Many lessons were learned from the 2007-2008 financial crisis, including the need to better understand an organization’s expected credit losses (ECLs). In response, the International Accounting Standards Board (IASB) put in place International Financial Reporting Standard 9 (IFRS 9) to address perceived deficiencies in the accounting for financial instruments. You may be well aware that the deadline for complying with IFRS 9 is fast approaching, but have you taken the steps needed to comply with the required changes? If not, now is the time for action.
Tackling the Challenge of Calculating Impairment
IFRS 9 contains three main components to contend with for each asset (investment):
1. Classification and measurements.
3. Hedge accounting.
Of the three, we believe the greatest challenge will likely come from the handling of the impairment of financial assets. Classification and measurement, which determines the way financial instruments are measured on the balance sheet, is typically an internal rules-based undertaking, and the hedge accounting requirements are optional at the moment. Impairment, however, must incorporate forward-looking information that requires significantly more data than before and substantial adjustments to existing approaches.
Impairment under IFRS 9 is calculated on an expected, rather than incurred, loss basis. ECL is a forward-looking measure and is influenced by a variety of factors, including the credit rating of an issuer and macroeconomic conditions. Having an inadequate approach to this requirement could leave your firm with an allowance that is too high, impacting deployment of capital to other revenue-generating functions. Alternatively, it could leave allowances that are too low, exposing your firm to unexpected losses in a downturn.
The Need for Robust, Efficient, and Transparent Analytical Tools
Insurance companies should consider analytical tools for IFRS 9 that:
- Consider a view of the future in addition to historical information.
- Offer a streamlined approach to handle the high volume of investments in a typical Insurance company’s book.
- Are adequately transparent to meet scrutiny of regulators and be easily explained to stakeholders.
We believe that a sound approach should follow the traditional method of estimating ECL from its base components: Probability of Default (PD; not paid when due), Loss Given Default (LGD; the severity of loss in the event of default), and Exposure at Default (EAD; exposure at risk of loss at date of calculation).
The team at S&P Global Market Intelligence specifically designed our IFRS 9 solutions to meet this requirement. To learn more about our robust, efficient, and transparent IFRS 9 offering, contact us here.