Are groups limited to annual quarters where there is quarterly interim reporting?

Reference to standard: IFRS 17 paras 22, B137

Question

Does the prohibition in paragraph B137 of IFRS 17, on updating estimates from previous interim periods, restrict the level of aggregation to contracts written within a quarter if the entity does quarterly reporting?

Answer

No. Paragraph 22 of IFRS 17 specifically notes that the restriction on level of aggregation is an annual one, not a shorter interim period. Paragraph B137 notes that an entity should not change the treatment of accounting estimates made in previous interim financial statements when applying IFRS 17 in subsequent interim reporting periods or in the annual period. This latter provision means that, when determining whether a change in cash flows represents a change in estimate from that expected at the beginning of the period (an experience adjustment) versus a change in expectations of future cash flows (a change to the contractual service margin), an entity makes that determination as of the beginning of the current reporting period. In the subsequent reporting period, an entity uses the beginning of that reporting period as its starting point. Similarly, in its annual financial statements, it does not go back and redo its estimates based on information as of the beginning of the annual period.

The reporting period requirement in paragraph B137, for measurement of changes in cash flows, does not impact the annual restriction for contract groupings. For example, paragraph 28 of IFRS 17 notes that contracts incepted in the current reporting period can be added to an existing group of contracts that incepted in a prior reporting period, subject to the annual limitation in paragraph 22. This might result in a change in the determination of the ‘at inception’ discount rate, for example by calculating a revised weighted average discount rate (para B73 of IFRS 17) for the cumulative year-to-date period. The revised weighted-average discount rate would be applied from the start of the reporting period in which the new contracts are added.

Measurement differences in consolidated financial statements where interim reports are prepared applying IAS 34

Reference to standard: IFRS 17 para B137

Question

Where the reporting frequency of a group differs from the reporting frequency of its subsidiary, would the measurement of the insurance contracts issued by the subsidiary be equal in the group’s consolidated financial statements and the subsidiary’s stand-alone financial statements?

Answer

Not necessarily. Requiring the contractual service margin to be adjusted for changes in estimates of the fulfilment cash flows related to future events, but not for experience adjustments, has the consequence that the accounting depends on the timing of a reporting date.

IFRS 17 specifically prohibits entities from changing the treatment of accounting estimates made in previous interim financial statements when applying IFRS 17 in subsequent interim financial statements or in the annual financial statements. As a result, the measurement of insurance contracts issued by a subsidiary might differ between the subsidiary’s and the group’s financial statements if the group and subsidiary have different reporting frequencies.

For example, assume that a group prepares half-yearly interim financial statements (in accordance with IAS 34), but a subsidiary within the group does not. Assume that, in one of the subsidiaries (H1), there is a change in the estimate of fulfilment cash flows for an existing group of insurance contracts issued by the subsidiary that relates to service to be provided in another subsidiary (H2). Assume that the actual cash flows in H2 are in line with those revised expectations. For the purposes of H1 reporting of the group, there would be a change in estimate of the fulfilment cash flows in respect of future service that would adjust the contractual service margin of the group of insurance contracts. In accordance with paragraph B137, this adjustment to the contractual service margin would flow through to the group’s annual financial statements, which would therefore not account for any experience adjustment as a result of the change in cash flows. However, in the subsidiary’s annual financial statements, this change would be accounted for solely as an experience adjustment in relation to current service, which would not adjust the contractual service margin.

The requirement in IFRS 17, that an entity must not change the treatment of accounting estimates made in previous interim financial statements, also applies to the amortisation of the contractual service margin. This means that the reporting period referred to in IFRS 17 applies to the period since the last reporting date, which will include interim financial statements within the scope of IAS 34. Where the group prepares half-yearly interim financial statements, the reporting period used for the consolidated accounts at the year-end, to remeasure the contractual service margin and release the contractual service margin to revenue, would be the six-month period since the interim reporting date. In contrast, if the subsidiary only prepares annual financial statements, the contractual service margin amortisation would be for the year.

Following the issuance of IFRS 17, the IASB noted some concerns and implementation challenges relating to the treatment of accounting estimates in interim periods. After further deliberation, the Board decided not to extend the requirement stated to interim reports other than those defined in IAS 34.

In determining groups of contracts, can an entity determine a grouping below the minimum groups required by IFRS 17?

Reference to standard: IFRS 17 paras 16, 21, 23

Question

IFRS 17 sets out requirements for how an entity should determine the minimum number of groups of contracts for the purpose of applying other requirements in the standard. In determining such groups of contracts, can an entity use a lower level of aggregation than the minimum groups required by paragraph 16?

Answer

Yes. There are no restrictions to further disaggregate when determining groups, provided that the minimum number of groups described in paragraph 16 is followed. In some cases, an entity could determine a group to be an individual contract.

Determination of coverage period where there is potential insurance risk consequent on an incurred claim

Reference to standard: IFRS 17 App A

Question

Does the coverage period comprise only the specified period in which a policyholder suffers an event covered by the contract (such as becoming disabled or the occurrence of a fire), or does it comprise the period over which the amount of payments is uncertain (for example, until the period of disability or the cost of rebuilding the house is known)?

Background

Some insurance contracts exist where an incurred claim under the original contract can create additional insurance risk for the entity that would not have existed if no claim were made (referred to as ‘consequential insurance risk’). An example is a policy that provides coverage for a policyholder becoming disabled during a specified period. The consequential insurance risk is that, if a valid claim is made, the entity is required to make regular payments to the policyholder until the policyholder recovers, reaches a specified age, or dies. Another example is a fire insurance coverage that provides coverage for the (potentially uncertain) cost of rebuilding a house damaged by fire.

Answer

At the September 2018 meeting of the IASB Transition Resource Group for IFRS 17 Insurance Contracts (‘TRG’), it was concluded that either approach could be a valid interpretation of IFRS 17, and that it is a matter of judgement for the entity to develop an accounting policy that reflects the insurance service provided by the entity to the policyholder.

In accordance with IAS 8, an entity is required to apply accounting policies consistently for similar transactions, other events and conditions. For example, the same approach should be applied to contracts of the same product type or with similar insurance service; but an entity might adopt different policies for, say, disability products and workers’ compensation products. However, different accounting policies could not be applied to the same products offered in different geographies.

Can an asset or liability be recognised in respect of insurance acquisition cash flows relating to contracts not yet issued?

Reference to standard: IFRS 17 para 27

In June 2018, the IASB tentatively decided to amend IFRS 17, to clarify that insurance acquisition cash flows relating to insurance contracts in the group yet to be issued can be recognised as an asset or liability.

Classification of costs as insurance acquisition costs

Reference to standard: IFRS 17 para B65 Insurance

Question

Is classification of insurance acquisition cash flows under IFRS 17 restricted to those which are related to the initial recognition of the group of insurance contracts? Can ‘renewal commissions’ be classified as insurance acquisition cash flows?

Background

The timing of insurance acquisition cash flows might differ, depending on the agreement between the insurer and an intermediary. In some situations, a deferred payment schedule might exist to share in the insurer’s lapse risk or to decrease the amount of upfront costs on inception of the insurance contract. Commission payments might comprise both initial commission and recurring commissions. Consider the following example:

An insurance intermediary places insurance contracts with an insurance entity, whereby premiums are paid over a number of years. The insurer and the intermediary have agreed that the intermediary will receive commissions, for the first three years, of 20%, 15% and 10% of premiums paid in a particular year respectively and, for Year 4 onwards, of 3% of the premiums paid subsequently.

All commissions are calculated and paid based on the premiums paid, and they are not subject to any clawbacks once paid.

