The goals IFRS 17 Insurance contracts wants to achieve are quite impressive. The goals are to establish a comprehensive set of principles around the recognition, measurement, presentation and disclosure of insurance contracts that reflect the effect of economic changes and improve comparability across insurers.

It is a complex standard that will fundamentally change the accounting rules that govern the measurement of insurance contracts and profit recognition.

It is a balance between the anticipated complexity and heavy lifting to implement IFRS 17, and the potential IFRS 17 has to provide more accurate and comparable insights into insurers’ financial position and profitability, thereby improving investor understanding of the sector.

Under IFRS 17, insurers will need to account for and disclose their business performance at a more granular level by aggregating contracts of similar risk profile.

Overview – IFRS 17 Insurance contracts

IFRS 17 Insurance Contracts is an international financial reporting standard issued by the International Accounting Standards Board (IASB) that provides comprehensive guidance on the accounting treatment and disclosure requirements for insurance contracts. It aims to improve the transparency, consistency, and comparability of financial reporting for insurance contracts across different jurisdictions. Here’s a comprehensive overview of IFRS 17:

Background:

Need for Standardization: Prior to the issuance of IFRS 17, there was diversity in accounting practices for insurance contracts, leading to inconsistencies and difficulties in comparing financial statements across companies and jurisdictions.
Convergence Efforts: IFRS 17 was developed as part of the IASB’s broader convergence efforts with the Financial Accounting Standards Board (FASB) in the United States, which issued its own standard for insurance contracts, known as Topic 944.

Key Principles:

Measurement Basis: IFRS 17 establishes a consistent measurement basis for insurance contracts, requiring insurers to measure the liability for future policyholder benefits and the related revenue based on current estimates of future cash flows.
Recognition Criteria: Insurance contracts are recognized as assets or liabilities in the balance sheet when the insurer has an obligation to the policyholder and is entitled to receive consideration.
Contractual Service Margin (CSM): IFRS 17 introduces the concept of the CSM, which represents the unearned profit that insurers will recognize over the coverage period of the insurance contract. The CSM is released to profit or loss as the insurer provides coverage over time.
Discounting of Cash Flows: Future cash flows are discounted using current market interest rates to reflect the time value of money, with the discount rate reflecting the characteristics of the insurance contract and the currency in which the cash flows are denominated.
Risk Adjustment: IFRS 17 requires insurers to include a risk adjustment in the measurement of insurance liabilities to reflect the uncertainty and risk inherent in the insurance contracts.

Scope:

Insurance Contracts: IFRS 17 applies to all insurance contracts issued by insurers, including reinsurance contracts issued by reinsurers. It covers a wide range of insurance products, such as life insurance, health insurance, property and casualty insurance, and annuities.
Investment Contracts with Discretionary Participation Features (DPFs): Certain investment contracts with DPFs, where the policyholder’s returns are dependent on the performance of underlying assets, are also within the scope of IFRS 17.

Implementation Challenges:

Data Collection and Systems: Implementing IFRS 17 requires insurers to collect and analyze large volumes of data, including policyholder information, cash flow projections, and discount rates. It may necessitate upgrades to accounting systems and processes.
Actuarial Assumptions: IFRS 17 relies on actuarial assumptions, such as mortality rates, lapse rates, and claims experience, which may require judgment and estimation, particularly for long-duration contracts.
Transition Methods: Insurers have a choice of transition methods when adopting IFRS 17, including full retrospective, modified retrospective, and fair value approaches, each with its own complexities and implications.
Disclosure Requirements: IFRS 17 imposes extensive disclosure requirements to provide users of financial statements with detailed information about the nature, amount, timing, and uncertainty of cash flows arising from insurance contracts.

Benefits:

Improved Transparency: IFRS 17 enhances transparency by providing users of financial statements with more relevant and reliable information about insurers’ financial performance and risk exposure.
Consistency and Comparability: The standard promotes consistency and comparability of financial reporting for insurance contracts across different jurisdictions, facilitating better-informed decision-making by investors, analysts, and regulators.
Better Risk Management: IFRS 17 encourages insurers to improve their risk management practices by incorporating risk adjustments and market-consistent valuation techniques into their accounting and reporting processes.

Conclusion:

IFRS 17 represents a significant milestone in the standardization of accounting for insurance contracts, aiming to enhance transparency, consistency, and comparability in financial reporting for insurers worldwide. While implementation poses challenges for insurers, the benefits of improved transparency, better risk management, and enhanced investor confidence justify the efforts required to comply with the standard.

IFRS 17 Insurance contracts – In and Out of Scope

IFRS 17 applies to:

Insurance contracts and reinsurance contracts issued;
Reinsurance contracts held; and
Investment contracts with discretionary participation features if the entity also issues insurance contracts.

