Measurement of insurance contracts

Measurement of insurance contracts

The carrying amount of a group of insurance contracts at the end of each reporting period is
the sum of the liability for remaining coverage and the liability for incurred claims.

At the end of each reporting period the liability for remaining coverage and the liability for incurred claims for a group of insurance contacts comprise the following components:

Liability for remaining coverage Liability for incurred claims
Fulfilment cash flows related to future service allocated to the group Contractual service margin of the group (CSM) Fulfilment cash flows related to past service allocated to the group

An entity should then recognise income and expenses for the following changes in the carrying amount of the above liabilities:

Measurement of insurance contracts

The fulfilment cash flows are measured following the same principles as for initial measurement. The contractual service margin at the end of the period represents the profit in the group of insurance contracts that has not yet been recognised in profit or loss because it relates to future services.

Contractual service margin (CSM) on contracts without discretionary participation feature (DPF) 

The approach for measuring the CSM for contracts without discretionary participation feature at the end of the reporting period is illustrated below:

(Note: Read the note)

CSM

Profit or loss

Carrying amount at the beginning of the period

X

Effect of any new contracts added to the group

X

Interest accrued during the period1

X

(X)

Changes in fulfilment cash flows related to future service2

X

Foreign currency gains/losses

(X)

X

Carrying amount before allocation

X

Amount recognised as insurance revenue in the period3

(X)

X

Carrying amount at the end of the period

X

Examples of changes in fulfilment cash flows that relate to future services include: experience adjustments from premiums received in the period that relate to future service and related acquisition expenses and taxes; changes in the risk adjustment that relate to future service; difference between actual investment component payable in the period and the one expected to become payable, etc. Measurement of insurance contracts

Changes in estimates of cash flows in the liability for incurred claims and changes in assumptions that relate to financial risk are not regarded as relating to future services; therefore, they do not adjust the CSM. However, changes in the discretionary cash flows of contracts without DPF are regarded as relating to future service, and accordingly adjust the CSM.

Measurement of insurance contracts

Where an entity cannot distinguish at contract inception between what it is committed to and what it regards as discretionary, it should regard its commitment to be the return implicit in the estimate of fulfilment cash flows at contract inception, updated to reflect current assumptions related to financial risk.

Contractual service margin (CSM) on contracts with discretionary participation feature (DPF)

The approach for measuring the CSM for contracts with DPF at the end of the reporting period follows the same logic as outlined above for contracts without DPF. The changes in fulfilment cash flows represent the changes in the entity’s share in fair value changes of the underlying items. Measurement of insurance contracts

A reporting entity should recognise in profit or loss the combined effect of the changes in fulfilment cash flows (excluding cash flows arising in the period) and the changes in the CSM, and analyse those between insurance services revenue, insurance services expenses and insurance finance income or expenses.

The modifications to the above general measurement approach are referred to as the ‘Variable fee’ approach and are discussed in a dedicated section of this publication.

Recognition of the CSM in profit or loss

 The release of CSM to profit or loss in each reporting period should reflect the service provided under the group of insurance contracts in that period and should follow the process illustrated below. Measurement of insurance contractsMeasurement of insurance contracts


Example: Allocation of the CSM to profit or loss

In the example below the following assumptions have been made: Measurement of insurance contracts

  • The contracts are of equal size, therefore one unit of coverage is provided under each contract each year. Measurement of insurance contracts
  • The contracts expire in year 3 to the extent the holder has not terminated them earlier. Measurement of insurance contracts

Measurement of insurance contracts

A new tool is required

CSM measurement and presenting/disclosing it in financial statements will cause complex but interesting operational challenges and many times requires significant IT investment, process
re-design and changes to data capture and analysis. But on the other hand, having a clear data qualification model and out-of-the-box query tools might help to either temporarily serve as the data deliverance platform or develop it into a low code solution, easy adapt and fully understand what an application does.

A CSM calculation engine should

  1. ‘read’ actuarial models for future cash flows;
  2. identify the correct historic discount rates per aggregation cohort for interest accretion;
  3. link to financial records and ‘track’ recouping of previously recognised losses on onerous contracts;
  4. retranslate for FX rate changes, and
  5. ‘mine’ operational and actuarial databases to update remaining units of coverage (based on actual experience and future assumptions).

The three measurement approaches under IFRS 17

IFRS 17 insurance contracts  –  Next to all the above measurement/presentation matters there are three measurement approaches under IFRS 17 for different types of insurance contract:

The general model should be applied to all insurance contracts, unless they have direct participation features or the contract is eligible for, and the entity elects to apply, the premium allocation approach. Measurement of insurance contracts

The premium allocation approach is an optional simplification for measurement of liability for remaining coverage for insurance contracts with short-term coverage. Measurement of insurance contracts

The variable fee approach should be applied to insurance contracts with direct participation features. This approach deals with participating business where payments to policyholders are contractually linked and substantially vary with the underlying items. This approach cannot be used for the measurement of reinsurance contracts. Measurement of insurance contracts

In summary: Measurement of insurance contracts

Measurement of insurance contracts

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

  • fulfillment cash flows, comprising of: Measurement of insurance contracts
    • a current estimate of unbiased and probability-weighted future cash flows expected to arise during the life of the contract;
    • a discount adjustment to reflect the time value of money and financial risks, such as liquidity and currency risks (layers of discounting);
    • an explicit risk adjustment for non-financial risks; and Measurement of insurance contracts
  • a contractual service margin representing the unearned profit from the contract.

An entity may simplify the measurement of the liability for remaining coverage of a group of insurance contracts using the Premium Allocation Approach (PAA) on the condition that, at the inception of the group:
a) the entity reasonably expects that this will be a reasonable approximation of the General Model, or
b) the coverage period of each contract in the group is one year or less [IFRS 17:53]

Thus, the variable fee approach (VFA) is applied to insurance contracts with direct participation features that contain the following conditions (‘eligibility criteria’) at initial recognition:

  1. the contractual terms specify that the policyholder participates in a share of a clearly identified pool of underlying items;
  2. the entity expects to pay to the policyholder an amount equal to a substantial share of the returns from the underlying items; and
  3. a substantial proportion of the cash flows the entity expects to pay to the policyholder should be expected to vary with cash flows from the underlying items.

In order to be in scope of the VFA, an insurance contract would need to meet all the three eligibility criteria stated above, and this eligibility test is only performed at inception. In addition, it is noted that the definition refers only to the terms of the insurance contract, and therefore it is not necessary that the entity holds the identified pool of underlying items.

Measurement of insurance contracts

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