Answer

It depends. The classification of costs as insurance acquisition cash flows will depend on the facts and circumstances of the agreement between the insurer and the intermediary. Entities are required to apply judgement to determine which cash flows meet the definition of insurance acquisition cash flows in Appendix A to IFRS 17. The timing of payments of acquisition cash flows is not determinative in the analysis of whether the cash flows meet the definition of an acquisition cash flow. However, certain other cash flows (such as level renewal commissions that are recurring throughout the entire life of the contract) will not meet the definition of an insurance acquisition cash flow, but instead are policy administration or maintenance expense fulfilment cash flows. These latter types of costs are mentioned in paragraph B65(h) of IFRS 17, and they would not be considered acquisition cash flows under paragraph B65(e).

In the probability-weighted estimated cash flows, entities are required to include all acquisition cash flows and policy administration and maintenance expenses within the contract boundary of the group of insurance contracts. The acquisition cash flows will subsequently be presented as insurance revenue and insurance service expenses ‘in a systematic way based on the passage of time’. Costs classified as policy administration and maintenance costs are expensed as incurred, and they are classified as insurance service expense. The expected amount of these expenses is recognised as revenue in the same period.

Allocation of acquisition costs attributable to multiple groups of contracts

Reference to standard: IFRS 17 para 27

Question

How should acquisition costs incurred, that are attributable to multiple groups of insurance contracts, some of which are not yet issued, be accounted for?

Background

Assume that an insurance company incurs acquisition costs of CU100, for which contracts are expected to be written in the remainder of 20X1 and in 20X2. The contracts issued because of the acquisition costs incurred are allocated to two groups of contracts: one group of contracts that is expected to incept in 20X1 (‘Group 1’); and a second group of contracts expected to incept in 20X2 (‘Group 2’).

Answer

At the IASB meeting in June 2018, the IASB agreed to propose an annual improvement to amend IFRS 17, to include insurance acquisition cash flows relating to insurance contracts yet to be issued. The term ‘issued’ was originally included in IFRS 17 to identify insurance contracts issued (as opposed to reinsurance contracts held). The amendment clarifies that an asset can be recognised for acquisition costs relating to groups of contracts that are yet to be issued.

As a result of the amendment, the acquisition costs should be treated as preacquisition cash flows of both Group 1 and Group 2, and they should be allocated to the contracts in Group 1, as well as to the contracts in Group 2, on a reasonable and supportable basis.

At what point are individual contracts added to an existing group?

Reference to standard: IFRS 17 para 28

In June 2018, the IASB tentatively decided to amend IFRS 17 to clarify that individual insurance contracts should be included in an existing group only when they meet the criteria for recognition applied to the individual contract.

When measuring fair value in IFRS 17, does the exclusion of the deposit floor in IFRS 13 always apply?

Reference to standard: IFRS 13 para 47, IFRS 17 para BC 166

Does the exclusion of the deposit floor (in IFRS 13) extend to areas of IFRS 17 other than the referenced contracts – for example, when the fair value of underlying items in an insurance contract with discretionary participation features is determined?

Yes. The fair value of underlying items could include the valuation of financial liabilities. Measuring the fair value of insurance contract liabilities as part of underlying items should maintain the IFRS 17 requirement to exclude the deposit floor feature of IFRS 13. For example, where in-payment annuities (classified as insurance contracts) form part of a with-profits fund, the value of any pension transfer or lump sum benefits does not establish a floor when determining the fair value of liabilities associated with these contracts.

What are the building blocks that make up the general model, and how do they affect the statement of comprehensive income?

Reference to standard: IFRS 17 para 32

The diagram below summarises the major building blocks in the general model, and how the changes in the building blocks flow into the statement of comprehensive income:

* Accounting policy choice for future cash flows and risk adjustment: (1) recognise all in profit or loss; or (2) recognise insurance finance income or expenses by unwinding discount rate locked in at inception in profit or loss, and changes in discount rate in other comprehensive income.

** Entity can choose whether to disaggregate change in risk adjustment for non-financial and financial risk. If it does not, the entire change is in the insurance service result.

*** Not all experience adjustments are recognised in profit or loss. Experience adjustments for premiums related to future services are treated as changes in estimates; that is, they adjust the contractual service margin and are not recognised in profit or loss immediately. Estimated future cash flows

What are some of the practical considerations in assessing contract boundaries?

Reference to standard: IFRS 17 para 34

The result of the contract boundary assessment depends on an entity’s practical ability to reprice a portfolio of insurance contracts. Thus, contract boundaries could be affected by how an entity defines the portfolio. Applying the definition of a portfolio in practice might require judgement.

Health insurance products in some jurisdictions offer annual guaranteed renewal options. Entities are often not able to reassess risks fully for individual policyholders, because a policyholder does not have to go through health assessment procedures on renewal. However, entities can reset the price based on full reassessment of the risks for the portfolio of insurance contracts, considering insurance risk up to the next renewal date. Such contracts will have an annual contract boundary if other criteria in the contract boundary assessment also indicate that this is a one-year contract.

Which ‘risks’ are included in the reassessment of risks under paragraph 34 of IFRS 17?

Reference to standard: IFRS 17 para 34

Question

When assessing the boundary of a contract under IFRS 17, which risks are included to determine whether the entity issuing the contracts ‘has the practical ability to reassess the risks’ of the particular policyholder or of the portfolio of insurance contracts?

Answer

At the February and May 2018 meetings of the IASB Transition Resource Group for IFRS 17 Insurance Contracts (‘TRG’), it was clarified that the ‘reassessment of risks’ (referred to in determining the contract boundary under para 34(b) of IFRS 17) refers only to risks transferred from the policyholder to the entity, such as insurance risk and financial risk. It does not include other risks, such as lapse and expense risk.

The TRG noted that paragraph 34(b) is an extension of paragraph 34(a), which focuses on policyholder risk. Therefore, insurance risk is relevant, because it is a risk transferred from the policyholder to the entity. Other risks, such as lapse and expense risk, are not relevant in the assessment, since these are risks of the insurer but they are not risks transferred from the policyholder.

Reassessment of risk: step-rated premium

Reference to standard: IFRS 17 para 34

Question

Is a life insurance contract with a step-rated premium table based on age that can be repriced annually at the portfolio level, a one-year contract under IFRS 17?

Answer

It depends. A similar question was discussed by the IASB Transition Resource Group for IFRS 17 Insurance Contracts (‘TRG’) in February 2018. The fact pattern in this example, and in the one presented at the TRG meeting, assumes that premiums increase in line with age each year, based on the step-rated table (that is, the contract does not charge level premiums), and as a result it is assumed that the requirements in IFRS 17 are met. With regard to the criterion, if, in the annual portfolio repricing exercise, the entity has the contractual right to use the actual experience of the portfolio, rather than a general mortality table, the entity is effectively repricing to a level that fully reflects the risk of the portfolio. In other words, even if individual policyholders are not medically re-underwritten to reflect changes in individual mortality risk, the entire portfolio is effectively re-underwritten by considering the experience of the group. As a result, the requirement is met. Therefore, the requirements are met, resulting in an annual contract boundary.

Conversely, if, in repricing the portfolio, the entity was not allowed to consider the risks of the specific portfolio, but the repricing was based instead on general mortality tables, the answer would be different. The entity potentially would not be able to reprice to a level that fully reflects the risks of the portfolio; as a result, the criterion would not be met, and the contract boundary would extend until the entity no longer had the substantive obligation to provide the policyholder with services.

Measurement on initial recognition: Interpreting the phrase ‘practical ability to reassess the risks’ when assessing the boundary of an insurance contract

Reference to standard: IFRS 17 paras 34, BC 161

IFRS 17 notes that an entity should include, in the measurement of a group of insurance contracts, all of the future cash flows within the boundary of each contract in the group. According to IFRS 17:

“… cash flows are within the boundary of an insurance contract if they arise from substantive rights and obligations that exist during the reporting period in which the entity can compel the policyholder to pay the premiums or in which the entity has a substantive obligation to provide the policyholder with services. A substantive obligation to provide services ends when:

·        the entity has the practical ability to reassess the risks of the particular policyholder and, as a result, can set a price or level of benefits that fully reflects those risks; or

·        both of the following criteria are satisfied:

o   the entity has the practical ability to reassess the risks of the portfolio of insurance contracts that contains the contract and, as a result, can set a price or level of benefits that fully reflects the risk of that portfolio; and

o   the pricing of the premiums for coverage up to the date when the risks are reassessed does not take into account the risks that relate to periods after the reassessment date.”

