General model in Insurance contracts measurement

General model in Insurance contracts measurement – Insurance contracts may be highly complex bundles of interdependent rights and obligations and combine features of a financial instrument and features of a service contract. As a result, insurance contracts can provide their issuers with different sources of income – e.g. underwriting profit, fees from asset management services and financial income from spread business (when insurers earn a margin on invested assets) – often all within the same contract. [IFRS 17 IN5, IFRS 17 BC18]General model in Insurance contracts

The general measurement model introduced by IFRS 17 provides a comprehensive and coherent framework that provides information reflecting the many different features of insurance contracts and the ways in which the issuers of insurance contracts earn income from them. General model of measurement of insurance contracts

Under IFRS 17, insurance contracts are aggregated into groups. When measuring a group of insurance contracts, IFRS 17 identifies two key components of the liability, the fulfilment cash flows and the CSM. For profitable groups of contracts, the CSM has an equal and opposite value on initial recognition to the fulfilment cash flows, plus any cash flows arising from the group at or before that date. This is because the entire value of the contracts relates to services to be provided in the future, and therefore, profit to be earned in the future. [IFRS 17 24, IFRS 17 32 and IFRS 17 38]

After inception, the fulfilment cash flows are reassessed and remeasured at each reporting date, using current assumptions, identifying those changes that are part of insurance revenue, insurance service expense and insurance finance income or expense. The CSM is allocated to profit or loss as a component of revenue. [IFRS 17 40 -42]General model in Insurance contracts

The General Model

The general model of measurement of insurance contracts is based on the following estimation parameters: General model of measurement of insurance contracts

The diagram below summarises the major estimation parameters in the general model and how the changes in the estimation parameters flow into the statement of comprehensive income. Measurement of each building block and its impact on the statement of comprehensive income are considered in more detail. General model of measurement of insurance contracts

Changes in estimation parameters

>

Contractual

service

margin

>

Release of contractual service margin

>

Profit or loss


(insurance service result)

>

>

Interest accretion at inception date1

>

FCFx

Risk adjustment

financial risks

>

Experience adjustment2

>

>

FCFx

Risk adjustment

non-financial risks

>

Release of risk adjustment3

>

>

FCFx

Unbiased

and

probability-weighted

future cash flows

>

Time value of money and other assumptions related to financial risk4

>

Profit or loss


and/or


Other comprehensive income

(insurance finance income or expense)

FCFx   = Fulfilment Cash Flows (see above for components)  General model of measurement of insurance contracts

After initial recognition of a group of insurance contracts, the carrying amount of the group at each reporting date is the sum of:

Carrying amount of the group of insurance contracts after initial recognition

The liability for remaining coverage

The liability for incurred claims

Contractual service margin

General model of measurement of insurance contracts

Risk adjustment financial risks

Risk adjustment financial risks

Risk adjustment non-financial risks

Risk adjustment non-financial risks

Unbiased and probability-weighted future cash flows

Unbiased and probability-weighted future cash flows

Liability for remaining coverage – An entity’s obligation to investigate and pay valid claims under existing insurance contracts for insured events that have not yet occurred (i.e., the obligation that relates to the unexpired portion of the coverage period).  General model of measurement of insurance contracts

Liability for incurred claims – An entity’s obligation to investigate and pay valid claims for insured events that have already occurred, including events that have occurred but for which claims have not been reported and other incurred insurance expenses. General model of measurement of insurance contracts

Estimates of future cash flows

Estimates of future cash flows should [IFRS 17 33]: General model of measurement of insurance contracts

  • Include all cash flows that are within the contract boundary (see below) General model of measurement of insurance contracts
  • Incorporate, in an unbiased way, all reasonable and supportable information available without undue cost or effort about the amount, timing and uncertainty of those future cash flows (see below) General model of measurement of insurance contracts
  • Reflect the perspective of the entity, provided that estimates of any relevant market variables are consistent with observable market prices for those variables (see below)
  • Be current (based on actual data on the measurement date), and explicit (No historical model but based on current insights of the future)

General model in Insurance contracts

An entity may estimate the future cash flows at a higher level of aggregation than a group and then allocate the resulting fulfilment cash flows to individual groups of contracts.

Cash flows referred to in IFRS 17 are primarily payments of cash exchanged between the parties under an insurance contract in accordance with the terms and conditions of the contract. The term “cash flow” can also be used as shorthand for other transfers of economic resources (cash flow equivalents) that are not settled in cash between the parties to the insurance contract.

They may also include such items as administration costs, payments to third parties and non-cash transactions such as the provision of goods and services.

Insurance contract boundary

Identifying the contract boundary under IFRS 17 is fundamental to the measurement of the fulfillment cash flows of a group of contracts.

Cash flows are within the boundary (see below) of an insurance 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. A substantive obligation to provide services ends when [IFRS 17 34]: General model of measurement of insurance contracts

  • The entity has the practical ability to reassess the risks of the particular policyholder and, as a result, can set a price or level of benefits that fully reflects those risks; or
  • Both of the following criteria are satisfied: General model of measurement of insurance contracts
    • The entity has the practical ability to reassess the risks of the portfolio of insurance contracts that contains the contract and, as a result, can set a price or level of benefits that fully reflects the risk of that portfolio. General model of measurement of insurance contracts
    • 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 periods after the reassessment date.

A liability or asset relating to expected premiums or claims outside the boundary of the insurance contract must not be recognized. Such amounts relate to future insurance contracts [IFRS 17 35].

IFRS 17 does not explicitly state whether the boundary condition relating to repricing for risk refers to insurance risk only or whether it also reflects other types of risk under the contract. At the February 2018 meeting of the Transition Resources Group, the IASB staff expressed the view that it was only the policyholder risk that would be relevant. This is risk that the policyholder transfers to the insurer under the contract. Lapse risk therefore would not be considered (except in the case of a reinsurance contract).

Essentials

  • Establishing the boundary of a contract is crucial as it determines the cash flows that will be included in its measurement. Drawing a contract boundary at the point where the entity has the practical ability to reprice (or amend the benefits under the contract) to fully reflect the risks of the policyholder may not reflect the entity’s expectations about future cash flows from renewals. This could result in contracts being reported as onerous even when an insurer expects to recover all costs from future renewals.
  • An entity’s ability to reprice an individual insurance contract (and a policyholder’s option not to renew the contract) creates a contract boundary. This means that, if premiums are received from the policyholder after the contract boundary date (i.e., the contract continues beyond the boundary period) this will treated as the recognition of a new contract — even if the rights and obligations of the entity and the policyholder are included within the single original policy document. The consequence would be that payments and related future cash flows will be recognized as new separate contracts. This is likely to result in a change from how entities deal with future premiums under current practices.
  • An entity might expect renewal of contracts subject to repricing and, consequently, would be willing to pay commissions and other acquisition expenses to acquire a contract that it may be unable to claw back if a contract does not renew. Accounting for the payment of insurance acquisition cash flows on insurance contracts which are expected to last for many years, but where the contract boundary is much shorter, may cause a profit or loss mismatch.For example, an insurer may pay significant up-front insurance acquisition cash flows in the first year of a contract on the basis of the expectation that the contract will renew for a number of years, but the contract boundary may be only one year. Absent claw-back provisions that would permit the insurer to recoup some of these cash flows in the event of non-renewal, the size of the acquisition cash flows may mean that the one-year contract is onerous.

