As part of its reforms to the accounting treatment of financial instruments, the International Accounting Standards Board (IASB) finalized International Financial Reporting Standard 9 (IFRS 9) Financial Instruments in July 2014 to replace International Accounting Standard 39 (IAS 39) Financial Instruments: Recognition and Measurement.
The migration from IAS 39 to IFRS 9 is expected to result in changes to the accounting treatment of different types of financial instruments. Some of these accounting changes will have implications for the level and volatility of reported profits, which may in turn drive changes in investment behavior.
This article discusses some potential effects of IFRS 9 on bond and equity investment1 strategies and styles, focusing on three key areas:
Fixed income investing, and the introduction of expected credit losses calculation, which may encourage more detailed credit analysis and active management of bond portfolios.
Equity investing, and the potential attractiveness of high dividend strategies now that realized gains or losses are not booked into the profit or loss if an election to present fair value changes in Other Comprehensive Income has been made.
Hedge accounting, and the relative ease of qualification, which is likely to encourage the use of derivatives to manage certain portfolio risks.
The new accounting standard will be effective from 1 January 2018. While the IASB has proposed a deferral approach for insurance companies until 2021, it is nonetheless imperative for insurers to fully understand this new accounting standard and its investment implications.
1 This paper focuses on direct investments in bonds and equities, rather than indirect investments, for example via mutual funds.
International financial reporting standards are applied to the preparation of financial statements in many jurisdictions outside of the U.S.2 As part of its reforms to the accounting treatment of financial instruments, the IASB finalized IFRS 9 Financial Instruments to replace IAS 39 Financial Instruments: Recognition and Measurement in 2014. The principles set out in IFRS 9 contain several changes to the rules provided by IAS 39, which focus on financial recognition and measurement, impairments and hedge accounting.
The new accounting standard will be effective from 1 January 2018, although the IASB has proposed a deferral approach for insurance companies until 2021. Nevertheless, given the potentially significant implications on investment and asset allocation decisions, it is crucial that insurers fully understand the new accounting standards to prepare for any changes in investment strategies driven by this migration. This is particularly important for insurers that are subsidiaries of larger financial services groups, as they may well be required to provide IFRS 9 information to their parent companies for consolidated accounting purposes from January 2018 onwards if insurance is not the dominant business of the parent.3
This PDF focuses4 on the impact of IFRS 9 on bond and equity investments, which typically form the majority of a life insurance company’s general asset allocation. We believe that investment behavior is likely to change as a result of the introduction of IFRS 9. Not least because of the way that IFRS 9 classifies bonds and equities, but also due to the methods used to measure the financial performance of these financial instruments, and by the location (on either the balance sheet or the P&L statement) where they are measured.
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