The issue of cash flows within the contract boundary, including consideration of what constitutes a practical ability to reassess risks, was discussed by the IASB Transition Resource Group for IFRS 17 Insurance Contracts (‘TRG’) in May 2018.

Question

How should entities interpret the phrase ‘practical ability to reassess the risks’ of a policyholder or a portfolio of insurance contracts when assessing the boundary of an insurance contract?

Answer

IFRS 17 clarifies that, if an entity has the practical ability to reassess the risk presented by a policyholder but it does not have the right to set a price that fully reflects the reassessed risk, the contract still binds the entity.

As a result, the practical ability to reassess the risks is not a stand-alone criterion, but it always has to be accompanied by the entity’s ability to set a price or level of benefits that fully reflects those risks. The phrase ‘practical ability to reassess the risks’ has to be interpreted as part of a pricing process whose objective is to calculate prices that fully reflect the risks of an insurance contract (or a portfolio of insurance contracts) or to set a level of benefits to align the risks to the price that will be charged.

TRG members observed at the May 2018 meeting that the ability ‘to set a price or level of benefits that fully reflects … risks’ includes consideration of contractual, legal and regulatory restrictions, as well as market competitiveness and commercial considerations. For example, although permitted by the terms of the contract, an increase in the price (or a decrease in the level of benefits) of the contract, to reflect an increase in the risks of the particular policyholder or portfolio, might result in unfavourable economic consequences for the entity. Competitive pressure, reputational risk, or negative reactions from distribution channels might force an entity from setting a price that fully reflects its risks and thereby extend the contract boundary. (As noted, entities needs to evaluate whether the same constraints exist for current and new policyholders.) On the other hand, an entity might voluntarily decide, as a marketing strategy, not to raise its price, which might not be deemed a limitation on the entity’s practical ability to reprice.

Cash flows within the contract boundary; pricing subject to legal and regulatory constraints

Reference to standard: IFRS 17 paras 34, BC 161

Question

Where the pricing of an insurance contract is subject to constraints stemming from law or regulation, how are such constraints considered when assessing the contract boundary under IFRS 17?

Answer

When determining the boundary of an insurance contract, an entity should consider its substantive rights and obligations, whether they arise from a contract, law or regulation. However, the entity should disregard terms that have no commercial substance (that is, no discernible effect on the economics of the contract). As noted in IFRS 17, if an entity has the practical ability to reassess the risk presented by a policyholder, but it does not have the right to set a price that fully reflects the reassessed risk, the contract still binds the entity. Thus, cash flows after that point would be within the boundary of the existing contract, unless the restriction on the entity’s ability to reprice the contract is so minimal that it has no commercial substance.

Some local regulations might:

a. require an entity to fix contractual benefits at contract inception; and

b. prevent an entity from reducing those benefits over the whole term of the contract (although benefit enhancements might be allowed).

At the IASB Transition Resource Group for IFRS 17 Insurance Contracts (‘TRG’) May meeting, it was noted that, although such regulatory restrictions might prevent the entity from amending the benefits of an existing contract, in applying IFRS 17, the entity should assess whether those restrictions would affect existing contracts and new contracts to the same extent. If the entity can set the same price for the existing contract as it would for a new contract with the same characteristics issued on the same date, or it can reprice the existing contract to reflect overall changes in the risks in a portfolio, the entity’s practical ability to set a price that fully reflects the risks of the policyholders would not be constrained by such regulatory restrictions, and the cash flows after that point would not be within the boundary of the contract.

In the assessment of the contract boundary, should a regulator’s statutory right to veto changes in prices be considered?

Reference to standard: IFRS 17 paras 2, 34, BC 64

Background

In some jurisdictions, regulators might have a right to veto price increases by insurers. Consider the following example: a yearly renewable health insurance contract, where renewals are guaranteed without requiring the policyholder to be subject to an annual health assessment. On renewal, the premium rates will increase with the age of the policyholder (the rate table is fixed on inception). On an individual policyholder basis, the issuer does not have a right to reprice the contract, but it has a right to reassess the risks of the portfolio and to reprice premium rates for that portfolio. However, all changes in rates are subject to approval by the regulatory body in that jurisdiction. Historically, the regulators have not vetoed or disapproved any of the issuer’s attempt to reprice the premiums.

Question

Should an entity consider the regulator’s statutory right to veto in assessing the contract boundary when considering if it has the practical ability to reprice the risks in the context of determination of contract boundary?

Answer

Yes, rights and obligation under an insurance contract include those that arise from law and regulation. Therefore, the regulator’s right to veto any price increases should not be ignored.

However, there could be situations where, despite the regulatory veto rights, the issuer still has the practical ability to reprice the risks in accordance with IFRS 17. Factors to consider include the objective of such regulatory veto rights – for example, whether the regulator has introduced this veto right from a solvency perspective (for example, to protect the policyholders from bankruptcy of the insurer) or whether it is to meet the regulatory objective of regulating market prices. IFRS 17 notes that customary business practice should be considered, and the historical behaviour of the regulators might indicate that the regulatory constraint lacks commercial substance in accordance with IFRS 17.

Therefore, an entity needs to consider all facts and circumstances to determine whether regulatory veto rights on price increases by a regulator restrict the entity’s practical ability to reprice a contract.

What tax payments and receipts are included as cash flows within the contract boundary?

Reference to standard: IFRS 17 para B65

Income tax payments and receipts that an entity does not pay or receive in a fiduciary capacity are recognised and measured under IAS 12, and they are not included in the expected cash flows. In some territories, entities pay tax on behalf of policyholders, but these taxes meet the definition of an income tax and so are not included in the measurement of the insurance contract. Measurement requirements under IAS 12 and IFRS 17 are different. For example, IAS 12 does not require discounting, leading to benefits being measured on a present value basis, while related taxes are measured on undiscounted basis.

However, if taxes paid on behalf of policyholders are not measured under IAS 12, they will be within the scope of IFRS 17 and thus will be included in fulfilment cash flows when measuring insurance liabilities.

How should mutual entities consider what cash flows to include within the fulfilment cash flows?

Reference to standard: IFRS 17 paras B65, BC 265–BC 267

Often, mutual insurers have no shareholders. Insurance contracts provide policyholders with a share in returns of the mutual insurer that issues the insurance contract. As a result, the residual interest of such mutual insurers is due to current and future policyholders. In some situations, the fulfilment cash flows of a mutual insurer might include the rights of policyholders to the whole of any surplus of assets over liabilities. In this scenario, there might be no equity remaining and nil net comprehensive income reported in any accounting period.

Insurance contracts are measured using current estimates, except for accounting for the contractual service margin. Mutual insurers might elect to measure the majority of assets at fair value in accordance with other IFRSs, except for certain assets and liabilities, such as goodwill, deferred income tax and provisions. Accordingly, some accounting mismatches are likely between the value of assets and liabilities, due to different measurement bases.

The result of the accounting mismatches (that is, the difference between total assets and insurance liabilities) will be recognised as either liability or equity, depending on the legal form of the mutual insurer’s organisation and terms of its insurance contracts.

In addition, the IASB has issued educational material for mutual insurers, entitled ‘Insurance contracts issued by mutual entities’ that can be found on its website.