Examples

Contract boundary of a stepped premium life insurance contract

An entity issues a group of insurance contracts that provide cover for death, and total and permanent disablement. The cover is guaranteed renewable (i.e., the entity must accept renewal) for 20 years regardless of changes in the insured’s health. However, the premiums increase annually with the age of the policyholder and the insurer may increase premium rates annually so long as the increase is applied to the entire portfolio of contracts (premium rates for an individual policyholder cannot be increased after the policy is underwritten).

Analysis Estimates of future cash flows

The contract boundary is one year. The guaranteed renewable basis means that the entity has a substantive obligation to provide the policyholder with services. However, the substantive obligation ends at the end of each year. This is because the entity has the practical ability to reassess the risks of the portfolio that contains the contract. Therefore, it can set a price that reflects the risk of that portfolio. General model of measurement of insurance contracts

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 premiums after the reassessment date (as premiums are adjusted annually for age). Therefore, both criteria in paragraph 34(b) (ii) (see above) are satisfied. Estimates of future cash flows

Contract boundary of a level premium life insurance contract

An entity issues a group of insurance contracts that provide cover for death, and total and permanent disablement. The cover is guaranteed renewable (i.e., the entity must accept renewal) for 20 years regardless of changes in the insured’s health. The premium rates are level for the life of the policy irrespective of policyholder age. Therefore, the entity generally will “overcharge” in the early years of a contract and “undercharge” in the later years. General model of measurement of insurance contracts

In addition, the insurer may increase the remaining year’s level premium annually so long as the increase is applied to the entire portfolio of contracts (premium rates for an individual policyholder cannot be increased after the policy is underwritten). Estimates of future cash flows

Analysis Estimates of future cash flows

The contract boundary is 20 years. The guaranteed renewable basis means that the entity has a substantive obligation to provide the policyholder with services. The substantive obligation does not end until the period of the guaranteed renewable basis expires. Although the entity has the practical ability to reassess the risks of the portfolio that contains the contract and, therefore, can set a price that reflects the risk of that portfolio, the pricing of the premiums does take into account the risks that relate to premiums after the reassessment date.

The entity charges premiums in the early years to recover the expected cost of death claims in later years. Therefore, the second criterion for drawing a shortened contract boundary when an entity can reassess the premiums or benefits for a portfolio of insurance contracts is not satisfied. Estimates of future cash flows


Cash flows within the contract boundary

Cash flows within the boundary of an insurance contract are those that relate directly to the fulfilment of the contract, including those for which the entity has discretion over the amount or timing. IFRS 17 provides the following examples of such cash flows [IFRS 17 B65]:

  • Premiums and related cash flows General model of measurement of insurance contracts
  • Claims and benefits, including reported claims not yet paid, incurred claims not yet reported and expected future claims within the contract boundary
  • Payments to policyholders (or on behalf of policyholders) that vary depending on underlying items General model of measurement of insurance contracts
  • Payments to policyholders resulting from embedded derivatives, for example, options and guarantees
  • An allocation of insurance acquisition cash flows attributable to the portfolio to which the contract belongs
  • Claims handling costs General model of measurement of insurance contracts
  • Contractual benefit costs paid in kind General model of measurement of insurance contracts
  • Policy administration and maintenance costs, including recurring commissions that are expected to be paid to intermediaries
  • Transaction-based taxes and levies (such as premium taxes) Estimates of future cash flows
  • Payments by the insurer in a fiduciary capacity to meet tax obligations incurred by the policyholder, and related receipts
  • Claim recoveries, such as salvage and subrogation (to the extent they are not recognised as separate assets)
  • An allocation of fixed and variable overheads directly attributable to fulfilling insurance contracts. (Such overheads are allocated to groups of contracts using methods that are systematic and rational, and are consistently applied to all costs that have similar characteristics) General model of measurement of insurance contracts
  • Any other costs that may be charged specifically to the policyholder under the terms of the contract Estimates of future cash flows
  • Insurance acquisition cash flows are those arising from the cost of selling, underwriting and starting a group of insurance contracts that are directly attributable to the portfolio of insurance contracts to which the group belongs. Such cash flows include cash flows that are not directly attributable to individual contracts or groups of insurance contracts within the portfolio.

There is no restriction of insurance acquisition cash flows to only those resulting from successful efforts. Therefore, the directly attributable costs of an underwriter of a portfolio of motor insurance contracts, for example, need not be apportioned between costs for contracts issued and the cost of efforts that did not result in the issuance of a contract.

IFRS 17 provides a list of cash flows that should not be included in cash flows that arise as an entity fulfils an existing insurance contract, these include, for example [IFRS 17 B66]:

  • Investment returns (accounted for separately under applicable IFRSs) General model of measurement of insurance contracts
  • Cash flows (payments or receipts) that arise under reinsurance contracts held (accounted for separately)
  • Cash flows that may arise from future insurance contracts, i.e., cash flows outside the boundary of existing contracts
  • Cash flows relating to costs that cannot be directly attributed to the portfolio of insurance contracts that contain the contract, such as some product development and training costs; these are recognised in profit or loss when incurred General model of measurement of insurance contracts
  • Cash flows that arise from abnormal amounts of wasted labour or other resources that are used to fulfil the contract; such costs are recognised in profit or loss when incurred
  • Income tax payments and receipts the insurer does not pay or receive in a fiduciary capacity General model of measurement of insurance contracts
  • Cash flows between different components of the reporting entity, such as policyholder and shareholder funds, if these cash flows do not change the amounts paid to policyholders
  • Cash flows arising from components separated from the insurance contract and accounted for using other applicable IFRSs
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Considerations

  • As a change to many existing accounting practices under IFRS 4, no explicit deferred acquisition cost assets exist. Instead, the insurance acquisition cash flows are included as a “negative liability” within the measurement of the CSM on initial recognition. Because the CSM can never be negative, there is no longer a need to perform any recoverability assessments for acquisition costs deferred.
  • Investment returns are not part of the fulfilment cash flows of a contract because measurement of the contract should not depend on the assets that the entity holds. However, where a contract includes participation features, the measurement of the fulfilment cash flows should include the effect of returns from underlying items in those cash flows.The “Illustrative Examples” that accompany IFRS 17 explain that asset management is part of the activities the entity must undertake to fulfil the contract when there is an account balance calculated using returns from specified assets and fees charged by the entity. In general, an entity should incorporate asset management expenses in a way that is consistent with how it considers the returns from the assets it is holding in the estimates of fulfilment cash flows, based on the product features. So if investment returns from underlying items are included in fulfilment cash flows then the asset management expenses that relate to those returns should also be included.
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]. General model of measurement of insurance contracts

