Image © iStock
Councils do not explicitly underwrite risk, so why should local government entities need to account like insurers? If transactions and balances were not accounted for applying IFRS 4, its replacement IFRS 17 Insurance Contracts, is equally a non-issue surely?
Unfortunately, this logic is flawed.
Consider the following scenarios:
a district council’s bus services were privatised in the 1980s, and employees transferred along with their pension rights to the new employer’s pension scheme. The council pledged to make up any detriment the employees might experience from having changed schemes.
A unitary council provides claims management services to its directorates and associated entities; some of which may have exited the consolidation boundary (e.g. schools that have become academies) but still rely on the council for payment of property and public liability claims. The council holds insurance policies with insurers but pays those claims beneath the policies’ excess from an earmarked reserve.
A county council commits to building a swimming pool through one of its subsidiaries, guaranteeing to the leisure operating company that will run it that it will be complete and operationally ready by a certain date. If it is not, penalty payments are due to the leisure company.
Currently the standard for the arrangements above is typically IAS 37 Provisions, Contingent Liabilities and Contingent Assets. Should a potential liability arise this is accounted for as a provision or contingent liability, depending on the probability of occurrence and ability to accurately measure the eventual cash outflow. In the case of b) above, insurance claims by the council from the insurance companies are accounted for as contingent assets when probable, and current assets when more certain.
This treatment may have to change when IFRS 17 is in force:
This could be an IFRS 17 Insurance Contract, because the council has contracted to pay life-contingent annuities to the former employees should the new pension scheme be unable to pay.
Where the claims management service is being offered to a separate reporting entity, the council is likely issuing insurance contracts and holding reinsurance contracts with the insurance companies under IFRS 17 definitions. Although a contract may be held with the insurance company, there is possibly a separate contract issued to each associated entity (20 subsidiaries could mean 20 contracts).
The council has agreed to compensate the leisure company for the building project not finishing on time, for whatever reason. This is likely a performance guarantee that falls into scope of IFRS 17.
The absence of a premium being paid does not preclude treatment as insurance under IFRS 17. Instead, several criteria must be used to assess whether a contract, or group of contracts, are within scope. These can be summarised at a high level as:
Is there a contract (any arrangement that is legally enforceable) in place between one or more parties that are separate reporting entities?
Is one party to the contract adversely affected by an uncertain event (in either timing, size, or occurrence); and
Does the other party (the council) compensate the first party if that event were to happen?
When IFRS 17 was introduced into the private sector in 2023, many non-insurance entities found that arrangements accounted for while applying IAS 37 were in fact ‘insurance’ under the new standard.
Councils should assess their contracts as soon as possible to see if IFRS 17 applies to give them the most time to prepare for the 2025-26 year-end close and subsequent audit.
What if IFRS 17 applies?
IFRS 17 sets out the rules and considerations for the recognition, measurement, presentation, and disclosure of insurance contracts. None of them is easy to implement. For central government, the Treasury has adapted the standard in its Financial Reporting Manual guidance. For local government, the CIPFA LASAAC Code of Practice does not provide an adaptation (the ICAEW in their response to the 2025-26 Code consultation suggested adopting the adaptations in the FReM to ease the burden on reporting entities that did have IFRS 17 contracts) or application guidance.
The core measurement model for insurance contracts over one year in duration is the General Measurement Model that consists of several categories of collapsed discounted cash flows to determine the deferred profit within the contract. Time and effort must be dedicated to establishing the correct discount rate and the risk adjustment to the cashflows that reflects the inherent uncertainty in estimated future cashflows. Subsequent measurement requires unwinding the discounting, recognising profit and changes in financial and non-financial assumptions must be booked and tracked for subsequent periods. Several disclosure tables reconciling the component balances and their movement over the period are required by the standard along with numerous qualitative disclosures. If reinsurance is held, the challenges almost double because these contracts need to be separately measured, tracked, disclosed and presented. If these contracts are issued in volume a spreadsheet will not suffice, and investment in a system may be needed.
On transition, further disclosures are required along with a full set of comparative numbers for the preceding year. This means that the accounting for a contract must go back to its inception and be rolled forward to the accounting transition date of 1 January 2024 with full disclosure for the 2024-25 year and the 2025-26 year in the 2025-26 Statement of Accounts.
Materiality
If it is found that IFRS 17 does apply to one or two small contracts, it may be possible to agree with the auditors that it is immaterial and does not require changes to presentation of the primary statements or the rafts of accompanying disclosure.
To be able to prove that a contract (or group of contracts) is not material, the council will have to decide on accounting policies, make accompanying decisions and understand the measurement of those contracts before discussing with their auditors. To prove it is not qualitatively material, the potential presentation and disclosures will have to be communicated to the auditors. This will require access to specialist accounting and actuarial skills that councils do not typically possess. The same applies to some of the simplification choices given in the standard.
Conclusion
The work needed to account for IFRS 17 should not be underestimated. An early assessment of contracts will allow the council to engage early with its auditors and plan further work, should it be needed. Pre-emptive investment will avoid a nasty surprise at the eleventh hour and enable accounts to be produced and audited within the statutory deadlines.
The views expressed in this article are those of the author, and do not necessarily represent those of CIPFA
