Insurance contract liabilities

Insurance contract liabilities – The measurement under IFRS 17 requires the determination of a current value of the insurance contract, considering market perspectives for financial risks and the reporting entity’s perspective for all other risks, in IFRS 17 referred to as the Fulfilment Cash Flows. This current value is the basis of the measurement of the insurance contract and is to be disclosed. The disclosures include its conceptual parts, the unbiased estimate of the expected present value of future cash flows, which is adjusted for the time value of money and further adjustments applied for financial risks and non-financial risks. Insurance contract liabilities

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. 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.

At outset, a Contractual Service Margin (CSM) is established to offset any gain, if any, at initial measurement – that is the value of premiums in excess of the value of obligations. This is then recognized as revenue over the period providing coverage. While there is no unit of account defined for the Fulfilment Cash Flows, the unit of account for the CSM are partitions of annual cohorts, based on at least three different profitability categories, which are part of annual new business and form the unit of account of the CSM.

Discount rates will need to reflect the characteristics of the insurance contracts. Types of insurance contracts vary significantly, so there will be no single discount rate (curve) that will fit the characteristics of all insurance liabilities. Insurance contract liabilities

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 Insurance contract liabilities
• 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 Insurance contract liabilities
• 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 Insurance contract liabilities

The described main approach of IFRS 17 is referred to as General Measurement Approach (GMA). The general model in the standard requires insurance contract liabilities to be measured using probability-weighted current estimates of future cash flows, an adjustment for risk, and a contractual service margin representing the profit expected from fulfilling the contracts.

IFRS 17 allows for a simplified alternative approach to be used for contracts of short coverage period (typically not more than 12 months), known as the Premium Allocation Approach (PAA). The PAA is similar to the unearned premium method in that the measurement of the liability for remaining coverage of short duration contracts might be simplified by distributing premiums over the coverage period in line with the passage of time or in proportion to expected benefits. The PAA only applies to the part of the total measurement of the contract referred to as liability for remaining coverage, with the liability of incurred claims following the GMA.

Some special guidance applies for certain contracts whose benefits are determined based on indices or other underlying items like surplus (i.e., insurance contracts with direct participation features) sometimes referred to as the Variable Fee Approach (VFA). It includes a feature distributing the insurer’s share in changes of financial risk and incurred events over the remaining coverage period of the contract. Insurance contract liabilities

Reinsurance ceded is measured using assumptions that are consistent with the ceded contract. Insurance contract liabilities

Insurance contract liabilities