reporting milestones, the role of a partner with a keen understanding of the insurance business and accounting, reporting and disclosures will be crucial in determining business success in the post-Solvency II and IFRS 4 Phase II regime.
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29 May 2015
25 November 2021
08 March 2017