A reinsurance contract is an insurance contract issued by one entity (the reinsurer) to compensate another entity for claims arising from one or more insurance contracts issued by the other entity (underlying contracts).
IFRS 17 requires a reinsurance contract held to be accounted for separately from the underlying insurance contracts to which it relates. This is because an entity that holds a reinsurance contract (a cedant) does not normally have a right to reduce the amounts it owes to the underlying policyholder by amounts it expects to receive from the reinsurer.
A cedant measures reinsurance contracts it holds by applying a modified version of the general model or, if the contract is eligible, the premium allocation approach. The requirements of the general model are modified for reinsurance contracts held to reflect that [IFRS 17 BC302]:
- Groups of reinsurance contracts held are usually assets rather than liabilities
- Entities holding reinsurance contracts generally pay a margin to the reinsurer as an implicit part of the premium rather than making profits from the reinsurance contracts
- Mismatches can arise from accounting for reinsurance contracts held separately from the underlying insurance contracts. The general model has been adjusted to reduce some of those mismatches.
The overall result of the modifications of the general model for reinsurance contracts held are that:
- Both day 1 gains and day 1 losses are initially recognised in the statement of financial position as a contractual service margin and recognised in profit or loss as the reinsurer renders services, except for any portion of a day 1 loss that relates to events before initial recognition. This is quite different from the accounting for (re)insurance contracts issued, where all day 1 losses are recognised in profit or loss immediately
- Assumptions used for measurement should be consistent with those for measurement of the underlying insurance contracts issued.
- Non-performance risk of the reinsurer should be included in the measurement of the performance cash flows (non-performance risk is not included within the measurement of the underlying insurance contracts issued).
- The risk adjustment for non-financial risk reflects the amount of risk transferred from the insurer to the reinsurer.
- Changes in the fulfilment cash flows adjust the contractual service margin if they relate to future coverage and other future services. However, changes in fulfilment cash flows are recognised in profit or loss if the related changes arising on the underlying ceded contracts have been recognised in profit or loss. This would usually be the case when the underlying ceded contracts are onerous.
1. Level of aggregation
An entity should divide portfolios of reinsurance contracts held applying the same criteria as for insurance contracts issued discussed in ‘Portfolio of insurance contracts’. If a portfolio of reinsurance contracts held includes more than one contract, it must be divided into one of the following [IFRS 17 61]:
- A group of contracts on which there is a net gain on initial recognition (i.e., a net inflow), if any
- A group of contracts for which there is a net cost of purchasing reinsurance (i.e., a net outflow) with no significant possibility of a net gain arising subsequent to initial recognition, if any
- A group of the other contracts for which there is a net cost of purchasing reinsurance with a significant possibility of a net gain arising subsequent to initial recognition, if any
An entity is not allowed to group contracts purchased more than a year apart. A group of contracts is not reassessed after initial recognition. We believe that, for a number of reinsurance contracts (e.g., reinsurance treaties), a group will comprise a single contract.
Instead of applying the recognition requirements for an insurance contract issued (see ‘Initial recognition of insurance contracts’), an entity should recognise a group of reinsurance contracts held [IFRS 17 62]:
- If the reinsurance contracts provide proportionate coverage at the later of the beginning of the coverage period of the group, or the initial recognition of any underlying contract
- In all other cases, from the beginning of the coverage period of the group
Proportionate coverage includes reinsurance contracts held to cover the losses of underlying contracts on a proportionate basis [IFRS 17 BC304]. Therefore, this refers to reinsurance contracts where the cash flows paid or received are a proportion of the cash flows from the underlying insurance contracts covered by the reinsurance arrangement. An example would be a quota share contract where a fixed percentage of premiums and claims from certain insurance contracts are paid to, or received from, the reinsurer. Proportionate reinsurance contracts could be written on a treaty basis where a reinsurer accepts a share of all policies written over a specified time period; or they could be facultative where they cover a specified risk or contract.
When a reinsurance contract held provides proportionate coverage, the initial recognition of the (group of) reinsurance contract(s) will, as a simplification, be later than the beginning of the coverage period if no underlying contracts have been recognised as of that date [IFRS 17 BC305(a)].
Example – Recognition of reinsurance contract held providing proportionate coverage
An entity holds a reinsurance contract in respect of a term life insurance portfolio on a quota share basis whereby 20% of all premiums and claims from the underlying insurance contracts are ceded to the reinsurer. The reinsurance contract is considered a group for the purpose of aggregation and is effective 1 January 2021. The first underlying insurance contract is recognised on 1 February 2021.