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. General model of measurement of insurance contracts

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. General model of measurement of insurance contracts

The future cash flow estimates must be on an expected value basis and be unbiased. This means that they should exclude any additional estimates above the probability-weighted mean for “uncertainty”, “prudence” or what is sometimes described as “management loading”. The risk adjustment for non-financial risk is intended to reflect the compensation for bearing the non-financial risk resulting from the uncertain amount and the timing of cash flows. General model of measurement of insurance contracts

Reasonable and supportable information available at the reporting date without undue cost or effort includes information available from an entity’s own information systems about past events and current conditions, and forecasts of future conditions. An entity should estimate the probabilities and amounts of future payments under existing contracts based on information obtained, including [IFRS 17 B41]: General model of measurement of insurance contracts

  • Information about claims already reported by policyholders General model of measurement of insurance contracts
  • Other information about the known or estimated characteristics of the insurance contracts General model of measurement of insurance contracts
  • Historical data about the entity’s own experience, supplemented when necessary with data from other sources. Historical data is adjusted to reflect current conditions, for example, if:
    • Characteristics of the insured population differ (or will differ, for example, because of adverse selection) from those of the population that has been used as a basis for the historical data. General model of measurement of insurance contracts
    • There are indications that historical trends will not continue, that new trends will emerge or that economic, demographic and other changes may affect the cash flows that arise from the existing insurance contracts. General model of measurement of insurance contracts
    • There have been changes in items such as underwriting and claims management procedures that may affect the relevance of historical data to the insurance contracts. Information collection insurance contracts General model of measurement of insurance contracts
  • Current price information, if available. The standard refers to reinsurance contracts and other financial instruments (if any) covering similar risks, such as catastrophe bonds and weather derivatives, and recent market prices for transfers of insurance contracts. General model of measurement of insurance contracts

The measurement of a group of insurance contracts should reflect, on an expected value basis, the entity’s current estimates of how the policyholders in the group will exercise the options available, e.g., renewal, surrender and conversion options, and options to stop paying premiums while still receiving benefits under the contracts.

Considerations

  • 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.

  • Some insurers currently include management loadings or other forms of prudence within insurance liabilities. Implicit prudence in reserving tends to reduce volatility in profits. IFRS 17 requires calculation and disclosure of a point estimate of the mean of the expected future cash flows discounted to the reporting date with an explicit risk margin for non-financial risk. Insurers will need to educate investors about the potential effect of IFRS 17 on reported profits if they expect that the volatility of their results is likely to increase when they apply IFRS 17.

Market variables and non-market variablesGeneral model in Insurance contracts

IFRS 17 identifies two types of variable that can affect cash flow estimates [IFRS 17 B42]: General model of measurement of insurance contracts

  • Market variables (i.e., those that can be observed in, or derived directly from, markets (for example, prices of publicly-traded securities and interest rates))
  • Non-market variables (i.e., all other variables, such as the frequency and severity of insurance claims and mortality)

Market variables

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. General model of measurement of insurance contracts

Estimated cash flows reflect the perspective of the entity, provided that estimates of any relevant market variables are consistent with observable market prices for those variables. IFRS 17 has similar requirements to IFRS 13 Fair Value Measurement for maximising the use of observable inputs when estimating market variables [IFRS 13 3]. Consistent with IFRS 13, if variables need to be derived (for example, because no observable market variables exist) they need to be as consistent as possible with observable market variables [IFRS 17 B44]. General model of measurement of insurance contracts

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. General model of measurement of insurance contracts

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]. General model of measurement of insurance contracts

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]. General model of measurement of insurance contracts

The application guidance is clear that although market variables will generally provide a measurement basis for financial risks (e.g., observable interest rates) this will not always be the case. The same is true for non-financial risks and non-market variables. For example, some non-financial risks could be observable in markets, whereas not all financial risks will be observable.

In practice, we believe that the use of a replicating portfolio is likely to be rare as IFRS 17 refers to an asset whose cash flows exactly match those of the liability.

Non-market variables

Estimates of non-market variables should reflect all reasonable and supportable evidence available without undue internal or external cost or effort [IFRS 17 B49]. Entities need to assess the persuasiveness of information from different sources, as shown below: General model of measurement of insurance contracts

Persuasiveness of internal and national mortality statistics [IFRS 17 B50] General model of measurement of insurance contracts

An entity that issues life insurance contracts should not rely solely on national mortality statistics. It should consider all other reasonable and supportable internal and external information available without undue cost or effort when developing unbiased estimates of probabilities for mortality scenarios for its insurance contracts. For example:

  • Internal mortality statistics may be more persuasive than national mortality data if national data is derived from a large population that is not representative of the insured population.
  • Conversely, if the internal statistics are derived from a small population with characteristics that are believed to be close to those of the national population, and the national statistics are current, an entity should place more weight on the national statistics. General model of measurement of insurance contracts

Estimated probabilities for non-market variables should not contradict observable market variables. For example, estimated probabilities for future inflation rate scenarios should be as consistent as possible with probabilities implied by market interest rates [IFRS 17 B51]. General model of measurement of insurance contracts

In some cases, market variables and non-market variables may be correlated. For example, there may be evidence that lapse rates (a non-market variable) are correlated with interest rates (a market variable) [IFRS 17 B52]. General model of measurement of insurance contracts

Similarly, there may be evidence that claim levels for house or car insurance are correlated with economic cycles and therefore with interest rate inflation. The entity should ensure that the probabilities for scenarios and risk adjustments for non-financial risk that relate to market variables are consistent with the observed market prices that depend on those variables [IFRS 17 B53].

Using current estimates

Estimated cash flows should be current, i.e., reflect conditions existing at the measurement date, including assumptions about the future. An entity should review and update its estimates from the close of the previous reporting period. In doing so, an entity should consider whether updated estimates faithfully represent the conditions at the end of the reporting period and changes during the period [IFRS 17 B54]. General model of measurement of insurance contracts

Faithful representation of conditions at the reporting date and changes in the period

If conditions have not changed in a period, shifting a point estimate from one end of a reasonable range at the beginning of the period to the other end of the range at the end of the period would not faithfully represent what has happened during the period. General model of measurement of insurance contracts

If the most recent estimates are different from previous estimates, but conditions have not changed, an entity should assess whether the new probabilities assigned to each scenario are justified. In updating its estimates of those probabilities, the entity should consider both the evidence that supported its previous estimates and all newly available evidence, giving more weight to the more persuasive evidence. General model of measurement of insurance contracts

An entity should not update probabilities for claim events to reflect actual claims that took place after the reporting date but before the financial statements are finalised. For example, there may be a 20% probability at the end of the reporting period that a major storm will strike during the remaining six months of an insurance contract. After the end of the reporting period, but before the financial statements are authorised for issue, a major storm strikes. General model of measurement of insurance contracts

The fulfilment cash flows under that contract should not reflect hindsight (i.e., the storm that occurred in the next period). Instead, the cash flows included in the measurement should include the 20% probability apparent at the end of the reporting period (with disclosure applying IAS 10 Events After the Reporting Date that a non-adjusting event occurred after the end of the reporting period) [IFRS 17 B55 and IAS 10 10-11]. General model of measurement of insurance contracts

Explicit cash flows

An entity estimates future cash flows separately from other estimates, e.g., the risk adjustment for non-financial risk or the adjustment to reflect the time value of money and financial risks. There is an exception if the entity uses the fair value of a replicating portfolio of assets to measure some of the cash flows that arise from insurance contracts.

