The contract boundary distinguishes future cash flows to be considered in the measurement of the insurance contract from other future cash flows, even if they are expected to be paid under the same contract (see paragraphs 34 and B61). The contract boundary determines where a contract ends for measurement purposes, for a reporting period.
What is the definition of a contract boundary under IFRS 17?
Paragraph 34 defines the boundary of a contract for IFRS 17 measurement purposes.
“Cash flows under IFRS 17 are within the boundary of a contract if they arise from substantive rights and obligations that exist during the reporting period in which the entity can compel the policyholder to pay the premiums, or in which the entity has a substantive obligation to provide the policyholder with services.”
What are “Substantive rights and obligations”?
Paragraph 2 makes it clear that:
- rights and obligations arise from contract, law, or regulation; and
- enforceability of rights and obligations is a matter of law.
It applies the term “substantive” to identify when future cash flows arising from those rights and obligations can be recognised as assets or liabilities. Accordingly, all clear cases of present enforceable rights or present enforceable obligations, as discussed in BC160, are within the contract boundary, if they are substantive. Any terms that have no economic substance are disregarded.
According to paragraph 34, substantive rights and obligations “exist during the reporting period in which the entity can compel the policyholder to pay the premiums or in which the entity has a substantive obligation to provide the policyholder with services”.
Cases, where no party has any right, may be outside the contract boundary (see BC160 (a)). This is particularly the case if both parties have an unlimited cancellation right or no party has a renewal right.
If the policyholder, cannot be forced to pay the premium, e.g., if the policyholder is not obliged to renew a contract with an agreed upon duration, there is no substantive right of the entity to premiums after the agreed duration.
A substantive obligation could be present in cases where the applicable terms and conditions can cause future cash flows, compared with alternative cash flows within the contract boundary or premium component, to be onerous without the insurer having the ability to avoid such losses due to the absence of any cancellation or premium or benefit adjustment right. In that case, the guidance of paragraph 34 is likely to require that the loss is anticipated.
For example, in the case of a contractual clause that the funds of the contract might be used to purchase an annuity where the assumptions regarding longevity could be adjusted to represent the individual longevity risk, but not beyond that, the annuity is normally not within the contract boundary. If the terms and conditions determine a contractually fixed annuitisation rate, however, then the entity is likely to be subject to a substantive obligation and the loss-making annuitisation of the funds might be anticipated, considering the likelihood that the annuity will be elected. That might also apply in cases where a premium component, with a unilateral right of the policyholder to pay the premium in future, includes minimum financial guarantees that are in the money at the reporting date and the adjustment clauses would not allow the entity to avoid that loss if the policyholder decides to pay the premium.
Paragraphs 34 (a) and (b) describe two alternative cases of when a substantive obligation ends. Accordingly, to show that a future contractual cash flow is not a substantive obligation, it is necessary to demonstrate that it arises from (or after) a period for which one of the following cases apply:
- the entity has the practical ability to reassess the risk of a particular policyholder and can set a price accordingly; or
- both of the following conditions are satisfied:
- The entity has the practical ability to reassess the risks at a portfolio level and can reset the price or level of benefits accordingly; and
- The pricing of the premiums for coverage up to the date when the risks are reassessed does not take into account the risks that relate to future periods.
What is the consequence if a future cash outflow is outside the contract boundary, but not the originating premium?
This situation occurs if the future benefits are to be provided in the form of another service, e.g., an investment contract with an option to purchase an annuity with proceeds at maturity (see paragraph B24). In this case, the option to purchase an annuity, means the provision of an annuity is part of the contractual terms of the investment contract and it has significant insurance risk at inception. As noted in paragraph 24, however, if the contract as a whole is able to be repriced, which is the case here, when it becomes an annuity, and it is repriced to the then current terms for new entrants, then the annuity and associated provision of insurance coverage is outside the contract boundary. If terms of conversion to annuity are fixed at inception of the investment contract, the insurance coverage is within the boundary of the investment contract and the contract at inception, not just when annuity option is exercisable, is an insurance contract.