As the reinsurance contract held provides proportionate coverage, the contract is recognised at the later of the beginning of the coverage period and the initial recognition of any underlying contract, i.e., 1 February 2021.
In contrast, for contracts which do not provide proportionate coverage the recognition date is the start of the coverage period (unless the contract is onerous, in which case it is the date of signing). An example of such a contract is one that covers aggregate losses from a group of underlying contracts that exceed a specified amount [IFRS 17 BC304].
The coverage the entity benefits from starts at the beginning of the group of reinsurance contracts held because such losses accumulate throughout the coverage period [IFRS 17 BC305(b)]. An example of such a contract is one that provides cover for aggregate losses from a single event, excess of a predetermined limit and with a fixed payable premium.
Example – Recognition of reinsurance contract held that does not provide proportionate coverage
An entity holds a reinsurance contract that provides excess of loss protection for a motor insurance portfolio. In exchange for a fixed premium of CU100, the reinsurance contract provides cover for claims arising from individual events in the portfolio in excess of CU500 up to a limit of CU200. The reinsurance contract is considered a group for the purpose of aggregation and is effective 1 January 2021. The first underlying motor insurance contract is recognised 1 February 2021.
As the reinsurance contract held does not provide proportionate coverage (because neither the premiums nor claims are a proportion of those from the underlying insurance contracts), the contract is recognised at the beginning of the coverage period, i.e., 1 January 2021.
The recognition requirements for reinsurance contracts held that provide proportionate coverage are meant to simplify recognition and measurement for proportionate reinsurance contracts held. Circumstances in which the first underlying attaching contract is issued shortly after the reinsurance contracts are written will result in similar timing of recognition for proportionate and “other-than-proportionate” reinsurance contracts. In other cases, there may be a greater difference in the timing of recognition.
3. Initial measurement of reinsurance contracts
A reinsurance contract held must be measured using the same criteria for fulfilment cash flows and CSM as an insurance contract issued — to the extent that the underlying contracts are also measured using this approach. However, the entity must use consistent assumptions to measure the estimates of the present value of future cash flows for the group of both the reinsurance contracts held and the underlying insurance contracts [IFRS 17 63].
Fulfilment cash flows must also take into consideration that:
- Estimates of the present value of the future cash flows for the group of reinsurance contracts held must reflect the effect of any risk of non-performance by the issuer of the reinsurance contract, including the effects of collateral and losses from disputes [IFRS 17 63]. This is because an entity holding a reinsurance contract faces the risk that the reinsurer may default or may dispute whether a valid claim exists for an insured event [IFRS 17 BC308]. The estimates of expected credit losses are based on expected values.
- The estimate of the risk adjustment for non-financial risk must be determined to represent the amount of risk being transferred by the holder of the group of insurance contracts to the issuer of those contracts [IFRS 17 64].
The expected value measurement of credit losses is similar to the requirements of IFRS 9, which requires credit loss provisions for financial instruments on an expected loss basis. However, IFRS 9 does not apply to rights under a contract within the scope of IFRS 17, such as a receivable due under a reinsurance contract held (A cedant applies IFRS 17 to reinsurance contracts that it holds). Consequently, the IFRS 9 credit loss model does not apply. Instead, credit losses have an expected value basis over the estimated lifetime of the contract using the guidance for expected values as part of the fulfilment cash flows (see ‘Estimates of future cash flows‘).
Reinsurance contracts may provide cover across different groups of insurance contracts. For example, a motor reinsurance contract is likely to provide protection for underlying insurance contracts within a portfolio comprising both onerous contracts and those not expected to become onerous. Some reinsurance contracts are written on a “whole account” basis and cover all of an insurer’s underlying groups of insurance contracts. IFRS 17 does not provide guidance as to how to measure the reinsurance contract in these circumstances. Consequently, an insurer will have to use judgement in weighting the underlying cash flows from different insurance groups to the reinsurance contract.
In some cases, reinsurance contracts held will offer protection for underlying contracts that an entity has not yet issued. If the reinsurance cash flows arising from the underlying contracts are within the boundary of a reinsurance contract, the measurement of the reinsurance contract will reflect those cash flows — as the standard requires that future cash flows within the boundary be taken into account. An entity will need to estimate the fulfilment cash flows of contracts it expects to issue that will give rise to cash flows within the boundary of the reinsurance contracts that it holds. The estimates must be adjusted as time passes and the underlying direct contracts that are subject to reinsurance are actually issued. We think that reinsurance fulfilment cash flows for future underlying contracts expected to be issued include an estimate of the amount of risk adjustment an entity expects will be transferred to the reinsurer when underlying contracts are recognised, as well as estimated reinsurance premiums and claim recovery cash flows.
