The Impact from IFRS 17 and Climate Change on the Inherent Risk

Eugen Gesler Durig & Mathias Rud Pedersen

Student thesis: Master thesis

Abstract

As a result of an increasing complexity in accounting estimates the International Auditing and Assurance Standards Board (IAASB) revised ISA 540. This increases the auditor’s responsibility relating accounting estimates in order to create a more critical, challenging and sceptical view of the accounting estimates. Furthermore, the International Accounting Standard Board (IASB) has issued IFRS 17, which is a new accounting standard for insurance companies. This changes the set of rules of the financial reporting. On top of that, non-life insurance companies might be facing an increased uncertainty regarding climate change that needs to be taken into account in the estimation of insurance provisions. As a result of the above, the auditors are facing significant changes and challenges that need to be considered in the auditing process. This paper therefore aims to research how these changes in the accounting policy and climate change influence the inherent risk related accounting estimates of non–life insurance provisions. The research found that the change from RBK § 69 (the default method in measurement of non-life provisions under current accounting policy), to the Building Block Approach (BBA) (the default method in IFRS 17), did not change the scope of the estimation due to continuing estimation based on future cash flows. However, the changes can be found in the details regarding the discount rate and risk adjustment. Due to the principal-based approach of the IFRS 17, the insurance companies are no longer able to use fixed values. The values will be much more company specific which will result in a higher complexity and subjectivity which leads to an increase in the inherentrisk. Insurance companies prepare separate accounts for solvency purposes, which include the discount rate and the risk adjustment. The industry therefore hope and expects to be able to continue using fixed values for the sake of simplification. However, it is currently uncertain whether this will be possible. As an alternative to the RBK § 69, insurance companies can use RBK § 69 a, which is a simplified alternative to RBK § 69. The change from RBK § 69 a, to the Premium Allocation Approach (PAA), which is the similar simplified alternative to BBA in IFRS 17, provides a new risk due to the potential of being able to allocate acquisition cost over the expected lifetime of the contract, which leads to increased inherent risk. Furthermore, the claims provisions are an estimation, which conducts substantial accounting estimates which lead to a high inherent risk. However, the high inherent risk will not change due to the fact that claims provisions are based on an estimation of future cash flows regarding insurance events that have already happened in both current accounting policy and IFRS 17. Climate change may affect an increased inherent risk associated with estimating premium provisions using the BBA and PAA. This, because of narrow data on climate change and a climate related risk that might affect a reduction in the profitability of the contracts. An impact that comes primarily from more ‘ordinary’ ‘small-scale’ insurance events due to the fact that the insurance companies use reinsurance to cover the ‘large-scale’ natural disasters which means the climate change risks do not significantly affect the inherent risk. The risk of the climate change appears to be limited and IFRS 17 is not expected to bring out major changes. IFRS 17 and the risk of climate change might add a narrow degree of increased inherent risk in estimating non-life insurance provisions. However, there is great uncertainty about what the future will bring in terms of climate change and regarding the transition to IFRS 17.

EducationsMSc in Auditing, (Graduate Programme) Final Thesis
LanguageDanish
Publication date2021
Number of pages255