Premium- and other transaction-based taxes

Reference to standard: IFRS 17 para B123

Background

Under IFRS 17, transaction-based taxes (and levies) that arise under, or can be directly attributable to, existing insurance contracts are cash flows within the boundary of the contract. Similarly, paragraph B65(j) states that payments by an insurer in a fiduciary capacity to meet tax obligations incurred by a policyholder are cash flows within the contract boundary. Paragraph B65 does not distinguish between cash flows arising from transaction-based taxes collected on behalf of third parties and those that are not. Therefore, cash flows relating to transaction-based taxes within the boundary of a contract are fulfilment cash flows, irrespective of whether they are collected on behalf of third parties or paid as principal. The standard does not provide any further guidance on how to determine whether transaction-based taxes are collected on behalf of third parties (that is, where the insurer is acting as the agent) or whether they are being imposed on the insurer itself as principal. This distinction is important because, as noted in the definition of ‘revenue’ in IFRS 17, ‘transaction-based taxes collected on behalf of third parties’ should not be included in insurance revenue.

Question 1

How should an insurer determine whether transaction-based taxes (such as premium taxes, value added taxes, and goods and services taxes) are collected on behalf of third parties or whether the tax is imposed on the insurer as principal?

Answer

Judgement is required, based on the particular facts and circumstances, to determine whether the entity is the principal or the agent for the tax. Entities need to assess each tax, on a jurisdiction-by-jurisdiction basis, to conclude whether the tax is collected on behalf of third parties or whether the tax is imposed on the insurer as principal. The intention of the tax, as written into the tax legislation in the particular jurisdiction, should also be considered.

The name of the tax (for example, sales tax or excise tax) is not always determinative when assessing whether the entity is the principal or the agent for the tax. Whether or not the customer knows the amount of tax also does not necessarily impact the analysis. Management needs to look to the underlying characteristics of the tax, and the tax laws in the relevant jurisdiction, to determine whether the entity is primarily obligated to pay the tax or whether the tax is levied on the customer. This could be a significant undertaking for some entities, particularly those that operate in numerous jurisdictions with different tax regimes.

Some indicators that might be relevant in this analysis (which are given as examples rather than determinative criteria) include:

·        What happens if the customer does not pay the premium; is the entity still obligated to calculate and pay the transaction-based taxes? For example, sometimes the insurer issues a policy ‘on credit’ to a policyholder. If coverage is provided but the policyholder ultimately fails to pay the premium, and the insurer is not obligated to pay the premium taxes derived from the expected receipt, or it can claim a refund for any taxes already paid relating to the uncollectable premium, this is an indicator that the entity is acting as an agent. Conversely, if the entity is obligated to pay premium taxes irrespective of collection of premiums, this indicates that the taxes are imposed on the insurer.

·        Is there tax relief for the entity from other taxes based on the amount paid for transaction-based taxes? In some jurisdictions, the tax regulations are developed to impose a certain minimum level of taxes and assessments payable. In these jurisdictions, transaction-based taxes might be used as a credit or offset to other taxes or assessments payable, or vice versa. If the total tax payment to the authorities will be dependent on the premium taxes paid, it indicates that the taxes are imposed on the insurer. This should be distinguished from other situations, where cash settlements can be made on a net basis for different amounts owed to or due from the government for various types of tax.

·        Are there any differences in tax rates based on entity-specific characteristics? In some situations, the same insurance product, issued in the same jurisdiction, might be subject to different tax rates, depending on the characteristics of the issuer. For example, the same insurance coverage might be subject to a higher tax rate, based on the location of the insurer’s headquarters. This indicates that the nature of the tax is dependent on the issuer, and not the product, and indicates that it is imposed on the entity. On the other hand, it is not uncommon for different tax rates to apply to different products. This fact pattern is not sufficient to conclude that the tax is based on entity-specific characteristics.

Question 2

How should transaction-based taxes collected by the insurer on behalf of third parties be characterised and accounted for in the statement of financial position and in the statement of profit and loss?

Answer

Where the entity acts as an agent, the gross expected premiums from customers and the expected payments to the authorities would be included in fulfilment cash flows, and the taxes incurred would not be included either in revenue or as an expense.

These taxes, representing a cash flow directly related to the contract, would be included in the fulfilment cash flows as required by IFRS 17. Further, paragraph B65(j) requires payments of taxes (within the boundary) in a fiduciary capacity, to meet tax obligations incurred by the policyholders, to be included in the estimated cash flows.

Where the premium allocation approach (PAA) is applied, the term ‘premium receipts’ in paragraph B126 should be interpreted as excluding the element of receipts that represent the collection of ‘transaction-based taxes collected on behalf of third parties’, and there would correspondingly be no expense recorded for such pass-through payments to the taxing authorities on behalf of the policyholders.

Question 3

Can transaction-based taxes imposed on the insurer (that is, where the insurer is acting as principal) be considered ‘insurance acquisition cash flows’?

Answer

Yes. In determining the amount of insurance revenue related to insurance acquisition cash flows under IFRS 17, transaction-based taxes imposed on the insurer should be characterised as insurance acquisition cash flows. It follows that, under the general model, such transaction taxes would be recognised in a systematic manner over the coverage period of the contract, as are all other insurance acquisition cash flows, with a corresponding amount of revenue recognised in the same period as the expense. This characterisation is appropriate, because it treats all cash flows that arise from selling a contract consistently, and it avoids recording immediate revenue and expense for premium taxes paid at contract inception, which was the IASB’s rationale for accounting under paragraph B125, as explained in paragraphs BC 178 to BC 179. Under the PAA, this would also mean amortising such costs over the coverage period of the contract.

What costs can be included as acquisition cash flows under IFRS 17, and how are they recognised?

Reference to standard: IFRS 17 App A, paras BC 181–BC 183

Under IFRS 17, there is no separate asset recognised to defer acquisition cash flows. Rather, insurance acquisition cash flows decrease the contractual service margin and are thus implicitly deferred within the contractual service margin, and they are recognised as a decrease in revenue in future reporting periods as services are rendered. However, for presentation purposes, qualifying acquisition costs are amortised as an insurance service expense in a systematic way, with an equal amount recognised as insurance revenue.

The IASB decided not to distinguish between the following types of costs, all of which should be included in the measurement of insurance contracts, provided that they meet the definition of insurance acquisition cash flows:

(a) Successful and unsuccessful efforts

Costs of originating a portfolio of contracts include costs related to unsuccessful efforts to originate individual insurance contracts or a group of insurance contracts. The entity usually attempts to originate numerous contracts, and some of those attempts are generally not successful. Therefore, the costs of all attempts are necessary to originate a portfolio of successful contracts. It is generally expected that the types of costs qualifying as insurance acquisition cash flows and their impact on insurance liabilities will be comparable between entities, irrespective of the contracts acquisition models that an entity uses, such as an in-house sales department, working with third party intermediaries or direct response advertising.

(b) Direct costs and indirect costs that can be directly attributed to a portfolio of insurance contracts

Entities generally consider some indirect costs when pricing premiums, so exclusion of such costs would lead to overstatement of the contractual service margin. Insurance acquisition cash flows that are directly attributable to a portfolio level are included in the boundary of an insurance contract.

Can a commission that is paid in respect of an initially written contract be allocated to future ‘renewals’ of the contract that will be included in different groups of contracts under IFRS 17?

Reference to standard: IFRS 17 App A

No. This issue was discussed by the IASB Transition Resource Group for IFRS 17 Insurance Contracts (‘TRG’) in February 2018. Applying IFRS 17’s requirements, a commission that is paid unconditionally on the initially written contract cannot be allocated to future groups, and so it must be included in the measurement of the group to which the initially written contract belongs.

Insurance acquisition cash flows: can a non-refundable upfront commission be allocated to future insurance contracts?

Reference to standard: IFRS 17 App A

Question

How should a non-refundable commission (acquisition costs) be accounted for?