IFRS 17 may apply to:

Financial guarantee contracts if the entity has asserted it regards such contracts as insurance contracts (otherwise such contracts are within the scope of IFRS 9); and
Some service contracts, such as separately priced warranties on consumer goods that are serviced by third parties rather than the manufacturer (otherwise such contracts are within the scope of IFRS 15).

IFRS 17 Insurance contracts – Unit of account

IFRS 17 is applied at the level of groups of insurance contracts and not individual insurance contracts (though it is possible for groups of insurance contracts to consist of only a single contract) at initial recognition. The composition of the group is not subsequently reassessed.

Grouping is done at the start in portfolio level of insurance contracts sharing the same risks and that are managed together. At a minimum, contracts issued within a period of no longer than one year are sub-divided at initial recognition into groups that contain contracts that are:

Onerous, if any;
Have no significant possibility of becoming onerous subsequently, if any; and
Do not fall into either (a) or (b), if any.

An insurance contract is onerous if the fulfilment cash flows, any previously recognised acquisition cash flows and any cash flows arising from the contract are a net outflow.

Companies will need to set a definition of ‘similar risks’ and‘managed together’ and complete a profitability analysis. Significant impact on modelling and data storage requirements.

Level of aggregation

The aggregation of contracts into groups is required on initial recognition for all contracts in the scope of IFRS 17. [IFRS 17.IN6, BC118]

The grouping of individual contracts under IFRS 17 is performed in a way that limits the offsetting of profitable contracts against onerous ones, having regard to how insurers manage and evaluate the performance of their business. [IFRS 17.BC119]

The groups are established on initial recognition and are not reassessed subsequently. [IFRS 17.24]

In determining the level of aggregation, an entity identifies portfolios of insurance contracts. [IFRS 17.14 ]

An entity divides each portfolio into a minimum of:

a group of contracts that are onerous on initial recognition, if there are any (see Onerous contracts);
a group of contracts that, on initial recognition, have no significant possibility of becoming onerous subsequently, if there are any; and
a group of any remaining contracts in the portfolio. [IFRS 17.16]

Grouping considerations:

Some laws or regulations prevent insurers from pricing for certain risk indicators (e.g. gender)
If a law or regulation specifically constrains
- insurer’s practical ability to set a different price or level of benefits for policyholders with different characteristics,
- then ignore that characteristic for grouping (e.g. male or female drivers)

The objective is to identify contracts that fit into these groups at an individual contract level. This can be achieved by assessing a set of contracts if the entity can conclude, using reasonable and supportable information, that the contracts in the set will all be in the same group. [IFRS 17.17, IFRS 17.BC129]

IFRS 17 Insurance contracts

An entity cannot include contracts issued more than one year apart in the same group. Therefore, each portfolio will be disaggregated into annual cohorts, or cohorts consisting of periods of less than one year. However, exceptions apply in certain circumstances on transition (see Transition). [IFRS 17.22]

In summary, the flow from initial recognition of insurance contracts through the measurement of insurance contracts is a s follows:

IFRS 17 Insurance contracts

Insurance measurement models of reporting

IFRS 17 Insurance contracts provides one central measurement model:

The general model – applies to all insurance contracts in the scope of IFRS 17, except for those covered by the premium allocation approach and the variable fee approach. The general model is also modified for reinsurance contracts held.

Overview general model

The general model is also known as the building blocks approach (BBA), this is a way to reflect on this BBA:

Principles

Measurement uses current estimate assumptions
Contract are grouped by portfolio, year of sales and one of the three possible profitability levels
Profit measured and reported based on the delivery of the ‘insurance coverage service’
Deferred profit absorbs assumption changes for future coverage (‘Unlocking‘)
Discount rates based on market interest rates (currency, duration, liquidity)
Expected profit from participating contracts revalued based on assets

See below a more detailed discussion

Block 4 – Measurement at inception as the expected contract profit earned as services are fulfilled.

It is adjusted for changes in non-financial variables affecting future coverage cash flows. It accretes interest back based day 1 discount rate (locked-in-rate)

Block 3 – An entity-specific assessment of the uncertainty about the amount and timing of future cash flows

Block 2 – An adjustment that converts future cash flows into current amounts

Block 1 – Expected (probability-weighted) cash flows from premiums, claims, benefits, expenses and acquisition costs

The other models

However, simplifications or modifications apply to groups of:

Insurance contracts measured using the Premium allocation approach (“PAA”) – a method that simplifies the measurement of the liability for remaining coverage. The PAA is available for groups of contracts where the coverage period for all contracts is one year or less or if the entity reasonably expects that the PAA would produce a measurement of the liability for remaining coverage for the group that would not differ materially from the general model,
Investment contracts with DPFs using the Variable fee approach (“VFA”) – insurance contract liability is measured based on the obligation to pay the policyholder an amount equal to the value of the underlying items, net of consideration charged for the contract (“a variable fee”). Approach applies to direct participating contracts, based on policyholders being entitled to a significant share of the profit from a clearly identified pool of underlying items, and
One separate type of contracts – Reinsurance contracts held using the general model with certain modifications.