Many reinsurance contracts contain a break clause which allows either party to cancel the contract at any time following a 90-day notice period. This creates a contract boundary for any new business written by the cedant beyond the 90-day period from the reporting date. The question arises about how to treat what is effectively a rolling contract boundary in the next reporting period. Should coverage related to the period after the initial boundary be reported as new contracts, or do they reflect changes in assumptions about new business on the original contract? Allied to this question is which discount rate to use when determining the CSM for coverage beyond the initial boundary. Should this be the rate at inception of the contract, or a rate based on the revised boundary date?
The CSM for reinsurance contracts held can be either a net cost or net gain of purchasing reinsurance for services yet to be received. In contrast, the CSM for insurance contracts issued can only be the unearned profit for services yet to be provided. This represents a modification to the general model for the purposes of measuring reinsurance contracts held [IFRS 17 65].
An entity should recognise any net cost or net gain on purchasing a group of reinsurance contracts held as a CSM. It is measured at an amount equal to: the sum of the fulfilment cash flows, the amount derecognised at that date of any asset or liability previously recognised for cash flows for the group of reinsurance contracts held, and any cash flows arising at that date.
If expected cash outflows to a reinsurer exceed the sum of expected inflows and the risk adjustment, the CSM represents a net cost of purchasing reinsurance.
If expected cash inflows from the reinsurer plus the risk adjustment exceed expected outflows, the CSM represents a net gain of purchasing reinsurance.
An exception to measuring the CSM of a group of reinsurance contracts held occurs when the net cost of purchasing reinsurance coverage relates to events that occurred before the purchase of the group of reinsurance contracts (retroactive reinsurance). In this case, the entity must recognise such a cost immediately in profit or loss as an expense.
Example – Measurement on initial recognition of groups of reinsurance contracts held
(Based on Example 11 of IFRS 17 [IFRS IE124-129])
An entity enters into a reinsurance contract that, in return for a premium of CU300m, covers 30% of each claim from the underlying reinsurance contracts. Applying the relevant criteria, the entity considers that the group comprises a single contract held. For simplicity, this example disregards the risk of non-performance of the reinsurer and all other amounts.
The entity measures the estimates of the present value of future cash flows for the group of reinsurance contracts held using assumptions consistent with those used to measure the estimates of the present value of the future cash flows for the group of the underlying insurance contracts, as shown in the table below.
(Amounts in CU millions)
Estimates of the present value of future cash inflows
Estimates of the present value of future cash outflows/premium paid
Risk adjustment for non-financial risk
Insurance contract asset/liability on initial recognition
The entity measures the present value of the future cash inflows consistent with the assumptions of the cash outflows of the underlying insurance contracts. Consequently, the estimate of cash inflows is CU270m (i.e., 30% of CU900m). The risk adjustment is determined to represent the amount of risk being transferred by the holder of the reinsurance contract to the issuer of the contract. Consequently, the risk adjustment, which is treated as an inflow rather than an outflow, is CU18m (i.e., estimated to be 30% of 60).
The CSM is an amount equal to the sum of the fulfilment cash flows and any cash flows arising at that date. In this example, there is a net loss on purchasing the reinsurance and the CSM is an asset.
If the premium was only CU260m, there would be a net gain of CU28m on purchasing the reinsurance (i.e., inflows of CU270m, plus the risk adjustment of CU18m less outflows of CU260m) and the CSM would represent a liability of CU28m to eliminate the net gain on inception.
4. Subsequent measure of reinsurance contracts held
Instead of applying the subsequent measurement requirements of the general model, an entity must measure the CSM at the end of the reporting period for a group of reinsurance contracts held [IFRS 17 66]:
Example – movement in the carrying amount of the CSM in a period
A) CSM at the beginning of the period
X or (X)
B) Effect of new contracts added to the group
X or (X)
C) Interest accreted on the CSM in the period
[measured at discount rates determined at the date of initial recognition of a group of contracts applicable to nominal cash flows that do not vary based on the returns on any underlying items]
X or (X)
D) Change in fulfilment cash flows relating to future service unless the change results from a change in fulfilment cash flows allocated to a group of underlying insurance contracts that does not adjust the CSM for the group of underlying insurance contracts
X or (X)
E) Effect of currency exchange differences
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) or X
G) CSM at the end of the period
X or (X)
Example – Measurement subsequent to initial recognition of groups of reinsurance contracts held
Reference to Example 12 in IFRS 17, IE130 – 138
4.1. Exception to general principle for adjusting the CSM
There is an exception to the general principle of adjusting the CSM when changes in fulfilment cash flows for reinsurance contracts held represent future service from the reinsurer. If the change in reinsurance contract cash flows relate to changes in fulfilment cash flows allocated to a group of underlying insurance contracts that are recognised in profit or loss, rather than adjusting the CSM of the underlying insurance contracts, the change in reinsurance contract cash flows is also recognised in profit or loss. This exception to the general principle aims to avoid an accounting mismatch in profit or loss between the accounting for changes in expected cash flows for underlying insurance contracts an entity issues and reinsurance contracts it holds.