Background

An upfront commission of CU300 is paid to a broker for writing an insurance contract. The commission, once paid, is non-refundable. The contract is renewable annually at the option of the policyholder, but the insurer is able to reprice on renewal to fully reflect the risks; so the boundary of the contract, applying IFRS 17, is one year. The commission, in combination with other fulfilment cash outflows, is greater than the expected premiums for the one-year period. However, the entity expects a substantial number of renewals of the contract. These renewals are outside the boundary of the initially written contract. This issue was discussed by the IASB Transition Resource Group for IFRS 17 Insurance Contracts (‘TRG’) in February 2018.

Answer

Acquisition cash flows that are directly attributable to individual contracts should be included only in the measurement of the group to which the individual contracts belong, and not of other groups within the same portfolio.

The specified commission is paid on the initially written contract, and it is not refundable. Therefore, applying IFRS 17, it cannot be allocated to future contracts, and so the specified commission is included in the measurement of the group to which the initially issued contract belongs.

In this example, the initial group of insurance contracts is onerous at initial recognition; this is because, when allocating the acquisition cash flows to the initial group, the fulfilment cash outflows are greater than the cash inflows included in the contract boundary. Other renewed contracts in the same issue year will belong to a different group, because they will not be onerous. The renewed contracts in subsequent years belong to different groups, because those contracts are issued more than a year apart from the initial contracts.

Should insurance acquisition cash flows under both the general model and the VFA be amortised in each reporting period in a systematic way on the basis of the passage of time?

Reference to standard: IFRS 17 para B125

Yes. Insurance acquisition cash flows should be amortised in a systematic way, on the basis of the passage of time, under both the general model and the VFA. IFRS 17, which refers to allocating insurance acquisition cash flows to reporting periods in a systematic way on the basis of the passage of time, applies to all types of contracts, unless the entity has elected to use the premium allocation approach (PAA), in which case paragraph B126 applies.

Are insurance acquisition cash flows restricted to those which are incremental at the portfolio level?

Reference to standard: IFRS 17 para B66

Question

Are insurance acquisition cash flows restricted to those which are incremental at the portfolio level?

Answer

No. Insurance acquisition cash flows are defined in IFRS 17 as “cash flows arising from the costs of selling, underwriting and starting a group of insurance contracts, that are directly attributable to the portfolio of insurance contracts to which the group belongs”.

Unless the entity uses the practical expedient under the premium allocation approach (PAA), IFRS 17 requires entities to include an allocation of acquisition cash flows that are attributable to the portfolio to which an insurance contract belongs in the fulfilment cash flows of an insurance contract. Paragraph B65(l) is relevant for determining the types of acquisition cash flows that meet the criterion of being directly attributable. Paragraph B65(l) notes that fulfilment cash flows (which include acquisition costs) include an allocation of directly attributable fixed and variable overheads, allocated to groups of contracts using methods that are systematic and rational, and are consistently applied to all costs that have similar characteristics.

Cash flows arising from selling, underwriting and starting a group of insurance contracts incurred at a ‘higher level’ than the portfolio might meet the definition of acquisition cash flows, provided that they are ‘directly’ attributable to a portfolio. Judgement is required to determine which cash flows meet the definition of acquisition cash flows, both in assessing whether the cash flows arise from the costs of selling, underwriting and starting a group of insurance contracts and in assessing whether those cash flows are directly attributable to the portfolio of insurance contracts to which the group belongs.

Some expenses might relate to more than one identified portfolio of insurance contracts in the entity (for example, lease costs of a sales office that issues a variety of insurance contracts in different product lines). The lease costs of the sales office, to the extent that it is operating at normal capacity, would generally be considered an overhead cost that would be directly attributable to the issuance of contracts in different portfolios.

However, some expenses relate to the entity as a whole (for example, corporate brand advertising expenses). Although it is possible to allocate, in a systematic way, these costs to a portfolio, they would not be considered to be directly attributable to the issuance of particular policies.

Certain expenses might be incremental at the portfolio level, such as outsourced administrative activities (falling within IFRS 17), priced on a ‘per policy’ basis. Such costs are directly attributable to a portfolio but, since the cash flows are not ‘arising from the costs of selling, underwriting and starting a group of insurance contracts’, but are instead consequences of the sale, they would not meet the definition of an acquisition expense, even though they would not be incurred if the policy had not been sold.

How are market consistent measurement principles applied in the modelling of options and guarantees?

Reference to standard: IFRS 17 para B48

IFRS 17 requires stochastic modelling of financial options and guarantees (such as a guaranteed maturity value). Options and guarantees should be recognised and measured on a current, market consistent basis. All cash flows, including fixed, guaranteed and cash flows variable with underlying items, should be measured on a probability-weighted basis using market variables, where relevant, and considering all possible scenarios. The measurement of options and guarantees will, in many cases, involve stochastic modelling or using a deterministic model, run multiple times, to reflect a range of scenarios because of the non-symmetric distribution of outcomes for those features. A single deterministic approach might, for example, omit valuing the scenarios where the expected investment return is less than a guaranteed return. For certain simple options and guarantees, a formula (such as ‘Black-Scholes’) might exist which could be equivalent to stochastic modelling.

The most common methods for measuring financial options and guarantees on a market consistent, stochastic basis are the ‘risk neutral’ and ‘real world/deflator’ methods. In these methods, the financial options and guarantees are measured consistently with the cost of hedging the obligation (where observable) at the balance sheet date. This is achieved through the modelling of the interactions between cash flows that vary with underlying items and the discount rate for the contract as a whole. There are alternative ‘real world’ stochastic methods where, based on historical market averages, some asset classes (such as equity instruments and real estate) are assumed to outperform fixed-income asset classes. These ‘real world’ methods are not permitted under IFRS 17, because financial options and guarantees would not then be measured consistently with observable current market prices.

Can an asset-based discount rate be used?

Reference to standard: IFRS 17 para B75

IFRS 17 does not permit the use of an unadjusted asset-based discount rate if the asset returns do not affect the cash flows of the insurance contracts. However, depending on the characteristics of the liabilities, the assets held by the entity could be the starting point for determining a permissible discount rate.

Should a yield curve or single discount rate be applied?

Reference to standard: IFRS 17 para B75 Reference to standing text: 50A.95 Industry: Insurance

IFRS 17 does not specify whether an entity should use a yield curve or a single discount rate. The terms ‘yield curve’ and ‘discount rate’ are used interchangeably in IFRS 17. For some measurements, such as discounting of future cash flows, entities might need to use a yield curve; for others, such as accretion of interest on the contractual service margin using locked-in discount rates, entities are likely to use a single discount rate instead of a yield curve. Entities should ensure that the single discount rate or yield curve used for measurement fits the purpose of measurement and complies with the requirements of IFRS 17.

What is the impact of negative interest rates on the estimation of a discount rate?

Reference to standard: IFRS 17 para B84

In some economic environments, the interest rates for instruments with characteristics similar to those of the insurance contract might be negative. Our view is that the entity should nevertheless use those rates, even if this results in the present value of the payments exceeding the nominal amount. The use of a 0% floor is not appropriate.

Why is an explicit risk adjustment for nonfinancial risk included, and what should be considered in its estimation?

Reference to standard: IFRS 17 para B90

Incorporating an explicit risk adjustment into the measurement model is consistent with the pricing of insurance contracts. It also reduces the amount of what would otherwise be a larger contractual service margin.

IFRS 17 does not require entities to use any specific technique to estimate the risk adjustment. Examples of the techniques that entities might use include confidence level, conditional tail expectation and cost of capital. The significance of the challenge for entities to reliably and consistently measure the risk adjustment will vary by territory, depending on the experience in that territory and whether risk adjustment techniques are used for capital management or solvency requirements.

The time value of money is independent from the estimate of future cash flows, so the risk of changes in discount rates is not part of the risk adjustment. For example, reinvestment rates for long-term bonds to determine an appropriate discount rate for liabilities will not affect the amount of the risk adjustment.