Reinsurance contracts held and the general model with certain modifications

The modifications to the general measurement model for reinsurance contracts held add a number of potential practical impacts, including the following.

More independent fulfilment cash flow measurements

The assumptions used to determine the fulfilment cash flows of reinsurance contracts held are consistent with those used for the measurement of the underlying insurance contracts. However, the specific timing of cash flows expected under the reinsurance contracts held needs to be addressed separately if it departs from the timing of cash flows under the underlying insurance contracts.

The current practice of recognising reinsurance deposits will no longer exist. The operational impact could be more significant for contracts when the reinsurer and cedant use a net settlement process whereby the transfer of cash occurs only on an agreed timescale – e.g. end of year.

Linkage between reinsurance contracts held and underlying insurance contracts

Unlike direct insurance, reinsurance contracts are likely to be much less standardised in regard to the terms and conditions. In many cases, entities will need to consider reinsurance contracts on an individual basis and it is possible that a group will include only a single reinsurance contract.

In addition, on initial recognition of onerous underlying insurance contracts, an entity is required to recognise the recovery of losses if the contracts are covered by a reinsurance contract. It is possible that the reinsurance contract covers only some of the insurance contracts within an onerous group.

In these cases, the entity needs to determine what portion of the losses recognised on the onerous group of insurance contracts relates to the insurance contracts covered by the reinsurance contract. To determine the relevant portion, the entity uses a rational and systematic method; in many cases, judgement will need to be applied.

Reinsurance asset impairment included in the measurement model

Current practice applies an impairment assessment to reinsurance contract assets (reinsurance receivables). This is no longer needed as a separate exercise under IFRS 17, because any non-performance risk is included in the measurement of the reinsurance contract held from its inception and throughout subsequent periods.

‘Non-performance risk’ is the risk that an entity will not fulfil an obligation. The estimation of this risk includes losses arising from disputes. This also means that impairment losses related to reinsurance contracts held are recognised on an expected basis, similar to the expected credit loss model for credit-impaired assets under IFRS 9.

IFRS 17 Insurance contracts

General model

Insurance contracts may be highly complex bundles of inter-dependent 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.

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.

Insurance contracts may be highly complex bundles of inter-dependent 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.

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. [IFRS 17.24, IFRS 17.32, IFRS 17.38]

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.

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]

Insurance contract assets / Insurance contract liabilities
	Liability of Remaining Coverage
Component	Present value of future cash flows – estimate of all cash flows within the boundary of each contract in the group (e.g. premiums, acquisition cash flows, claims payments, claims handling costs, etc.). If certain requirements are met, fulfilment cash flows may be estimated at a higher level and then allocated to individual groups.	Risk adjustment for non-financial risk – The compensation an entity requires for bearing the uncertainty about the amount and timing of the cash flows that arises from non-financial risk as the entity fulfils insurance contracts.	Contractual service margin (“CSM”) (R) – represents the unearned profit the entity will recognise as it provides insurance contract services under the insurance contracts in the group.
Initial measurement	Estimate must be unbiased, reflect the perspective of the entity and be a current measure using all reasonable and supportable information available without undue cost or effort, discounted to reflect the time value of money.	The risk adjustment must be an explicit estimate and will be entity-specific, which should be the amount of compensation an entity would require to make itself indifferent between a fixed series of cash flows and uncertain cash flows in the group of contracts.	The CSM is set at an amount that makes a group of insurance contracts zero at the time of initial recognition (i.e. offsets fulfilment cash flows). If the fulfilment cash flows are negative (i.e. an onerous group of contracts exists), the loss is recognised immediately and no CSM exists.
Subsequent measurement	Updated at each reporting period based on information available, with the effect of the discount unwinding over time	Updated at each reporting period based on information available, with the effect of the discount unwinding over time. The release from risk may occur evenly over time or not depending on the nature of the risks insured.	CSM is updated for the effect of the discount unwinding and the unwinding of the CSM as insurance contract services are provided in the period based on the allocation of the CSM over the current and remaining coverage period.
Effect on comprehensive income	Accretion of the discount reflected in profit or loss (or OCI -> see Discounting).	Release of risk over time is reflected as insurance revenue, unless accounting policy choice is elected to reflect the accretion of the discount in insurance finance expense (see Discounting).	Accretion of the discount reflected in profit or loss (or OCI -> see Discounting), with the movement related to services provided reflected as insurance revenue.