This will combine the cash flows and the adjustment to reflect the time value of money and financial risks. The fair value of a replicating portfolio of assets reflects both the expected present value of cash flows from the portfolio of assets and the associated risk (see Market variables above). General model of measurement of insurance contracts

Some existing accounting practices incorporate implicit margins for risk in a best estimate liability. For example, determining the liability for incurred claims based on an undiscounted management best estimate, which often incorporates conservatism or implicit prudence. General model of measurement of insurance contracts

IFRS 17 appears to require a change to this practice such that incurred claims liabilities must be measured at the discounted probability-weighted expected present value of the cash flows, plus an explicit risk adjustment. Entities will need to be more transparent in providing information about how liabilities related to insurance contracts are made up.

Insurance contract discount rates

The adjustment is made by discounting estimated future cash flows. Discount rates must [IFRS 17 36]: General model of measurement of insurance contracts

  • Reflect the time value of money, characteristics of the cash flows and liquidity characteristics of the insurance contracts
  • Be consistent with observable current market prices (if any) for financial instruments with cash flows whose characteristics are consistent with those of the insurance contracts (e.g., timing, currency and liquidity) General model of measurement of insurance contracts
  • Exclude the effect of factors that influence such observable market prices, but do not affect the future cash flows of the insurance contracts

Discount rates used to measure the present value of future cash flows should reflect the characteristics of the cash flows; for example, in terms of currency and timing of cash flows and uncertainty due to financial risk. The effects of uncertainty in cash flows due to non-financial risks are included in the risk adjustment for non-financial risk.

General model in Insurance contracts

The discount rates calculated according to the requirements above should be determined, as follows [IFRS 17 B72]: General model of measurement of insurance contracts

Insurance liability measurement component  Discount rate
Fulfilment cash flows Current rate at reporting date
Contractual service margin interest accretion for contracts without direct participation features Rate at date of initial recognition of group
Changes in the contractual service margin for contracts without direct participation features Rate at date of initial recognition of group
Changes in the contractual service margin for contracts with direct participation features A rate consistent with that used for the allocation of finance income or expenses
Liability for remaining coverage under premium allocation approach Rate at date of initial recognition of group
Profit or loss component
Disaggregated insurance finance income included in profit or loss for groups of contracts for which changes in financial risk do not have a significant effect on amounts paid to policyholders (see ‘Financial risks not effecting insurance payments’) Rate at date of initial recognition of group
Disaggregated insurance finance income included in profit or loss for groups of contracts for which changes in financial risk assumptions have a significant effect on amounts paid to policyholders (see ‘Financial risks effecting insurance payments’) Rate that allocates the remaining revised finance income or expense over the duration of the group at a constant rate or, for contracts that use a crediting rate, uses an allocation based on the amounts credited in the period and expected to be credited in future periods
Disaggregated insurance finance income included in profit or loss for groups of contracts applying the premium allocation approach (see ‘Financial risks effecting insurance payments’) Rate at date of incurred claim

To determine the discount rates at the date of initial recognition of a group of contracts described above, an entity may use weighted-average discount rates over the period that contracts in the group are issued, which cannot exceed one year [IFRS 17 B73]. This can result in a change in the discount rates during the period of the contracts.

When contracts are added to a group in a subsequent reporting period (because the period of the group spans two reporting periods) and discount rates are revised, an entity should apply the revised discount rates from the start of the reporting period in which the new contracts are added to the group [IFRS 17 28]. This means that there is no retrospective catch-up adjustment.

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For insurance contracts with direct participation features, the contractual service margin is adjusted based on changes in the fair value of underlying items, which includes the impact of discount rate changes (see Contracts with discretionary participation features). General model of measurement of insurance contracts

Discount rates and characteristics of cash flows

Estimates of discount rates must be consistent with other estimates used to measure insurance contracts to avoid double counting or omissions; for example [IFRS 17 B74]:

  • Cash flows that do not vary based on the returns on any underlying items must be discounted at rates that do not reflect any such variability.
  • Cash flows that vary based on the returns on any financial underlying items must be discounted using rates that reflect that variability or adjusted for the effect of that variability and discounted at a rate that reflects the adjustment. General model of measurement of insurance contracts
  • Nominal cash flows (i.e., those that include the effect of inflation) must be discounted at rates that include the effect of inflation.
  • Real cash flows (i.e., those that exclude the effect of inflation) must be discounted at rates that exclude the effect of inflation.

Cash flows can vary based on returns from financial underlying items due to a contractual link to underlying items, or because the entity exercises discretion in providing policyholders with a financial return on premium paid. An entity need not hold related underlying items for cash flows to vary based on returns from underlying items [IFRS 17 B75].

When some of the cash flows vary based on returns from underlying items and others do not (e.g., a participating contract has fixed or guaranteed cash flows in addition to providing policyholders with financial returns), an entity may [IFRS 17 B76-B77]: General model of measurement of insurance contracts

  • Divide the estimated cash flows and apply appropriate discount rates to each type General model of measurement of insurance contracts
    Or General model of measurement of insurance contracts
  • Apply discount rates appropriate for the estimated cash flows as a whole (e.g., using weighted average rates, stochastic modelling or risk-neutral measurement techniques)

The requirement for discount rates to be consistent with the characteristics of the cash flows of insurance contracts is from the perspective of the entity. IFRS 17 requires an entity to disregard its own credit risk when measuring the fulfilment cash flows [IFRS 17 31 and IFRS 17 BC 197]. General model of measurement of insurance contracts

Considerations:

IFRS 17 does not require an entity to divide estimated cash flows into those that vary based on the returns on underlying items and those that do not. By not dividing the cash flows, an entity avoids the complexity of having to disentangle cash flows that may be interrelated.

However, if an entity does not divide the estimated cash flows in this way, it should apply discount rates for the estimated cash flows as a whole in a way that is consistent with the principles of the standard; for example, using stochastic modelling or risk-neutral measurement techniques. Both approaches, dividing or not dividing cash flows, have their own conceptual and practical implications, so entities should carefully assess what methods will be most suited to the particular circumstances.