Changes in fulfilment cash flows relating to future service to groups of underlying insurance contracts are recognised immediately in profit or loss (rather than being offset against the CSM) when the underlying groups of contracts are onerous. Insurers will need to identify the extent to which changes in fulfilment cash flows for reinsurance contracts held relate to corresponding changes in underlying contracts recognised in profit or loss. This will require a means of allocating changes in fulfilment cash flows of an onerous group of underlying contracts to those that are protected by reinsurance. This might not be straightforward, e.g., when only some of the underlying contracts in a group are reinsured by a particular group of reinsurance contracts held. An entity might choose to subdivide groups of issued contracts and/or groups of reinsurance contracts held in order to facilitate matching.
The general model is designed to avoid mismatches in profit or loss arising from subsequent measurement of insurance contracts an entity issues and changes in fulfilment cash flows of reinsurance contracts held. Mismatches in profit or loss between onerous insurance contracts and corresponding reinsurance contracts held may, however, occur at initial recognition. The effect of this mismatch at initial recognition will affect subsequent reporting periods too as the CSM on the reinsurance contracts is released to profit or loss over time, without a corresponding release on the underlying direct contracts.
4.2. Release of the CSM for reinsurance contracts held
The CSM is released to profit or loss as the insurer receives coverage from the reinsurer. Generally, the period in which the reinsurer renders services is the coverage period of the reinsurance contract. This is the time when insured events within the reinsurance contract can occur and are determined by the boundary of the reinsurance contract held.
Example – Coverage period for proportional reinsurance treaty that protects an insurer for contracts it issues in a year
An insurer holds a proportional reinsurance treaty that protects it for claims arising from underlying insurance contracts it issues in a year. Each of the underlying insurance contracts has a coverage period of one year. However, the reinsurance treaty provides coverage for claim events that can occur in a period of up to two years. Consequently, the coverage period for the reinsurance contract held is the two-year period.
5. Premium allocation approach for reinsurance contracts held
An entity may use the premium allocation approach (see ‘Premium allocation approach‘), adapted to reflect the features of reinsurance contracts held that differ from insurance contracts issued. For example, the generation of expenses or a reduction in expenses rather than revenue, to simplify the measurement of a group of reinsurance contracts held if, at the inception of the group [IFRS 17 69]:
- The entity reasonably expects that the resulting measurement would not differ materially from the result of applying the requirements in the general model for reinsurance contracts held, as discussed above
- The coverage period of each contract in the group of reinsurance contracts held (including coverage from all premiums within the contract boundary determined at that date applying the definition in the general model) is one year or less
An entity cannot meet the first condition above if, at the inception of the group, an entity expects significant variability in the fulfilment cash flows that would affect the measurement of the asset for remaining coverage during the period before a claim is incurred. Variability in the fulfilment cash flows increases with, for example [IFRS 17 70]:
- The extent of future cash flows relating to any derivatives embedded in the contracts
- The length of the coverage period of the group of reinsurance contracts held
Assessment of eligibility for reinsurance contracts held to the premium allocation approach is independent of whether the entity applies the premium allocation approach to the underlying insurance contracts it issues. Reinsurance contracts written on a 12-month risk-attaching basis (i.e., the underlying insurance contracts subject to the reinsurance contract issued over a 12-month period) will have a contract boundary of up to two years if each of the underlying insurance contracts have a coverage period of one year.
We believe that one-year ‘risks attaching’ reinsurance contracts have a coverage period of more than one year, because the coverage is provided on all direct contracts written by a cedant in that underwriting year. A one-year contract issued on the last day of the underwriting year will have a coverage period that extends until the end of the next year. Therefore, the reinsurer is providing coverage for up to two years. This means that these contracts will not meet the requirements to use the premium allocation approach by definition. Therefore, risks attaching reinsurance contracts would have to qualify for the premium allocation approach on the basis that the resulting measurement of the liability for remaining coverage would not differ materially from the result of applying the general model. A mismatch in measurement models may arise if the underlying contracts are accounted for under the premium allocation approach while the reinsurance contract has to use the general model.