	Liability for Incurred Claims
Component	Present value of future cash flows – once a loss event occurs, the best estimate of the cash flows required to settle the claim, including investigation, handling and settlement costs.	Risk adjustment for non-financial risk – same methodology as liability for remaining coverage.
Initial measurement	Same methodology as liability for remaining coverage. Liability for remaining coverage (R) – An entity’s obligation to (a) investigate and pay valid claims under existing insurance contracts for insured events that have not yet occurred (ie the obligation that relates to the unexpired portion of the insurance coverage); and (b) pay amounts under existing insurance contracts that are not included in (a) that relate to (i) insurance contract services not yet provided (ie the obligations that relate to future provision of insurance contract services); or (ii) any investment components or other amounts that are not related to the provision of insurance contract services and that have not been transferred to the liability for incurred claims.	Same methodology as liability for remaining coverage. Liability for remaining coverage (R) – An entity’s obligation to (a) investigate and pay valid claims under existing insurance contracts for insured events that have not yet occurred (ie the obligation that relates to the unexpired portion of the insurance coverage); and (b) pay amounts under existing insurance contracts that are not included in (a) that relate to (i) insurance contract services not yet provided (ie the obligations that relate to future provision of insurance contract services); or (ii) any investment components or other amounts that are not related to the provision of insurance contract services and that have not been transferred to the liability for incurred claims.
Subsequent measurement	Same methodology as liability for remaining coverage. Liability for remaining coverage (R) – An entity’s obligation to (a) investigate and pay valid claims under existing insurance contracts for insured events that have not yet occurred (ie the obligation that relates to the unexpired portion of the insurance coverage); and (b) pay amounts under existing insurance contracts that are not included in (a) that relate to (i) insurance contract services not yet provided (ie the obligations that relate to future provision of insurance contract services); or (ii) any investment components or other amounts that are not related to the provision of insurance contract services and that have not been transferred to the liability for incurred claims.	Same methodology as liability for remaining coverage. Liability for remaining coverage (R) – An entity’s obligation to (a) investigate and pay valid claims under existing insurance contracts for insured events that have not yet occurred (ie the obligation that relates to the unexpired portion of the insurance coverage); and (b) pay amounts under existing insurance contracts that are not included in (a) that relate to (i) insurance contract services not yet provided (ie the obligations that relate to future provision of insurance contract services); or (ii) any investment components or other amounts that are not related to the provision of insurance contract services and that have not been transferred to the liability for incurred claims.
Effect on comprehensive income	Accretion of the discount reflected in profit or loss (or OCI -> see Discounting). The effects of changes in estimates are recorded in insurance services expenses.	The effects of changes in estimate are reflected in insurance services expenses.

Premium Allocation Approach

The total carrying amount of a group of insurance contracts is made up of:

a liability for remaining coverage, which represents the fulfilment cash flows relating to future service that will be provided under the contract in future periods and the CSM; and
a liability for incurred claims, which represents the fulfilment cash flows related to past service for claims and expenses already incurred.

Under the PAA, the general measurement model may be simplified for certain contracts to measure the liability for remaining coverage.

Generally, the PAA measures the liability for remaining coverage as the amount of premiums received net of acquisition cash flows paid, less the net amount of premiums and acquisition cash flows that have been recognised in profit or loss over the expired portion of the coverage period based on the passage of time.

The PAA assumes that recognising the contract’s premium over the coverage period provides similar information and profit patterns to those provided by recognising insurance contract revenue measured using the general measurement model.

Insurance Contract Liabilities
	Liability of Remaining Coverage	Liability for Incurred Claims
Initial measurement	If certain conditions are met, simplified measurement equal to: Premiums received at initial recognition Minus insurance acquisition cash flows (entity may elect to expense as incurred); plus Plus or minus any amount arising from the derecognition at that date of any pre-coverage period contract acquisition cash flows; and any other asset liability previously recognised for cash flows related to the group of contracts are required by IFRS 17 (R). Conditions required to be met: There is a reasonable expectation that the measurement of the liability will not be materiality different from measurement using the full model in IFRS 17; and The coverage period of each contract in the group (including insurance contract services arising from all premiums within the contract boundary) is one year or less (R).	Measurement is consistent with the general model. However, discounting is not required if the cash flows on incurred claims are expected to be paid in one year or less from the date the claims are incurred
Subsequent measurement	If certain conditions are met, simplified measurement equal to: Carrying amount at start of period Plus premiums received in the period Minus insurance acquisition cash flows (entity may expense acquisition cash flows as incurred) Plus any amounts relating to the periodic amortisation of insurance acquisition cash flows recognised as an expense Plus adjustment for financing component Minus the amount recognised as insurance revenue for services provided in that period (R) (expected premiums are allocated to revenue on the basis of the passage of time unless the expected pattern of release of risk during the coverage period differs significantly from the passage of time) Minus any investment component paid or transferred	The same as at initial measurement – Measurement is consistent with the general model. However, discounting is not required if the cash flows on incurred claims are expected to be paid in one year or less from the date the claims are incurred

Variable fee approach

The variable fee approach modifies the treatment of the CSM under the general measurement model to accommodate direct participating contracts.