Entities should be aware that, even for participating contracts, at least some of the cash flows to policyholders are independent of returns on underlying items; for example, payments for fixed death benefit or expenses of the entity that do not vary with the underlying items.

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.

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 [IFRS 17 B78]. General model of measurement of insurance contracts

Considerations:

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.

The standard refers to yield curves in several places, without specifying that discount rates should be a curve or a representative single rate. However, IFRS 17 requires that the discount rates applied reflect the characteristics of the liability. One such relevant characteristic is timing and duration of the cash flows, which would the particularly prominent for long-term liabilities.

IFRS 17 therefore seems to raise the expectation that, typically, the characteristics of timing and duration need to be reflected through the use of a curve. Notwithstanding the expectation of using a curve to adequately reflect timing and duration of the insurance liability, possible practical considerations might be:

  • Whether a different method could be applied to some types of (cash flows of) participating contracts
  • Whether an entity could use an approach to convert a curve in a single rate as a practical simplification for some types of products. However, this requires careful consideration as an entity would still have to substantiate in every reporting period, whether the IFRS 17 discount rate principles are satisfied. As such, there will be a number of challenges to such an approach. In addition, this method differs from the approach followed to discounting in the Solvency II regulatory regime
  • Whether to use a flat rate for short-term liabilities as for such liabilities, the impact of the timing may not be significant. However, it would be a practical expedient that requires a definition of ‘short’ for these purposes. In addition, materiality aspects may have to be considered

Bottom-up approach

For cash flows of insurance contracts that do not vary based on the returns on underlying items, the discount rate reflects the yield curve in the appropriate currency for instruments that expose the holder to no or negligible credit risk, adjusted to reflect the liquidity characteristics of the group of insurance contracts. General model of measurement of insurance contracts

That adjustment must reflect the difference between the liquidity characteristics of the group of insurance contracts and the liquidity characteristics of the assets used to determine the yield curve. Yield curves reflect assets traded in active markets that the holder can typically sell at any time without incurring significant costs. In contrast, under some insurance contracts, the entity cannot be forced to make payments earlier than the occurrence of insured events, or dates specified in the contracts [IFRS 17 B79]. General model of measurement of insurance contracts

For cash flows of insurance contracts that do not vary based on the returns on underlying items, an entity may determine discount rates by adjusting a liquid risk-free yield curve to reflect the differences between liquidity characteristics of the financial instruments that underlie the rates observed in the market and liquidity characteristics of the insurance contracts [IFRS 17 B80].

Top-down approach

Alternatively, an entity may determine the appropriate discount rates for insurance contracts based on a yield curve that reflects the current market rates of return implicit in a fair value measurement of a reference portfolio of assets (a top-down approach). An entity should adjust that yield curve to eliminate any factors that are not relevant to the insurance contracts, but is not required to adjust the yield curve for differences in liquidity characteristics of the insurance contracts and the reference portfolio [IFRS 17 B81].

General model in Insurance contracts

In principle, a single illiquid risk-free yield curve should eliminate uncertainty about the amount and timing for cash flows of insurance contracts that do not vary based on the returns of the assets in the reference portfolio. However, in practice, the top-down and bottom-up approach may result in different yield curves, even in the same currency.

This is because of the inherent limitations in estimating the adjustments made under each approach, and the possible lack of an adjustment for different liquidity characteristics in the top-down approach. An entity is not required to reconcile the discount rate determined under its chosen approach with that of another approach [IFRS 17 B84].

Considerations

Entities will need to determine an appropriate method to adjust the observable market information in a way that reflects the illiquidity characteristics of the insurance contracts. The illiquidity characteristics will depend on the specific nature of a contract, for example, annuities in payment are generally viewed as very illiquid as they cannot be surrendered and only expire on the annuitant’s death. Different methods to estimate an illiquidity premium are available, for example, it can be derived from collateralised bonds or estimating it by adjusting a spread in an instrument for credit risk spreads based on credit default swaps.

Discount rates beyond the market observable range

Some insurance contracts will have a contract boundary that extends beyond the period for which observable market data is available. In these situations, the entity will have to extrapolate the discount rate yield curve beyond that period, as illustrated in the diagram below. General model of measurement of insurance contracts

General model in Insurance contracts

An entity must apply the following guidance for estimating the discount rate curve [IFRS 17 B82]: General model of measurement of insurance contracts

  • Use observable market prices in active markets for assets in the reference portfolio where they exist
  • If a market is not active, an entity should adjust observable market prices for similar assets to make them comparable to market prices for the assets measured
  • If there is no market for assets in the reference portfolio, an entity must apply an estimation technique. For such assets:
  • Develop unobservable inputs using the best information available. Such inputs might include the entity’s own data and, in the context of IFRS 17, the entity might place more weight on long-term estimates than on short-term fluctuations General model of measurement of insurance contracts
  • Adjust data to reflect all information about market participant assumptions that is reasonably available
Considerations

IFRS 17 provides no specific guidance on estimation techniques to extrapolate the discount rate curve. In practice, multiple techniques exist. The general guidance in IFRS 17 indicates that applying an appropriate estimation technique requires judgement, weighing the principle to use the best information available and adjusting for information about market participant assumptions. This will require establishing a robust estimation process for discount rates, including related controls for determining the inputs to discount rates based on the conditions at the reporting date.

Curves used for regulatory purposes may be a starting point to determine the discount rate curve (or components of that curve) under IFRS 17. However, an entity would have to decide if an estimate is consistent with the requirements in IFRS 17 and make necessary adjustments.

Risk adjustment for non-financial risks

The risk adjustment for non-financial risk is the compensation that the entity requires for bearing the uncertainty about the amount and timing of cash flows that arise from non-financial risk [IFRS 17 37]. The risks covered by the risk adjustment for non-financial risk are insurance risk and other non-financial risks such as lapse risk and expense risk [IFRS 17 B86].

In theory, the risk adjustment for non-financial risk for insurance contracts measures the compensation that the entity would require to make it indifferent between [IFRS 17 B87]:

  • Fulfilling a liability that has a range of possible outcomes arising from non-financial risk, and General model of measurement of insurance contracts
  • Fulfilling a liability that will generate fixed cash flows with the same expected present value as the insurance contracts

General model in Insurance contracts

Example – Risk adjustment for non-financial risk
[IFRS 17 B87]

Compensation an entity requires to be indifferent between fixed and variable outcomes

The risk adjustment for non-financial risk would measure the compensation the entity would require to make it indifferent between fulfilling a liability that, because of non-financial risk, has a 50% probability of being CU90 and a 50% probability of being CU110, and fulfilling a liability that is fixed at CU100. As a result, the risk adjustment for non-financial risk conveys information to users of financial statements about the amount charged by the entity for the uncertainty arising from non-financial risk about the amount and timing of cash flows.

