IFRS 17 Fair value approach

[IFRS 17 Insurance contracts – Fair value approach] An entity can elect to use the fair value approach if the full retrospective approach is impracticable, and it should use the fair value approach if the modified retrospective approach is impracticable. Applying the fair value approach:

  • The contractual service margin is determined as the difference between the fair value of a group of insurance contracts, measured in accordance with IFRS 13, ‘Fair Value Measurement’, and its fulfilment cash flows at the transition date. However, it should not increase the fair value to the amount that would be payable on demand as IFRS 13 requires.
  • An entity can choose to determine the following, either retrospectively (if reasonable and supportable data exists without use of hindsight) or at the transition date:
  • An entity can choose to include in group contracts issued more than one year apart.
  • An entity can choose to determine the cumulative amount recognised in other comprehensive income before the transition date, as described below if it chooses to recognise an eligible portion of insurance finance income and expenses in other comprehensive income:
    • retrospectively, if there is reasonable and supportable information available;
    • for insurance contracts with direct participation features where an entity holds underlying items as assets, as equal to the cumulative amount for the underlying items recognised in other comprehensive income; or
    • as nil, in any other circumstances.

Determining the fair value of a group of contracts under IFRS 13

IFRS 13 requires a fair value measurement of a liability to be a value that a market participant would require in return for assuming all of the obligations related to that liability. Entities are already using IFRS 13 for measurement of insurance contracts at fair value where they have business combinations accounted for in accordance with IFRS 3 or portfolio transfers. For business combinations and portfolio transfers, insurers generally have a market price, which is the transaction price. On transition to IFRS 17, there will be few or no observable market prices for many insurance contracts. This will require additional judgement compared to the use of IFRS 13 for business combinations or portfolio transfers today.

Discount rate

Cash flows and discount rates should reflect the assumptions that market participants would use when pricing the asset or liability. To avoid double-counting or omitting the effects of risk factors, discount rates should reflect assumptions that are consistent with those inherent in the cash flows.

In contrast to the measurement requirements under IFRS 17:

  • Own credit risk related to the liability should be considered in a fair value measurement.
  • An asset-based discount rate could be used if such approaches are used by market participants in pricing liabilities in actual transactions.

Profit margin

Irrespective of the approach used for measurement of the fair value, entities should compare the results to any actual market transactions, and they should adjust the measurement to consider the actual market transactions or quotes for similar groups of contracts. In particular, an acquirer of a group of insurance contracts is likely to require a profit margin (above the probability-weighted, risk-adjusted discounted cash flows), even if the contract would have no unearned profit if a full retrospective approach had been applied on transition.

Application of the fair value approach might be expected to result in the fair value of a group of insurance contracts being higher than its fulfilment cash flows. This is because IFRS 13 considers the fair value of insurance contracts from the perspective of a market participant, and a market participant would generally require a profit margin on top of the fulfilment cash flows to accept liability. This will be different to the full retrospective measurement or modified retrospective approach, where it is generally expected that onerous insurance contracts will have no contractual service margin because losses will be immediately recognised in profit or loss.

Leveraging embedded value or economic-based regulatory measures when applying the fair value approach

Historically, many insurers issuing long-term contracts applied Market Consistent Embedded Value (MCEV) or European Embedded Value (EEV) Principles, issued by the European Insurance CFO Forum, to measure insurance contracts for supplementary reporting purposes. Where still produced, entities will be able to use these measurements or other economic-based regulatory measures (such as Solvency II in Europe) as a starting point for the fair value approach on the transition to IFRS 17. However, entities should ensure that such measurement is consistent with the IFRS 13 requirements, and they should adjust it for any differences.

Fair value approach

Fair value approach

Fair value approach

Fair value approach Fair value approach Fair value approach Fair value approach Fair value approach Fair value approach Fair value approach

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