Insurance Contract Liabilities

Liability of Remaining Coverage

Liability for Incurred Claims

Similar to the general model, except that changes in estimates relating to the future fees an entity expects to earn from direct participating contract policyholders are adjusted against the contractual service margin.

The contractual service margin on direct participating contracts is recognised in profit or loss as part of insurance service results on the basis of the passage of time.

The accretion of interest relating to the contractual service margin is based on a current rate included in balance sheet measurements of specific assets, rather than a locked in rate as required in the general model.

Measurement is consistent with the general model (Liability for remaining coverage (R)).

Liability for remaining coverage (R) – An entity’s obligation to (a) investigate and pay valid claims under existing insurance contracts for insured events that have not yet occurred (ie the obligation that relates to the unexpired portion of the insurance coverage); and (b) pay amounts under existing insurance contracts that are not included in (a) that relate to (i) insurance contract services not yet provided (ie the obligations that relate to future provision of insurance contract services); or (ii) any investment components or other amounts that are not related to the provision of insurance contract services and that have not been transferred to the liability for incurred claims.

Investment contracts with discretionary participation features

General model is modified as follows:

the date of initial recognition is the date the entity becomes party to the contract.
the contract boundary is modified so that cash flows are within the contract boundary if they result from a substantive obligation of the entity to deliver cash at a present or future date. The entity has no substantive obligation to deliver cash if it has the practical ability to set a price for the promise to deliver the cash that fully reflects the amount of cash promised and related risks.
the allocation of the CSM is modified so that it is recognised over the duration of the group of contracts in a systematic way that reflects the transfer of investment services under the contract.

Reinsurance contracts held

General model is modified as follows:

the date of initial recognition is the date the entity becomes party to the contract.
the contract boundary is modified so that cash flows are within the contract boundary if they result from a substantive obligation of the entity to deliver cash at a present or future date. The entity has no substantive obligation to deliver cash if it has the practical ability to set a price for the promise to deliver the cash that fully reflects the amount of cash promised and related risks.
the allocation of the CSM is modified so that it is recognised over the duration of the group of contracts in a systematic way that reflects the transfer of investment services under the contract.

The CSM is subsequently measured as the previous carrying amount adjusted for:

The effect of any new contracts;
Interest accrued on the CSM;
Changes in the fulfilment cash flows;
The effect of any foreign exchange; and
The allocation of the CSM.

Changes in fulfilment cash flows that result from changes in the risk of non-performance by the issuer of the reinsurance contracts held do not relate to future service and therefore do not adjust the CSM.

The premium allocation approach may be used for reinsurance contracts held if certain criteria are met.

Discounting

For components of insurance contracts that must be discounted, the discount rate must:

reflect the time value of money;
be consistent with observable market prices for an instrument with cash flows whose characteristics are consistent with the insurance contracts; and
exclude the effect of factors that influence such observable market prices, but do not affect the future cash flows of the insurance contracts.

Entities may elect to reflect in profit or loss only the finance expense related to a systematic allocation of the expected total finance expense over the duration of the group of insurance contracts. The other impact of the discount on the insurance contracts being a current measure is reflected in other comprehensive income.

Modifications

Derecognise original contract only if any of the following apply:

Had the modified terms been included at contract inception:
It would have been outside the scope of IFRS 17;
Different components would have been separated from the host contract;
It would have had a substantially different contract boundary; or
It would have been included in a different group of insurance contracts.
The original, but not modified, contract met the definition of an insurance contract with direct participation features (or vice versa).
The premium allocation approach was applied to the original contract, but the eligibility criteria for that approach is not met for the modified contract.

If none of the above apply, do not derecognise the contract and instead treat changes in cash flows caused by the modification as changes in estimates of fulfilment cash flows.

Derecognition

Derecognise only when:

It is extinguished, i.e. when the obligation expires, is discharged or cancelled; or
A modification meets any of the conditions for the insurance contract to be derecognised.

The purchase of reinsurance results in the derecognition of the underlying insurance contract(s) only when the underlying insurance contract(s) is (or are) extinguished.

Accounting for the derecognition of insurance contract from within a group of contracts requires an adjustment to fulfilment cash flows, and contractual service margin of the group and remaining coverage units.