The risk adjustment for non-financial risk reflects the entity’s perception of the economic burden of its non-financial risks; it is not a current exit value or fair value, which reflects the transfer to a market participant [IFRS 17 BC209]. The risk adjustment for non-financial risk reflects [IFRS 17 B88]: General model of measurement of insurance contracts

  • The degree of diversification benefit the entity includes when determining the compensation it requires for bearing that risk,
  • Both favourable and unfavourable outcomes, in a way that reflects the entity’s degree of risk aversion General model of measurement of insurance contracts

IFRS 17 does not specify the estimation technique(s) used to determine the risk adjustment for non-financial risk. However, the risk adjustment for non-financial risk must have the following characteristics (IFRS 17 B91 – B92): General model of measurement of insurance contracts

  • Risks with low frequency and high severity generally will result in higher risk adjustments for non-financial risk than those with high frequency and low severity.
  • For similar risks, contracts with a longer duration generally will result in higher risk adjustments for non-financial risk than contracts with a shorter duration.
  • Risks with a wider probability distribution generally will result in higher risk adjustments for non-financial risk than those with a narrower distribution.
  • The less that is known about underlying assumptions used to determine the current estimate and its trend, the higher the risk adjustment for non-financial risk.

To the extent that emerging experience reduces uncertainty about the amount and timing of cash flows, risk adjustments for non-financial risk will decrease and vice versa. IFRS 17 does not specify the estimation technique(s) used to determine the risk adjustment for non-financial risk. Because the risk adjustment for non-financial risk is an entity-specific perception, rather than a market participant’s perception, different entities may determine different risk adjustments for similar groups of insurance contracts.

Accordingly, to enable users of financial statements to understand how entity-specific assessments of risk aversion might differ from entity to entity, the entity must disclose the confidence level used to determine the risk adjustment for non-financial risk or, if a technique other than confidence level is used, the entity must disclose the technique used and the confidence level corresponding to the technique (see ‘Disclosure of significant judgements for insurances‘). Risk adjustment for non-financial risks

Considerations

The risk adjustment reflects diversification benefits the entity considers when determining the amount of compensation it requires for bearing that uncertainty. This approach implies that diversification benefits could reflect effects across groups of contracts, or diversification benefits at even a higher level of aggregation. However, when determining the risk adjustment at a level more aggregated than a group of contracts, an entity must establish a method for allocating the risk adjustment to the underlying groups. This will form part of the requirements for systems and processes that an entity will need to develop when implementing the standard.

Changes in the risk adjustment will reflect several factors, for example: release from risk as time passes, changes in an entity’s risk appetite (the amount of compensation it requires for bearing uncertainty), changes in expected variability in future cash flows and diversification between risks. Entities will need to distinguish between changes in the risk adjustment relating to current and past service (reflected immediately in profit or loss) and those relating to future service (which adjust the CSM — see ‘Contractual service margin‘).

The standard does not prescribe particular techniques for estimating the risk adjustment for a group of contracts. The standard incorporates guidance with the aim to aid companies in selecting an appropriate method [IFRS 17 BC213 – 214].

The purpose of the risk adjustment is to measure the effect of uncertainty in the cash flows of insurance contracts that arise from risks other than financial risks. It should not reflect risks that do not arise from the rights and obligations created by an insurance contract, eg general operational risks. The risk adjustment is an entity-specific measure of uncertainty and should have the following characteristics: General model of measurement of insurance contracts

General model in Insurance contracts

IFRS 17 does not specify what estimation technique entities should use when calculating the risk adjustment. However, the following guidelines apply:

Lower – Risk adjustment for:

>

Higher – Risk adjustment for:

Contracts with:

  • low frequency and high severity of claims
  • longer duration for similar risks
  • wider probability distribution
  • emerging experience increases the uncertainty on non-financial risks.

Contracts with:

  • high frequency and low severity of claims
  • shorter duration for similar risks
  • narrower probability distribution
  • emerging experience decreases the uncertainty on non-financial risks.

A reporting entity should disclose the technique used in the estimation of the risk adjustment and the confidence level corresponding to the result of that technique.

Practical insight – entities’ own view on risk and diversification for risk adjustment

IFRS 17 allows a choice of estimation method and gives entities an opportunity to eliminate the high interest rate sensitivity from the cost of capital approach mandated by Solvency II. An entity specific pattern of risk release could also prove a useful basis for revenue recognition under the Premium Allocation Approach. Subject to the operational challenges of confidence level disclosures, entities could align their financial reporting to their own risk appetite.

Contractual service margin

1. Initial recognition

An entity should measure the CSM on initial recognition of a group of insurance contracts at an amount that, unless the group of contracts is onerous (see ‘Onerous insurance contracts‘), results in no income or expenses arising from [IFRS 17 38]: General model of measurement of insurance contracts

General model in Insurance contracts

Therefore, the CSM on initial recognition, assuming a contract is not onerous, is no more than the balancing number needed to avoid a day 1 profit. The CSM cannot depict unearned losses. Instead, IFRS 17 requires an entity to recognise a loss in profit or loss for onerous groups of contracts (see ‘Onerous insurance contracts‘). General model of measurement of insurance contracts

The approach above on initial recognition applies to contracts with and without participation features, including investment contracts with discretionary participation features.

For groups of reinsurance contracts held, the calculation of the CSM at initial recognition is modified to take into account the fact such groups are usually assets rather than liabilities and that a margin payable to the reinsurer, rather than making profits, is an implicit part of the premium (see ‘Initial measurement of reinsurance contracts‘).

Something else -   Insurance Contract modification and derecognition

A CSM is not specifically identified for contracts subject to the premium allocation approach, although the same underlying principle of profit recognition (i.e., no day 1 profit) applies (see ‘Measurement of remaining coverage‘). General model of measurement of insurance contracts

For insurance contracts acquired in a business combination or transfer, the CSM at initial recognition is calculated as the difference between the consideration and the fulfilment cash flows (see ‘Business combinations‘ in ‘Acquisition of insurance contracts‘). General model of measurement of insurance contracts

Considerations

Contracts accounted for under IFRS 17 will be the only type of contracts under IFRS that will explicitly disclose the expected remaining profitability. The notion of the CSM is a unique feature of the standard. The way users will evaluate and appreciate the CSM may be a critical aspect of the decision-usefulness of the IFRS 17 accounting model.

