The reference to the “practical ability” to reassess the risk is intended to differentiate from a pure formal legal right to do so, but where practical facts and circumstances actually prevent the entity from doing so. For example, it might be practically impossible to assess the risk due to any or all of the following:
- inaccessibility of the item bearing the risk;
- moral reasons;
- significant cost; or
- significant business dangers.
It is not the expectation that the entity does not intend to apply the reassessment but only the expectation that, even if it wishes to do so, it would not be able due to practical reasons.
Paragraph B64 notes that practicable ability exists if the entity can reprice the contract or portfolio (as applicable) to the same price it would charge for a new contract or portfolio with same characteristics. If an entity decides to charge a new price for new contracts, but for commercial reasons decides not to do so for existing contracts, then further judgment is required to assess whether this commercial decision was a free choice or refers to a practical inability to reprice.
What does it mean to reassess the risk of a particular policyholder?
When considering whether or not there is a substantive obligation, the entity may consider if there is any risk of anti-selection by the policyholder on the specific financial risk transfer. For instance, because of a possibly impaired risk profile it might be advantageous for the policyholder to continue the existing contract rather than effect a new contract. This advantage affects the substantive obligation of the entity to provide services.
The conditions outlined here might only be understood by considering the underlying risk for the “particular policyholder” and cannot be assessed based on collective information. Therefore, under paragraph 34 (a) this can be interpreted to refer to risks transferred from the policyholder, insurance and financial risk only. The substance of the obligation results from guaranteed insurability or minimum guarantees on participation contracts.
What does it mean to reassess the risks at a portfolio level?
This is more than the ability to reflect general market experience, it requires the ability to reflect the experience of the portfolio itself. Again, the risks being reassessed are policyholder risks, transferred from the policyholder, e.g., insurance and financial risks not lapse and expense risks created by the contract even though they would be reflected in pricing.
When does an obligation take into account the risks that relate to future periods?
The condition in paragraph 34 (b) refers to substantive obligations arising from premiums already paid in the past even in the case of a collective premium or benefit adjustment clause. If there are none, as outlined in paragraph 34 (b) (ii), there is no substantive obligation in this case. This is typically the case if the entity charges premiums only to finance services in the premium payment period and the premium or benefit adjustment clause refers to future premiums financing the services in future periods entirely without support from already paid premiums. If the entity charged premiums in the past which included parts intentionally considered to finance coverage together with future premiums, those past premiums result in a substantive obligation of the entity, even if the future premiums are subject to a collective premium or benefit adjustment clause.
Paragraph 34 (b) reflects two of the common types of premiums:
- those which are often referred to as “yearly renewable” that only cover the risk arising in the next period e.g., one year (no substantive obligation); and
- level premiums for the whole contract which in any one year might be greater or less than the cost of the risk for that next year with any excess premium being used to help “finance” the cost of risk in a later period (substantive obligation).