Specific requirements apply to the accounting on the derecognition of an insurance contract arising from either:

A modification that meets any of the conditions for the insurance contract to be derecognised; or
The transfer of the insurance contract to a third party.

Measuring a group of insurance contracts

Measuring a group of insurance contracts comprises of the following steps (see building blocks approach above):

Develop estimates of expected cash flows (Block 1),
Apply discounting to reflect the time value of money (Block 2),
Adjust the present value of expected cash flows for non-financial risk (Block 3), and
Determine the unearned profit, represented by the CSM for profitable groups of contracts, or the loss component for groups of onerous contracts (Block 4).

Develop estimates of expected cash flows

IFRS 17 requires estimates of expected cash flows of a group of insurance contracts to:

incorporate all reasonable and supportable information that is available without undue cost or effort about the amount, timing and uncertainty of those expected cash flows in an unbiased way;
include all the expected cash flows within the boundary of each contract within the group;
reflect the perspective of the entity, provided that, when relevant, the estimates are consistent with observable market prices; and
be current and explicit. [IFRS 17.24, IFRS 17.33]

The expected cash flows may be estimated at a higher level of aggregation and then allocated to groups of contracts.

These characteristics raise the following questions, which will be discussed in this chapter.

How are different possible outcomes incorporated in the estimates?
Which cash flows are included in the estimates?
What information is used to make the estimates?

Insurance acquisition cash flows
Insurance acquisition cash flows (IACF) may fall within the boundary of an insurance contract. They arise from selling, underwriting and starting a group of insurance contracts issued or expected to be issued. [IFRS 17.B65(e)]

These cash flows need to be directly attributable to a portfolio of insurance contracts to which the group belongs. Cash flows that are not directly attributable to the groups or individual insurance contracts within the portfolio are included.

Insurance acquisition cash flows:

can arise internally (e.g. in the sales department) or externally (e.g. by using external sales agents);
include not only the incremental costs of originating insurance contracts, but also other direct costs and a proportion of the indirect costs that are incurred in originating insurance contracts; and
include cash flows related to both successful and unsuccessful acquisition efforts. [IFRS 17.BC182–BC183]

The following overview provides details on the accounting implications of the requirements under the general measurement model for insurance acquisition cash flows.

Accounting event and driver	Accounting implications
1. Before recognition of related insurance contract Occurrence of IACF or incurrence of liability to pay IACF¹	Allocate IACF to existing and future groups of insurance contracts using a systematic and rational method	Recognise an asset for IACF for each related group of insurance contracts
2. Initial recognition Related insurance contract meets recognition requirements	Derecognise related part of the asset for IACF	The derecognised IACF asset is deducted from the CSM of the related group of contracts
3. Reporting date – reallocation Changes in assumptions used in allocation method	Revise allocation of IACF amounts to groups to reflect any changes in assumptions that determine the inputs to the method of allocation used
4. Reporting date – Two stage recoverability test Facts and circumstances indicate impairment	Level 1 test for recognised groups: Reduce the carrying amount of each asset for IACF so it does not exceed the expected net cash inflows for the related group and recognise an impairment loss in profit or loss	Level 2 test for renewal groups: Reduce the carrying amount of the asset for IACF to the extent the entity expects the IACF to exceed the net cash inflows for expected renewals, and recognise impairment loss in profit or loss²
5. Reporting date – Reversal of impairment Impairment conditions no longer exist or have improved	Increase the carrying amount of the asset for IACF and recognise impairment reversal gain in profit or loss

An entity recognises as an asset any insurance acquisition cash flows relating to a group of existing or future insurance contracts that it pays – or incurs a liability to pay – before the group is recognised. These assets and liabilities are derecognised when the group of insurance contracts to which the cash flows are allocated is recognised, as part of determining the CSM on initial recognition. [IFRS 17.28B–C, IFRS 17.33]

If insurance acquisition cash flows are expected to be paid after the related group is recognised, then they are included as part of the fulfilment cash flows of that group.

If they are paid or the liability to pay them is incurred at the date of initial recognition of the group, then they are in effect deducted from the CSM at that date.