2. Subsequent measurement of CSM

The CSM at the end of the reporting period represents the profit in the group of insurance contracts that has not yet been recognised in profit or loss, because it relates to the future service to be provided under the contracts in the group. General model of measurement of insurance contracts

For a group of insurance contracts without direct participation features, the carrying amount of the CSM of the group at the end of the reporting period equals the carrying amount at the beginning of the reporting period adjusted, as follows [IFRS 17 44]: General model of measurement of insurance contracts

Example – movement in the carrying amount of the CSM in a period

A) CSM at the beginning of the period General model of measurement of insurance contracts

X

B) Effect of new contracts added to the group General model of measurement of insurance contracts

X

C) Interest accreted on the CSM in the period General model of measurement of insurance contracts

X

D) Change in fulfilment cash flows relating to future service General model of measurement of insurance contracts

X or (X)

E) Effect of currency exchange differences General model of measurement of insurance contracts

X or (X)

F) Amount of CSM recognised in profit or loss as insurance revenue because of the transfer of services in the period

(X)

G) CSM at the end of the period General model of measurement of insurance contracts

X

2.1 Interest accretion

For insurance contracts without direct participation features, interest is accreted on the carrying amount of the CSM at discount rates determined at the date of initial recognition (“locked-in discount rate”) of a group of contracts applicable to nominal cash flows that do not vary based on the returns on any underlying items.

The locked-in discount rate applicable to a group of contracts can be the weighted average of the rates applicable at the date of initial recognition of contracts that can join a group over a 12-month period (see ‘Discount rates‘). General model of measurement of insurance contracts

The requirement to accrete interest on the CSM at historic rates for groups of contracts without direct participation features creates a data challenge for entities because they need to store and accurately apply a potentially large number of discount rates. Some would prefer to accrete interest on the CSM at current rates to avoid the need to track historic rates. Accreting the CSM at current rates, however, would create theoretical and practical issues and would not ease the data burden for entities that choose to disaggregate insurance finance expense between profit or loss and other comprehensive income.

As noted below, the number of historic discount rates that need to be tracked is greater for participating contracts without direct participation features. The reason is that the rate applied to adjust the CSM for changes in fulfilment cash flows is likely to differ from the rate to accrete interest on the CSM as the former should reflect the characteristics of the specific liabilities rather than a risk-free rate.

2.2. Adjust CSM for changes in fulfilment cash flows relating to future serviceGeneral model in Insurance contracts

An entity adjusts the CSM for changes in fulfilment cash flows relating to future service, except to the extent that [IFRS 17 44]:

  • Such increases in the fulfilment cash flows exceed the carrying amount of the CSM, giving rise to a loss
    Or General model of measurement of insurance contracts
  • Such decreases in the fulfilment cash flows are allocated to the loss component of the liability for remaining coverage (see ‘Onerous insurance contracts‘).

For insurance contracts without direct participation features, changes in fulfilment cash flows relating to future service that adjust the CSM comprise [IFRS 17 B96]:

  • Experience adjustments arising from premiums received in the period that relate to future service (and related cash flows, such as insurance acquisition cash flows and premium-based taxes). General model of measurement of insurance contracts
  • Changes in estimates of the present value of the future cash flows in the liability for remaining coverage, except those relating to the time value of money and changes in financial risk (recognised in the statement of profit or loss and other comprehensive income rather than adjusting the CSM). General model of measurement of insurance contracts
  • Differences between any investment component expected to become payable in the period and the actual investment component that becomes payable in the period.
  • Changes in the risk adjustment for non-financial risk that relate to future service. General model of measurement of insurance contracts

Except for changes in the risk adjustment, adjustments to the CSM noted above are measured at discount rates that reflect the characteristics of the cash flows of the group of insurance contracts at initial recognition (see ‘Discount rates‘). General model of measurement of insurance contracts

For participating contracts without direct participation features this discount rate (i.e., the rate that reflects the characteristics of the cash-flows on initial recognition) will be made up of a mix of an asset-based discount rate (for asset-dependent cash flows) and a rate for cash flows that are not asset-dependant (calculated using either the “top down” or “bottom-up” approaches). This rate will therefore be different from the rate used to accrete interest on the carrying amount of the CSM. Interest is accreted in the CSM using either the top down or bottom-up approach locked in at inception. General model of measurement of insurance contracts

An experience adjustment is a difference between: General model of measurement of insurance contracts

  • For premium receipts (and any related cash flows such as insurance acquisition cash flows and insurance premium taxes), the estimate at the beginning of the period of the amounts expected in the period and the actual cash flows in the period
    Or General model of measurement of insurance contracts
  • For insurance service expenses (excluding insurance acquisition expenses) — the estimate at the beginning of the period of the amounts expected to be incurred in the period and the actual amounts incurred in the period General model of measurement of insurance contracts

Experience adjustments generally relate to current or past service and are recognised immediately in profit or loss. However, experience adjustments for premiums received (or due) for future coverage relate to future service and consequently adjust the CSM.

Considerations

Deciding whether a premium experience adjustment relates to future service or is part of the coverage in current and past periods is not always clear and may require judgement. Premiums tend to be due in advance of the related service. However, this is clearly not the case, for example, with adjustment premiums in reinsurance contracts that are often determined after the end of a coverage period. Attributing expected premium receipts that are overdue to past or future coverage might not be obvious.

As noted in IFRS 17 Definitions, investment components are amounts that an insurance contract requires the entity to repay to a policyholder even if an insured event does not occur. IFRS 17 requires any unexpected repayment of an investment component to adjust the CSM (see ‘Contractual service margin‘). The CSM also will be adjusted for changes in future estimates of cash flows which will include (but not separately identify) the reduction in future repayments of investment components. General model of measurement of insurance contracts

Consequently, the net effect on the CSM of a delay or acceleration of repayment of an investment component is the effect of the change in timing of the repayment.

The terms of some insurance contracts without direct participation features give an entity discretion over the payments to policyholders. A change in the discretionary cash flows is regarded as relating to future service and, therefore, adjusts the CSM and will be reflected in profit or loss over time. Discretionary cash flows are discussed further in ‘Investment contracts with discretionary participation features‘. General model of measurement of insurance contracts

2.3. Currency exchange differences

The carrying amount of a group of insurance contracts that generate cash flows in a foreign currency, including the CSM, is treated as a monetary item when applying IAS 21 The Effects of Changes in Foreign Exchange Rates.93 Treating insurance contracts as monetary items means that groups of insurance contracts in a foreign currency are retranslated to the entity’s functional currency using the exchange rate applying at each reporting date. General model of measurement of insurance contracts

Exchange differences arising on retranslation are accounted for in profit or loss and are accounted for under IAS 21 The effects of Changes in Foreign Exchange Rates.