What needs to be considered in calculating a risk adjustment?

Reference to standard: IFRS 17 para B90

The table below describes an insurance contract under a range of scenarios that reflect all possible outcomes. The table summarises information about net cash inflows and the probability of each scenario:

The expected probability-weighted future cash flows for the insurance contract are CU10,800. Two outcomes are possible, due to uncertainty that arises from insurance, lapse, persistency, expense and other non-financial risks associated with the contract.

An entity will require compensation for the uncertainty, if it has a choice between an insurance contract and a financial instrument (such as a deposit) that pays CU10,800 and has no uncertainty. The risk adjustment represents this compensation for non-financial risks arising from insurance contracts.

The expected probability-weighted outcome of this example amounts to CU10,800. However, in this example the risk adjustment will be lower, because less uncertainty is associated with this scenario – that is, the spread between the cash flows in the different outcomes is lower (CU10,000 and CU15,000), as opposed to (CU10,000, nil, CU5,000 and CU15,000 in the other example).

Example: calculating the contractual service margin at initial recognition

Reference to standard: IFRS 17 para 38

An entity issues an insurance contract which is the only contract in a group. The entity has paid acquisition costs of CU50 before the start of the coverage period, and the acquisition costs meet the definition of insurance acquisition cash flows. The total premiums are CU1,000, paid at the beginning of the coverage period. Total present value of expected cash outflows is CU545. The risk adjustment for non-financial risk on initial recognition equals CU90.

At the date when acquisition costs were paid, the entity should recognise prepaid acquisition costs of CU50.

At the beginning of the coverage period (insurance contract inception date), the entity should recognise the insurance contract as follows (debits are presented as positive amounts, and credits as negative):

Order of adjustments to the contractual service margin

Reference to standard: IFRS 17 para 44

Question

In what order should the adjustments to roll the contractual service margin (CSM) forward, from the opening to the closing position, be made?

Answer

Under IFRS 17, the adjustment to recognise the CSM in revenue, to reflect the transfer of services during the reporting period, should be made last, after all other adjustments. The order in which the other adjustments should be recognised is not specified, and so an entity can recognise these adjustments in any order. The order of the adjustments could affect the amount of the CSM recognised at the end of the reporting period.

How could the release pattern of the contractual service margin be calculated?

Reference to standard: IFRS 17 para B119

This example illustrates one of the possible interpretations of the requirements related to treatment of coverage units. Other interpretations of the requirements might also be acceptable.

The contractual service margin (CSM) at the end of the reporting period, after all adjustments other than release of the CSM to revenue, is CU1,000. At the end of the period, there are two contracts in force in a group. Presented below is the information about benefits and remaining coverage periods for those contracts:

The number of coverage units and the allocation of the CSM between current period and future periods could be calculated as follows:

How should groups of onerous contracts be measured?

Reference to standard: IFRS 17 paras 49, 50

An entity should maintain accounting records for the loss component of the liability for remaining coverage. Throughout the coverage period, the entity should allocate changes in the liability for remaining coverage and insurance finance expenses between the loss component and liability for remaining coverage excluding the loss components on a systematic basis. Applying a proportion, calculated as the ratio of the loss component to the present value of expected future cash outflows, is an acceptable example of a systematic allocation basis. Entities would be expected to apply a consistent allocation basis period-on-period. The amount of the change in the liability for remaining coverage allocated to the loss component represents a decrease in insurance service expenses during the period rather than insurance contract revenue.

An example of accounting for onerous contracts is presented in Illustrative Example 8 to IFRS 17.

When there is a reversal of losses in an onerous group of insurance contracts, should the contractual service margin (‘CSM’) that is re-established be amortised in the same period?

Reference to standard: IFRS 17 paras 44, 50

Yes.

IFRS 17 (for contracts under the VFA, para 45) notes that any changes in fulfilment cash flows that relate to future services should adjust the CSM, except to the extent that the decrease in fulfilment cash flows is allocated to the loss component of the liability for remaining coverage, applying paragraph 50(b). Paragraph 44(e) notes that the amortisation of the CSM is the final step when the CSM is adjusted, and the amount recognised as insurance revenue is determined by the allocation of the CSM “remaining at the end of the reporting period (before any allocation) over the current and remaining coverage period applying paragraph B119”. Therefore, to the extent that the re-establishment of the CSM results from the reversal of losses in the current period, a portion of the newly re-established CSM should be allocated to the current reporting period.

Can contracts of one year or less be grouped with those greater than one year in assessing eligibility for the PAA

Reference to standard: IFRS 17 para 53

Question

IFRS 17, is an entity permitted to perform the PAA eligibility test on a group of contracts that contains both contracts that (1) have coverage periods of one year or less in duration and (2) have coverage periods greater than one year in duration? If so, how would the test be applied?

Answer

Yes, for eligibility purposes, an entity is not prohibited from combining contracts with coverage periods that are one year or less with those that have coverage periods greater than one year. However, paragraph 53(b) of IFRS 17 is only applicable if the coverage period of ‘each contract’ in the group is one year or less. Therefore, if contracts in categories (1) and (2) are combined into one group, paragraph 53(b) is not applicable to that group; instead, the eligibility analysis must be performed under paragraph 53(a).

Alternatively, an entity can disaggregate a portfolio of contracts written in a single year into separate groupings for those in which (1) each contract within the group has a coverage period of one year or less and (2) each contract within the group has a coverage period greater than one year. The first group will be automatically eligible for the PAA under paragraph 53(b). For the second group, the entity should perform the eligibility assessment under paragraph 53(a).

What amounts are compared when performing the PAA eligibility analysis?

Reference to standard: IFRS 17 para 53

Question

What amounts need to be compared when performing the eligibility analysis under paragraph 53(a) of IFRS 17 to determine whether “the entity reasonably expects that such simplification would produce a measurement of the liability for remaining coverage for the group that would not dif er materially from the one that would be produced applying the requirements in paragraphs 32–52”?

Answer

The guidance specifically states that the comparison between the two approaches should consider only the “measurement of the liability for remaining coverage for the group”. Therefore, eligibility for the PAA is based on a comparison, at inception, made through consideration of a range of potential scenarios that can be reasonably expected to occur in each future reporting period, of the expected balance of the liability for remaining coverage under the PAA model versus the expected balance of the liability for remaining coverage under the general model. The liability for remaining coverage under the general model includes fulfilment cash flows and the contractual service margin.

Although the test itself is conducted only at inception, it is implicit that the test would need to consider what the liability for remaining coverage balances might reasonably be expected to be at each future reporting date, and whether the two balances would not materially differ at any of those reporting dates. The objective is to determine whether the PAA would produce a reasonable approximation of the general model over time.

When is a quantitative test needed to determine eligibility for the PAA?

Reference to standard: IFRS 17 para 53

Question

In performing the PAA eligibility analysis under paragraph 53(a) of IFRS 17 at inception of a group of contracts, and determining whether an entity ‘reasonably expects’ that the PAA would produce a measurement of the liability for remaining coverage (LFRC) for the group that would not differ materially from the one that would be produced applying the requirements in the general model, would a quantitative analysis be required in all situations? Or are there some situations where a qualitative test might be sufficient?

Answer

While the guidance does not explicitly state that a quantitative analysis is required or provide any specifics on the calculations, because one is comparing the difference in measurement between two balances, there is an inherent expectation that some estimation of those balances will be required. A number of factors might cause differences between the LFRC balances under the PAA and the general model, including:

·        Reasonably expected variability in expected future cash flows during the unexpired risk period, which will increase with the length of the coverage period.

·        The extent of reasonably expected changes in discount rates during the unexpired risk period.

·        The expected PAA revenue recognition pattern versus the combined results of the following:

o   the recognition pattern of the contractual service margin (CSM) under the general model;

o   the timing of release of the LFRC under the general model; and

o   the pattern of release of the risk adjustment under the general model.