As an exception to the above requirements, an entity is not required to recognise an asset for insurance acquisition cash flows if it applies the PAA to the related group of contracts and chooses to expense the insurance acquisition cash flows as they are incurred, see liability for remaining coverage. [IFRS 17.59(a)]

When allocating insurance acquisition cash flows to groups of insurance contracts, entities need to consider, in an unbiased way, all reasonable and supportable information that is available without undue cost or effort. An entity applies a systematic and rational method to include insurance acquisition cash flows in the measurement of groups:

if they are directly attributable to a group of contracts, then it allocates them to that group and to the groups that will include insurance contracts that are expected to arise from renewals of the insurance contracts in that group; and
if they are directly attributable to a portfolio of contracts, but not to a group of contracts or individual contracts, then it allocates them to existing and future groups within that portfolio. [IFRS 17.28A, IFRS 17.B35A]

At each reporting date, an entity revises the amounts of insurance acquisition cash flows allocated to groups of insurance contracts to reflect any changes in assumptions that determine the inputs to the method of allocation used. An entity does not change the amounts allocated to a group of insurance contracts once all contracts have been added to the group. [IFRS 17.B35B]

If insurance contracts are to be added to a single group of insurance contracts in more than one reporting period, then an entity derecognises the portion of the asset for insurance acquisition cash flows that relates to the insurance contracts added in that period and continues to recognise an asset for insurance acquisition cash flows to the extent that the asset relates to insurance contracts expected to be added to the group in a future reporting period. [IFRS 17.B35C]

At each reporting date, if facts and circumstances indicate that an asset arising from insurance acquisition cash flows may be impaired, then an entity:

recognises an impairment loss so that the carrying amount of each asset does not exceed the expected net cash inflow for the related group; and
if the asset relates to groups that are expected to arise from renewals of insurance contracts in a group, recognises an impairment loss to the extent that:
- it expects those insurance acquisition cash flows to exceed the net cash inflow for the expected renewals; and
- the excess has not already been recognised as an impairment loss under a). [IFRS 17.28E, IFRS 17.B35D]

A previously recognised impairment loss is reversed in a subsequent period to the extent that the impairment has improved or no longer exists. [IFRS 17.28F]

The requirements to recognise an asset for insurance acquisition cash flows are relevant when the PAA is applied, unless the entity has an accounting policy to expense the insurance acquisition cash flows as they are incurred. See Premium allocation approach on the accounting policy choice available when the PAA is applied.

Food for thought – Types of costs included in the insurance acquisition cash flows

There is diversity in practice under IFRS 4 over the types of costs and the amounts identified as acquisition costs, depending on the type of contract or the jurisdiction.

Many entities completed an analysis to identify their acquisition costs. This analysis formed the basis for the development of a wide variety of methods used to estimate these costs under IFRS 4 – e.g. portions of the acquisition cash flows could be based on:

a certain percentage of the premium;
direct costs specifically related to an individual contract; or
a portion of all of the administrative costs incurred by the entity.

Entities need to review their models for identifying and measuring acquisition cash flows, and change them if necessary to ensure that they meet the new requirements.

Cash flows to policyholders in a contract that affect or are affected by other contracts
Some contracts require the policyholder to share the returns of a specified pool of underlying items with policyholders of other contracts. Additionally, these contracts require that either:

the policyholder bears a reduction in its share of returns on the underlying items as a result of required payments to those other policyholders that share in that pool; or
the other policyholders bear a reduction in their share of returns on the underlying items as a result of a required payment to the policyholder. [IFRS 17.B67–B71]

When these contracts are in different groups, the cash flows for each group reflect the effects above on the entity. So, the fulfilment cash flows for a group:

include payments arising from the terms of existing contracts to policyholders of contracts in other groups; and
exclude payments to policyholders in the group that have been included in the fulfilment cash flows of another group.

To determine the fulfilment cash flows of groups that affect or are affected by contracts in other groups, different practical approaches can be used. If it is possible to identify the change in the underlying items and resulting change in cash flows only at a higher level than the group, then the effects of the change in the underlying items are allocated to each group on a systematic and rational basis.

After all of the insurance contract services have been provided to the contracts in a group, the fulfilment cash flows may still include payments expected to be made to current policyholders in other groups or to future policyholders. In these cases, an entity can recognise and measure a liability for the fulfilment cash flows arising from all groups. Therefore, it does not have to continue to allocate these fulfilment cash flows to specific groups.

Food for thought – Future policyholders vs future insurance contracts

As described in cash flows included in estimates, cash flows that may arise from future insurance contracts are outside the boundary of insurance contracts. However, cash flows to policyholders in contracts that affect or are affected by other contracts can include payments to future policyholders in the same group or other groups.

This is necessary because the contractual terms of an existing contract may create an obligation for the entity to pay to policyholders amounts based on underlying items. Given that the terms of the existing contract require it to pay the amounts, even though it does not yet know when or to whom, these cash flows would be included within the contract boundary. [IFRS 17.BC172]

Apply discounting to reflect the time value of money

The second step in measuring a group of insurance contracts is to apply discounting to reflect the time value of money.

