Disclosure of significant judgments for insurances – Consistent with IAS 1, IFRS 17 requires disclosure of significant judgment and changes in judgment that an entity makes in applying the standard [IFRS 17 93 and IAS 1 122]. Specifically, an entity must disclose the inputs, assumptions and estimation techniques it has used, including [IFRS 17 117]:
- Methods to measure insurance contracts within the scope of IFRS 17 and processes to estimate the inputs to those methods. Unless impracticable, an entity must also provide quantitative information about those inputs.
- Any changes in methods and processes for estimating inputs used to measure contracts, the reason for each change, and the type of contracts affected.
- to the extent not covered above, the approach used:
- To distinguish changes in estimates of future cash flows arising from exercising discretion from other changes in estimates of future cash flows for contracts without direct participation features Disclosure of significant judgments for insurances
- To determine the risk adjustment for non-financial risk, including whether changes in the risk adjustment for non-financial risk are disaggregated into an insurance service component and an insurance finance component, or are presented in full in the insurance service result.
- To determine discount rates Disclosure of significant judgments for insurances
- To determine investment components Disclosure of significant judgments for insurances
If an entity chooses to disaggregate insurance finance income or expenses into amounts presented in profit or loss and in other comprehensive income (see ‘Disaggregating insurance finance result‘), it must disclose an explanation of the methods used to determine the insurance finance income or expenses recognised in profit or loss [IFRS 17 118].
An entity must also disclose the confidence level used to determine the risk adjustment for non-financial risk. If the entity uses a technique other than the confidence level technique, it must disclose the technique used, and the confidence level corresponding to the results of that technique [IFRS 17 119]. Disclosure of significant judgments for insurances
An entity must disclose the yield curve (or range of yield curves) used to discount cash flows that do not vary based on the returns on underlying items. When an entity provides this disclosure in aggregate for a number of groups of insurance contracts, it must provide such disclosures in the form of weighted averages, or relatively narrow ranges [IFRS 17 120].
Unlike IFRS 4, IFRS 17 does not include an explicit disclosure requirement for an insurer’s accounting policies for insurance contracts and related liabilities, income and expense. However, IAS 1 requires an entity to disclose its significant accounting policies.
The need for judgment in IFRS 17 Insurance contracts
Fixed-fee service contract
A fixed-fee service contract is one in which the level of service depends on an uncertain event but the fee does not. Examples include roadside assistance programmes and maintenance contracts in which the service provider agrees to repair specified equipment after a malfunction. Such contracts can meet the definition of an insurance contract because (IFRS 17 BC95) Disclosure of significant judgments for insurances
- It is uncertain whether, or when, assistance or a repair will be needed Disclosure of significant judgments for insurances
- The owner is adversely affected by the occurrence Disclosure of significant judgments for insurances
- The service provider compensates the owner if assistance or repair is needed Disclosure of significant judgments for insurances
Although they may meet the definition of insurance contracts, their primary purpose is to provide services for a fixed fee. IFRS 17 permits entities a choice of applying IFRS 15 instead of IFRS 17 to such contracts that it issues if, and only if, they meet specified conditions. The entity may make that choice contract by contract, but the choice for each contract is irrevocable. The conditions are (IFRS 17 8): Disclosure of significant judgments for insurances
- The entity does not reflect an assessment of the risk associated with an individual customer in setting the price of the contract with that customer.
- The contract compensates the customer by providing services, rather than by making cash payments to the customer.
- Insurance risk transferred by the contract arises primarily from the customer’s use of services, rather than from uncertainty over the cost of those services.
Whether an individual risk assessment is present or not may require the exercise of judgement. In many cases, service agreements are priced to reflect some form of risk assessment. If an entity charges each policyholder the same fee to service the same asset, then the risk assessment is performed at a portfolio level rather than the individual customer level.
However, if the fixed fee for servicing is based on the specific condition of the asset (for example, the age or type of motor vehicle), this would appear to be an individual risk assessment that reflects the characteristics of an insurance contract rather than a service contract.
The accounting policy choice between applying IFRS 17 or IFRS 15 applies to fixed-fee service contracts. IFRS 17 does not mention contracts that are priced depending on the level of service. When an entity charges a fee which varies with the level of service provided (e.g., an elevator service contract that levies a fee per breakdown according to the work required), then the contract is unlikely to have significant insurance risk and this would be a service contract within the scope of IFRS 15.