Given the number of variables that impact the analysis, it would seem unlikely that a purely qualitative assessment would be sufficient to demonstrate eligibility under paragraph 53(a) in most instances.

However, there might be some limited circumstances where a qualitative assessment might satisfy the quantitative ‘not materially different’ requirement; in effect, where the quantitative analysis is obvious. For example, this might be the case with very short-tail business, in very stable interest-rate environments, where the time value of money could be expected to have an immaterial impact, and, in addition, where it is a predictable type of coverage (high-frequency, low-value insurance) in which claims are not expected to change much in the short term and are expected to have a relatively straight-line pattern of claims, along with an even pattern of risk expiration. In these limited instances, an entity might reach its conclusions about PAA eligibility for a group of contracts by evaluating its adherence to the above or similar characteristics of the class of contracts to which it belongs. These conclusions and the supporting rationale should be clearly documented.

We believe that a quantitative test might not be required for each group of contracts that incepts within each reporting period if the entity has already performed quantitative calculations for groups of contracts within a portfolio that have substantially the same characteristics and measurement factors (for example, discount rates, timing of claims) and where the entity can assert that those measurement factors have not changed since that initial quantitative assessment. For example, an entity might have done a quantitative assessment for a group of two-year motor contracts that incepted on 1 January of the current year and determined that the group was eligible for the PAA. Throughout the remainder of the year, the entity might write additional two-year motor contracts and, after determining that the measurement factors have not changed since that prior quantitative assessment, make a qualitative assessment that its prior judgement is appropriate.

How should ‘reasonably expects’ be interpreted in determining eligibility for the PAA?

Reference to standard: IFRS 17 para 53 Reference to standing text: 50A.125 Industry: Insurance

Question

In performing the PAA eligibility analysis under paragraph 53(a), how should ‘reasonably expects’ be interpreted?

Answer

IFRS 17 notes that the PAA can be applied where “at the inception of the group the entity reasonably expects that such simplification would produce a measurement of the liability for remaining coverage for the group that would not differ materially from the one that would be produced applying the requirements in paragraphs 32–52”.

Although the test itself is conducted only at inception, it is implicit in paragraph 53(a) that the test would need to consider what the liability for remaining coverage balances might reasonably be expected to be at each future reporting date, and whether the two balances would not materially differ at any of those reporting dates. The standard does not define what is meant by ‘reasonably expects’, and judgement will be required in making this determination. Therefore, we believe that, at inception of a group of contracts, entities will need to consider a range of potential scenarios that they believe can be reasonably expected to occur in each future reporting period within the coverage period, and compare the liability for remaining coverage (LFRC) using the general model and the LFRC using the PAA.

If the expected balance of the LFRC under the PAA model, compared to the expected balance of the LFRC under the general model, is within the insurer’s quantitative thresholds under all reasonably expected scenarios, the PAA approach can be used. Where one or more scenarios differ materially from the reasonably expected result under the general model, the general model should be used.

As noted, in some limited circumstances, where the quantitative analysis is obvious, the running of scenarios might not be required.

What contracts could be eligible for the PAA?

Reference to standard: IFRS 17 para 53, 54

It is expected that, where the eligibility criteria are met, many entities issuing general insurance contracts will apply the PAA to account for their liabilities for remaining coverage, because it avoids the need to calculate the contractual service margin and it is broadly similar to previous approaches for unexpired risk (liabilities for remaining coverage) by recognising an unearned premium liability. Insurance contracts with a coverage period of one year or less are automatically eligible for the PAA. Many contracts with a coverage period of more than one year will not be eligible for the PAA. Entities should consider the following questions for the eligibility assessment, at initial recognition of groups, for using the PAA:

·        Does the entity underwrite insurance contracts with the coverage period longer than one year?

·        How should ‘would not materially differ’ be interpreted?

·        How do differences in measurement, resulting from differences in the consideration of discounting for the liability for remaining coverage in the general model and in the PAA, affect eligibility?

·        How do different patterns of release of the liability for the remaining coverage to revenue under the general model and the PAA affect eligibility?

·        Which cash flows are considered for the general model and are not considered for the PAA, and how does this impact the eligibility?

Comparison of the liability measurement under the general model and the PAA

Reference to standard: IFRS 17 para 53, 54 Reference to standing text: 50A.126 Industry: Insurance

The diagram below compares the major building blocks in the general measurement model with the PAA (both with and without the discounting of incurred claims):

* NB – The third column would represent contracts that meet the definition to apply the PAA, but where settlement of incurred claims occurs quickly and therefore the impact of discounting would be trivial.

Is the premium due to an insurer within the scope of IFRS 17 or IFRS 9?

Reference to standard: IFRS 17 para 55

Question

Is the premium due to an insurer within the scope of IFRS 17 or IFRS 9 in the following scenarios?

Background

A policyholder has remitted premiums due under an insurance contract to an intermediary. The intermediary has not yet remitted the premiums to the insurer.

Scenario 1 – The intermediary is acting on behalf of the policyholder In the event of default by the intermediary, the insurer can either enforce payment of the premium by the policyholder or cancel the insurance contract.

Answer

IFRS 17 applies. The premium receivable has arisen from an insurance contract, so it should be accounted for in accordance with IFRS 17. That is, the premium receivable is still due from the policyholder (or, in this case, from the intermediary, who is acting as the policyholder’s agent), and therefore represents a fulfilment cash flow not yet received.

Scenario 2 – The intermediary is acting on behalf of the insurer In the event of default by the intermediary, the insurer is still obliged to fulfil its obligations to the policyholder under the insurance contract.

Answer

IFRS 9 applies. The entity has a receivable from the intermediary. The payment of the premium by the policyholder to the intermediary discharges the insurer’s right to payment from the policyholder under the insurance contract (since the insurer is now unconditionally obliged to fulfil its contractual obligations to the policyholder). The right to receive premiums from the intermediary is a separate right not arising under an insurance contract, and so it is included in the scope of IFRS 9. That is, on payment by the policyholder to the intermediary, expected fulfilment cash inflows should be reduced by the insurer and a separate receivable from the intermediary should be established. Unlike Scenario 1, in Scenario 2 the intermediary is acting as the agent for the insurer, and not as the agent for the policyholder. Therefore, the policyholder has effectively paid the premium to the insurer (albeit, the insurer has chosen to accept payment to its agent, the intermediary, which results in the establishment of an IFRS 9 receivable from the agent).

Can an entity accrete interest for contracts where the gap between premium receipt and provision of coverage is not more than a year?

Reference to standard: IFRS 17 para 56

For contracts where the time between provision of services and the related premium due date is less than a year, an entity can voluntarily accrete interest at the rate determined at inception as an accounting policy choice, even though it is not required to do so under IFRS 17. Some entities might choose to accrete interest on all contracts, to ensure consistent treatment. The accounting policy choice should be applied consistently to all similar transactions.

What pattern of revenue should be used when applying the PAA for hurricane insurance?

Reference to standard: IFRS 17 para B126

The expected pattern of release of risk is usually not linear for an annual policy with coverage against damage from hurricanes. The probability of damage caused by hurricanes is significantly higher during the hurricane season. The pattern of revenue recognition for such insurance coverage should reflect the fact that the risk of incurring a claim is significantly higher in the hurricane season and lower throughout the rest of the year. The difference in risk throughout the policy coverage period is likely to be captured using the expected pattern of incurred claims as a proxy of the risk release pattern. Insurance services expense from acquisition cash flows for these contracts can be recognised on the same basis as revenue.

What pattern of revenue should be used when applying the PAA for an excess loss reinsurance contract?

Reference to standard: IFRS 17 para B126

The following diagram demonstrates an example of the pattern of release of risk for an excess loss reinsurance contract issued by a reinsurer with a coverage period of one year where loss limits are triggered.