Discounting adjusts the estimates of expected cash flows to reflect the time value of money and the financial risks associated with those cash flows (to the extent that the financial risks are not already included in the cash flow estimates). [IFRS 17.36, IFRS 17.B86]

The discount rates applied to the estimates of expected cash flows:

reflect the time value of money, the characteristics of the cash flows and the liquidity characteristics of the insurance contracts;
are consistent with observable current market prices; and
exclude the effects of factors that affect observable market prices used in determining the discount rate, but do not affect the expected cash flows of the insurance contract.

Food for thought – Inclusion of financial risks

Financial risks arise within an insurance contract in a variety of ways. For example, when contractual payments to and from a policyholder are:

linked to an index of prices or exchange rates;
determined based on a specified rate of return on an investment component of the contract (e.g. a fixed annuity); or
linked to the rate of return from a specified pool of assets (e.g. a variable annuity).

The estimates of expected cash flows are adjusted to reflect the financial risks associated with them. This can be achieved by adjusting the estimates of expected cash flows for financial risk, or by adjusting the discount rate.

The effect of changes in financial risks is presented in a similar way when determining the amounts recognised in the statement(s) of financial performance, regardless of how they were incorporated in the estimates.

For example, if an entity issues a group of insurance contracts in which the policyholders’ unit values are linked to a price index, then the financial risk may be reflected implicitly within the estimates of expected cash flows or as an adjustment to the discount rate. For presentation purposes, changes related to this variable (together with the effect of the time value of money) are included within insurance finance income or expense, which is presented separately from the insurance service result (see further discussion in Presentation insurance contracts).

Currently, an entity might be able to identify these items explicitly. However, it will need to confirm that its current methodologies are consistent with the principles of IFRS 17.

An entity that prefers to include an implicit adjustment for financial risk may need to adapt its processes in order to identify the effect explicitly for presentation purposes.

Adjust the present value of expected cash flows for non-financial risk.

The third step in measuring a group of insurance contracts is to adjust the present value of expected cash flows for non-financial risk.

The risk adjustment conveys information to users of financial statements about the amount the entity charges for bearing the uncertainty over the amount and timing of cash flows arising from non-financial risk. It measures the compensation that the entity would require to make it indifferent between:

fulfilling a liability that has a range of possible outcomes arising from non-financial risk; and
fulfilling a liability that will generate fixed cash flows with the same expected present value as the insurance contract. [IFRS 17.B87]

Determine the unearned profit

Determine the unearned profit, represented by the CSM for profitable groups of contracts, or the loss component for groups of onerous contracts

The final step in measuring a group of insurance contracts on initial recognition is to determine the unearned profit, represented by the CSM for profitable groups of contracts, or the loss component for groups of onerous contracts.

Initial measurement
On initial recognition of a profitable group of insurance contracts, the CSM is the equal and opposite amount of the net inflow that arises from the sum of the following:

the fulfilment cash flows;
the derecognition of any asset or liability previously recognised for cash flows
related to the group³; and
any cash flows arising from contracts in the group at that date. [IFRS 17.28, IFRS 17.32, IFRS 17.38]

An entity calculates a CSM for each group of insurance contracts. For further discussion of how to group insurance contracts, see level of aggregation.

Subsequent measurement
Generally, at each reporting date the carrying amount of a group of insurance contracts is remeasured by:

estimating the fulfilment cash flows using current assumptions; and
updating the CSM to reflect changes in fulfilment cash flows related to future services, a financing effect and the profit earned as insurance contract services are provided in the period. The updated CSM represents the profit that has not yet been recognised in profit or loss because it relates to future services to be provided.

[IFRS 17.44]

IFRS 17 Insurance contracts

The sum of the updated fulfilment cash flows and the updated CSM represents the carrying amount of the group of insurance contracts at each reporting date.

Presentation

Separately for both portfolios (R) of insurance contracts issued and reinsurance contracts held:

Statement of Financial Position

Insurance contracts issued that are assets;
Insurance contracts issued that are liabilities.

Statement of Financial Performance

Insurance revenue;
Insurance service expenses (e.g. incurred claims, other incurred insurance service expenses, amortisation of acquisition cash flows, etc.)
Insurance finance income or expenses

The difference between (a) and (b) comprises the insurance service result which must be presented in the statement of financial performance.

Disclosure

Overall objective is to disclose sufficient information to gives a basis for users to assess the effect that insurance contracts have on an entity.

Disclosure requirements are significant and include both quantitative and qualitative disclosures about the amounts recognised in the statements of financial position, performance and cash flows, including reconciliations of amounts and the components comprising insurance contract assets and liabilities and significant judgments concerning their recognition and valuation.

For entities applying the premium allocation approach, some disclosure simplifications exist, however, disclosure requirements concerning the liability for incurred claims remain extensive, including the level used to determine the risk adjustment, the yield curve used for discounting, and the nature and extent of risks by major groups of contracts.

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