Identifying portfolios Disclosure of significant judgments for insurances
A portfolio comprises contracts that are subject to similar risks and managed together. Contracts have similar risks if the entity expects their cash flows will respond similarly in amount and timing to changes in key assumptions. Contracts within a product line would be expected to have similar risks and, thus, would be in the same portfolio if they were managed together. Contracts in different product lines (for example, single premium-fixed annuities as opposed to regular-term life insurance) would not be expected to have similar risks and would be in different portfolios (IFRS 17 14).
Deciding which contracts have similar risks is a matter of judgement. Many insurance products provide a basic level of insurance cover with optional add-ons (or riders) at the discretion of the policyholder. For example, a homeowner insurance policy may provide legal cost protection or additional accidental damage cover at the policyholder’s discretion in return for additional premiums. Disclosure of significant judgments for insurances
The question arises as to the point at which policies of a similar basic type have been tailored to the level at which the risks have become dissimilar. Rider benefits issued and priced separately from the host insurance contract may need to be accounted for as separate contracts because they, in substance, represent new contracts.
Incorporate all reasonable and supportable information available without undue cost or effort
The objective of estimating future cash flows is to determine the expected value, or the probability-weighted mean, of the full range of possible outcomes, considering all reasonable and supportable information available at the reporting date without undue cost or effort (IFRS 17 B37).
An entity need not identify every possible scenario. The complexity of techniques an entity uses to estimate the full range of outcomes will depend on the complexity of the cash flows of a group of insurance contracts and the underlying factors that drive cash flows. In some cases, relatively simple modelling may give an answer within an acceptable range of precision, without the need for many detailed simulations.
However, in some cases, the cash flows may be driven by complex underlying factors and may respond in a non-linear fashion to changes in economic conditions. This may occur if, for example, the cash flows reflect a series of interrelated options that are implicit or explicit. In such cases, it is likely that more sophisticated stochastic modelling will be necessary to satisfy the measurement objective.
CONSIDER THIS! Disclosure of significant judgments for insurances
Techniques such as stochastic modelling may be more robust or easier to implement if there are significant interdependencies between cash flows that vary based on returns on assets and other cash flows. Judgement is required to determine the technique that best meets the objective of consistency with observable market variables in specific circumstances.
Market variables affect estimates of cash flows in participating contracts (contracts with participation features), and non-participating contracts, e.g., if cash flows vary with changes in an index for price inflation. Disclosure of significant judgments for insurances
The standard refers to the notion of a replicating asset or replicating portfolio of assets as a means of measuring the liability based on market information. A replicating asset is one whose cash flows exactly match, in all scenarios, the contractual cash flows of a group of insurance contracts in amount, timing and uncertainty. In some cases, a replicating asset may exist for some of the cash flows that arise from a group of insurance contracts. Disclosure of significant judgments for insurances
The fair value of that asset reflects both the expected present value of the cash flows from the asset and the risk associated with those cash flows. If a replicating portfolio of assets exists for some of the cash flows that arise from a group of insurance contracts, the entity can use the fair value of those assets to measure the relevant fulfilment cash flows instead of explicitly estimating the cash flows and discount rate (IFRS 17 B46). Disclosure of significant judgments for insurances
IFRS 17 does not require an entity to use a replicating portfolio technique. Judgement is required to determine the technique that best meets the objective of consistency with observable market variables in specific circumstances. In particular, the technique used must result in the measurement of any options and guarantees included in the insurance contracts being consistent with observable market prices (if any) for such options and guarantees (IFRS 17 B48). Disclosure of significant judgments for insurances
Current discount rates consistent with observable market prices
An entity should discount cash flows using current discount rates that reflect the time value of money, characteristics of the cash flows and the liquidity characteristics of the insurance contracts. Discount rates should be consistent with observable market prices. The use of current discount rates that are consistent with observable market prices is in line with the requirement that entities should use current estimates of cash flows in the measurement of insurance contracts and estimates of any relevant market variables should be consistent with observable market prices for those variables. Disclosure of significant judgments for insurances
An entity should maximise the use of observable inputs and reflect all reasonable and supportable internal and external information on non-market variables available without undue cost or effort. In particular, the discount rates used should not contradict any available and relevant market data, and any non-market variables used should not contradict observable market variables.77
It is unlikely that there will be an observable market price for a financial instrument with the same characteristics as an insurance contract in terms of the timing and nature of the estimated cash flows. An entity will need to exercise judgement to assess the degree of similarity between the features of the insurance contracts measured and those of the instruments for which observable market prices are available and adjust those prices to reflect the differences. Disclosure of significant judgments for insurances
Disclosure of significant judgments for insurances
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