2.4. Release of the CSM in profit or loss

An amount of the CSM for a group of insurance contracts is recognised in profit or loss in each period to reflect the services provided under the group of insurance contracts in that period. The amount is determined by [IFRS 17 B119]: General model of measurement of insurance contracts

  • Identifying the coverage units in the group General model of measurement of insurance contracts
  • Allocating the CSM at the end of the period (before recognising any amounts in profit or loss to reflect the services provided in the period) equally to each coverage unit provided in the current period and expected to be provided in the future General model of measurement of insurance contracts
  • Recognising in profit or loss the amount allocated to coverage units provided in the period General model of measurement of insurance contracts

The number of coverage units in a group is the quantity of coverage provided by the contracts in the group, determined by considering for each contract the quantity of the benefits provided under a contract and its expected coverage duration. General model of measurement of insurance contracts

The CSM is recognised over the expected period of coverage for a group of contracts. The CSM remaining at the end of the reporting period is allocated to the services provided in the current period and the services expected to be provided in future periods based on coverage units. General model of measurement of insurance contracts

IFRS 17 does not specify whether an entity should consider the time value of money in determining the allocation and, consequently, does not specify whether the allocation should reflect the timing of the expected provision of the coverage units. For example, an entity could place more weight on the current period of coverage compared with expected coverage in the future, by reflecting the time value. The Board concluded it should be a matter of judgement [IFRS 17 BC282]. General model of measurement of insurance contracts

The movements in the CSM for subsequent measurement are summarised below5:

(Amounts in CU’000) General model of measurement of insurance contracts

Contractual service margin (CSM)

Opening balance General model of measurement of insurance contracts General model of measurement of insurance contracts

8,858

Changes that relate to future services: General model of measurement of insurance contracts

-116

Contracts initially recognised in the period General model of measurement of insurance contracts

1,375

Changes in estimates reflected in the CSM General model of measurement of insurance contracts

-1,491

Changes that relate to current services: General model of measurement of insurance contracts

-923

CSM recognised in profit or loss General model of measurement of insurance contracts

-923

Changes that relate to past services General model of measurement of insurance contracts

Insurance service result General model of measurement of insurance contracts

-1,039

Insurance finance expenses General model of measurement of insurance contracts

221

Total changes in the statement of comprehensive income General model of measurement of insurance contracts

-818

Cash flows General model of measurement of insurance contracts

Currency exchange differences General model of measurement of insurance contracts

Closing balance General model of measurement of insurance contracts

8,040

Considerations

The wording in IFRS 17 suggests that the allocation of the CSM to profit or loss for groups of insurance contracts should be based solely on insurance coverage. The allocation disregards other services provided to policyholders. This approach can lead to surprising patterns of profit recognition in contracts that provide insurance coverage for only part of a contract’s term.

Some also question whether this approach faithfully represents profit for contracts with direct participation features that the standard describes as substantially investment-related service contracts. It also creates a difference with the approach that will be followed for investment contracts with discretionary participation contracts that are also in the scope of the standard. For these groups of contracts, the CSM will be spread on the basis of investment services.

Whether an entity allocates the CSM to profit or loss to reflect the time value of money is a matter of judgement. In our view, both methods (i.e., considering time value of money and not considering it) are acceptable, but an entity must apply the method consistently.

We expect practitioners will ask for more guidance on how to determine coverage units and the meaning of the quantity of benefits. For example, does a contract that would pay a large amount in relation to a very unlikely insured event provide a greater quantity of benefit than a similar contract that pays a smaller amount for a more likely event?

2.5. Subsequent measurement of the CSM and interim reporting

The CSM is adjusted for changes in estimates of future fulfilment cash flows, whereas experience adjustments relating to current or past service are recognised in profit or loss instead of the CSM. One of the consequences is that the total liability and profit reported will be influenced by the frequency of reporting and the reporting date. An entity that publishes interim financial statements (see Example – CSM and Interim reporting below) would therefore ordinarily need to maintain separate carrying amounts for CSMs for purposes of interim and annual financial statements to meet the requirement in IAS 34 Interim Financial Reporting that the frequency of an entity’s reporting should not affect the measurement of its annual results [IAS 34.28 and IFRIC 10.9].

IFRS 17 avoids a requirement to maintain separate CSMs for annual and interim reporting, by making an exception to the requirement of IAS 34. It prohibits entities from changing the treatment of accounting estimates made in previous interim financial statements when applying IFRS 17 in subsequent interim financial statements or in the annual reporting period [IFRS 17 B136 and IFRS 17 BC236].

Example – CSM and Interim reporting

An entity with an annual reporting period ending on 31 December publishes half-yearly interim financial statements. General model of measurement of insurance contracts

  • At 31 December 20X0, the entity has issued a group of insurance contracts with a CSM of CU1,200 and an expected remaining coverage period of two years. The entity expects to provide coverage evenly over the remaining coverage period, and expects to incur claims in H2 20X1 of CU300. General model of measurement of insurance contracts
  • At the end of H1 20X1, the entity increases its estimate of claims to be incurred in H2 of 20X1 by CU200 to CU500. The entity adjusts (reduces) the related CSM by CU200 and releases CSM of CU250 for services provided in H1 (CU1,200 – CU200)/4. At the end of H1 20X1, the entity carries forward a CSM of CU750.
  • The entity incurs claims in H2 20X1 of CU300 (as originally expected) and, consequently, recognises a favourable experience adjustment in profit or loss of CU200 in its H2 interim financial statements. General model of measurement of insurance contracts
  • The entity releases CU250 from the CSM to profit or loss in H2 and carries forward a CSM of CU500 (CU750 – CU250) at 31 December 20X1 in the interim financial statements.

In summary, in 20X1 the entity recognises revenue of CU500, a positive experience adjustment in profit or loss of CU200 and carries forward a carrying amount for CSM of CU500 in both its interim financial statements for H2 20X1, as well as its annual financial statements for that year. General model of measurement of insurance contracts

If the entity maintained a CSM for annual reporting purposes independent of the CSM for interim reporting: General model of measurement of insurance contracts

  • There is no experience adjustment in the year — claims in 20X1 are as expected at 31 December 20X0. General model of measurement of insurance contracts
  • The entity would release CSM to profit or loss in the calendar year 20X1 of CU600 and would carry forward a CSM of CU600 (CU1,200 brought forward — CU600 release to P&L = CU600 ).

In summary, the entity would recognise revenue of CU600 in 20X1 and carry forward a CSM of CU600 at 31 December 20X1.

IFRS 17 requires the entity in this example to include the change in estimate made in H1 for the purposes of its annual financial statements. The entity would have the same result and amount of CSM at 31 December 20X1 in its interim and annual financial statements. General model of measurement of insurance contracts

[The example assumes there are no other changes in expectations and ignores accretion of interest for simplicity] General model of measurement of insurance contracts

Considerations

The requirement not to change the treatment of accounting estimates made in previous interim financial statements is a significant exception from the requirements in IAS 34 Interim Financial Reporting. Entities may welcome this exception as a simplification that allows them to maintain a single CSM for interim and annual reporting. However, the consequence is that entities with different interim reporting periods, but are equal in all other aspects, are likely to report different results.

Furthermore, for subsidiaries issuing their own IFRS financial statements, differences with the numbers reported for consolidation purposes are likely to emerge if the frequency of the reporting of a subsidiary’s own financial statements differs from the reporting frequency of the consolidated accounts of the group.

General model in Insurance contracts

General model of measurement of insurance contracts

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Something else -   Concise information

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