Strategic Report | Governance | Financial Statements | 131
Key audit matter
How our audit addressed the key audit matter
Valuation of insurance contract liabilities and reinsurance assets and liabilities - Implementation of IFRS 17: Judgements, new models and data flows (Group) Refer to Group Audit Committee Report and Accounting policy 1.3 Adoption of IFRS 17. IFRS 17 became effective for periods beginning on or after 1 January 2023, replacing International Financial Reporting Standard 4, ‘Insurance Contracts’. As a result, the Group has adopted IFRS 17 in these financial statements. International Accounting Standard 8 ‘Accounting Policies, Changes in Accounting Estimates and Errors’ (“IAS 8”) requires that when the impact of adopting a new accounting standard would be material to the financial statement comparatives, these comparatives should be restated. As a result, the 2022 opening balance sheet and the 2022 comparatives have been restated in order to comply with the requirements of IFRS 17. Transition to IFRS 17 introduces significant changes to the recognition, measurement and presentation of (re-)insurance contract liabilities (or assets), and requires significant judgement to estimate the impact on 1 January 2022 (the transition date) and 31 December 2022 comparative period. IFRS 17 adoption has resulted in a significant reduction in the Group’s accumulated profit at the transition date (£0.9bn). This is primarily due to the establishment of the Contractual Service Margin (“CSM”) on adopting IFRS 17 which reflects the slower release of profits compared to IFRS 4. The CSM is the mechanism in IFRS 17 by which profits are deferred and amortised over the duration of a contract. The implementation of IFRS 17 requires the Group to interpret the requirements of the new standard and make significant judgments and assumptions to develop its accounting policies. Key judgments made include: • The determination of the date before which it is impracticable to apply the fully retrospective approach; • The approach for how the fair value has been determined to calculate the CSM on transition; • The CSM amortisation approach for deferred annuities; • Assessment of the expense assumptions (an ongoing key audit matter post transition); • Assessment of the credit default assumptions (an ongoing key audit matter risk post transition); and • Calibration of risk adjustment for longevity risk (an ongoing key audit matter post transition). New models and processes are also required in order to calculate the transition balance sheet, in addition to changes to end-state models and processes following transition. In particular, the key audit matter relates to: • The implementation of the Just IFRS 17 CSM engine (“JACI 17”); • The new data transfers introduced by the implementation of JACI 17 and the general ledger (including appropriate mapping of the models to the general ledger); and • The enhancements to policyholder and transaction data to the unit of account level as required by IFRS 17. Consideration is required as to whether the models and processes developed adequately incorporate the methodology and have been through an appropriate governance and review process.
We performed the following procedures to audit the transition to IFRS 17: • Assessed the implementation methodology for compliance with the requirements of IFRS 17 and market practice; • Assessed the impracticability of adopting the fully retrospective approach to measure the transition CSM prior to 2021; • Tested the calibration, methodology and models to measure the fair value at the transition date (for contracts incepting prior to 2021), including assessing the calibration and methodology relative to market data (to the extent available and relevant) and independently replicating certain aspects of management’s models; • Tested the transition balances for business written from 2021 onwards (measured using the fully retrospective approach) relative to previously audited IFRS 4 liabilities and new business operating profit; • Assessed the appropriateness of the approach to amortise the CSM relative to the requirements of IFRS 17 and market practice, including the approach to weight the insurance and investment-return services for deferred annuities; • Assessed management’s risk adjustment methodology relative to the compensation required by management for non-financial risk (as set out in the ongoing significant key audit matter post transition relating to annuitant mortality); • Assessed the allowance for expected and unexpected credit risk as part of discount rate assumptions to measure the future cash flows at transition (as set out in the ongoing key audit matter post transition); • Assessed the expense assumptions used to measure the future cash flows at transition (as set out in the ongoing key audit matter post transition); • Tested the derivation of current and locked-in discount rates, including the selection of the reference portfolio and the weightings applied to determine the locked-in rates; • Tested the CSM engine by assessing the calculation methodology against the IFRS 17 requirements, examining management’s baseline testing relative to our independent test cases, and independently replicating the calculation of a sample of the steps in the analysis of change. We also performed model change testing over any subsequent developments by management; • Tested developments made to the existing cash flows models to incorporate IFRS 17 functionality; • Tested reconciliations to confirm the completeness and accuracy of data transfers in the new data flows introduced as a result of IFRS 17; • Tested the appropriateness of the IFRS 17 data enhancements in the general ledger and JACI 17, including the allocation of (re-)insurance contracts to groups (portfolios, annual cohorts and profitability categories); and • Assessed the transition date and 31 December 2022 comparative period disclosures for compliance with IFRS 17. Based on the audit procedures performed and evidence obtained, we consider the judgments applied, new models and data flows implemented for transition to IFRS 17, and related disclosures to be appropriate.
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