Generally, risks under such contracts are released throughout the year, even though claims reimbursements might be expected towards the end of the year when the excess loss point is reached. IFRS 17 requires the revenue recognition pattern to be based on the passage of time if the pattern of release of risk is not significantly different from the passage of time. Because, in this example, the pattern of release of risk from the underlying contract is not significantly different from the passage of time, the pattern of revenue recognition for such contract should also be based on the passage of time.

When allocating premium revenue under the PAA based on the expected timing of incurred insurance service expenses, what types of expenses are considered ‘incurred insurance service expenses’?

Reference to standard: IFRS 17 para B126

‘Incurred insurance service expenses’ are not explicitly defined in IFRS 17. However, paragraph BC 290 of the Basis for Conclusions to IFRS 17 clarifies the requirement in paragraph B126. Where the release from risk differs from the passage of time, paragraph BC 290 notes that the allocation of the liability for remaining coverage should be recognised based on the expected timing of incurred claims and benefits. Therefore, the basis of allocation should not consider amortisable acquisition costs. That is, acquisition costs are capitalised and amortised rather than being expensed as incurred, and so they are not ‘incurred insurance service expenses’.

Should insurance acquisition cash flows be allocated in the same pattern as insurance revenue, or are entities required to allocate insurance acquisition cash flows in a systematic way based on the passage of time?

Reference to standard: IFRS 17 para B125

Under the premium allocation approach (PAA), entities are permitted to allocate insurance acquisition cash flows to revenue in the same pattern as insurance revenue. Unless the practical expedient in IFRS 17 – of expensing the costs when incurred – is applied, payments of insurance acquisition cash flows reduce the liability for remaining coverage, whilst the later amortisation of these cash flows increases the liability for remaining coverage. IFRS 17, which refers to allocating insurance acquisition expenses in a systematic way on the basis of the passage of time, applies to all types of contracts, unless the entity has elected to use the PAA, in which case paragraph B126 applies.

Presentation of insurance service expenses under the PAA

Reference to standard: IFRS 17 para B125

Question

Where an entity applies the PAA, is it required to identify which cash flows meet the definition of fulfilment cash flows in presenting the insurance service result?

Answer

Yes, irrespective of the measurement model, the requirements within IFRS 17 for the presentation of the insurance service result are applicable for all contracts within the scope of the standard. The PAA is a simplification of the measurement of the liability for remaining coverage under the general measurement model, and so the presentation of insurance service expenses should be consistent between the two measurement models. Entities are required to identify cash flows that do not meet the definition of a fulfilment cash flow, and to exclude these cash flows from the presentation of the insurance service result.

How should onerous contracts be measured under the PAA?

Reference to standard: IFRS 17 para B125

Requirements for the measurement of the liability of the remaining coverage for onerous contracts under the PAA are similar to the requirements for the general model. For example, entities are required to calculate fulfilment cash flows using the general model if insurance contracts are onerous.

Entities applying the PAA and not having onerous contracts do not have to measure the liability for remaining coverage using the general model. However, they should ensure that their accounting systems are ready to use the general model if a group of contracts is or becomes onerous.

When are acquisition costs excluded from the onerous contract assessment when applying the PAA?

Reference to standard: IFRS 17 para B125

Question

In applying the PAA, should acquisition costs be excluded from the onerous contract assessment and measurement of the onerous loss if, at initial recognition, the entity has made an accounting policy choice to expense these costs? Subsequently, would acquisition costs that are expected to be incurred in the future be included in the onerous contract assessment and in the measurement of the loss component?

Answer

Yes, acquisition costs that were expensed when an entity applied the accounting policy choice, in accordance with IFRS 17, should be excluded from the onerous contract assessment at initial recognition. However, acquisition costs that are expected to be incurred during the coverage period will need to be included in the determination of the loss component on onerous contracts.

IFRS 17 allows entities applying the PAA to make an accounting policy choice to expense acquisition costs immediately, instead of including these costs in the measurement of the liability for remaining coverage at initial recognition. An entity is required to perform an onerous contract assessment if there are facts and circumstances that indicate that a group of contracts is onerous at initial recognition [IFRS 17 para 18] or subsequent to issuance. [IFRS 17 para 57]. At initial recognition, an entity measures the liability for remaining coverage under the PAA (applying para 55(a)(ii) of IFRS 17) as premiums received “minus any insurance acquisition cash flows at that date, unless the entity chooses to recognise the payments as an expense applying paragraph 59(a)”. Therefore, where an entity applies the accounting policy choice and expenses acquisition costs immediately on initial recognition, it would exclude those acquisition costs from the measurement of the liability for remaining coverage, both when determining if a contract is onerous at initial recognition and in measuring the amount of any resulting loss.

On subsequent measurement, acquisition costs that are expected to be incurred (for example, for renewals that are within the contract boundary) will need to be included in the onerous contract assessment, even if the entity has taken an accounting policy choice to expense them. In accordance with paragraph 57 of IFRS 17, the loss component will be determined as the difference between the carrying amount of the liability for remaining coverage and the fulfilment cash flows for the group, which will include future acquisition cash flows.

How should changes in the loss component for an onerous contract accounted for under the PAA be treated?

Reference to standard: IFRS 17 paras 57(b), 58

Background

When contracts measured under the PAA are onerous at initial recognition or become onerous subsequently, IFRS 17 requires a loss to be recognised, with a corresponding increase in the liability for remaining coverage (LFRC), which is consistent with the requirement to increase the liability for remaining coverage under the general model. However, IFRS 17 is silent on the reversal of the loss component.

Question

Should an increase in the LFRC affecting the loss component be reversed in subsequent periods?

Answer

Yes. To the extent that the entity has previously recognised a loss in profit or loss for a group of contracts in accordance with paragraph 58 of IFRS 17, and facts and circumstances indicate that the carrying amount of the LFRC subsequently exceeds the amount described in paragraph 57(b) of IFRS 17 for that group of contracts, an entity should recognise this change in the LFRC in subsequent periods, either positive or negative, in profit and loss.

How to determine the risk adjustment for participating contracts where the entity/shareholders and policyholders share in the profits from a group of contracts

Reference to standard: IFRS 17 paras 37, BC67–BC71

Question

Should the risk adjustment for participating contracts, where the entity/shareholders and policyholders share profits from the contracts, reflect non-financial risks on 100% of the expected future fulfilment cash flows?

Background

IFRS 17 requires an entity to adjust its estimates of the present value +of the expected future cash flows to reflect the compensation that the entity requires for bearing the uncertainty about the amount and timing of the cash flows that arises from non-financial risk. In order to do this, the entity must assess the non-financial risk that it bears. IFRS 17 provides guidance for contracts with cash flows that affect or are affected by cash flows to other policyholders or contracts.

IFRS 17 does not prescribe how the risk adjustment should be calculated for participating contracts where the entity/shareholders and policyholders share in the results from the underlying items (for example, 90:10 funds where the entity/shareholders receive 10% of the interest in the underlying items and the other 90% is shared with policyholders).

In July 2018 the IASB issued educational material for mutual entities where it determined that: “Although the policyholders with a residual interest as a whole bear the pooled risk collectively, the mutual as a separate entity, has accepted risk from each individual policyholder. The risk adjustment for contracts with policyholders that have residual interests in a mutual entity reflects the compensation the mutual entity requires for bearing the uncertainty from the non-financial risk in those contracts.”

Answer

No.

The risk adjustment for non-financial risk is the compensation that the 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 the insurance contract.

For mutual entities, there are no other parties to take on the risk, and so 100% of the non-financial risk is borne by the mutual entity. This is different from a participating contract in a shareholder entity, where the entity/shareholders and policyholders share in the results from the underlying items. However, the entity’s/shareholders’ compensation should not be limited to its share in the underlying items (that is, 10% in the example above) if it is also exposed to ‘burn-through’ risk on the policyholders’ share – that is, the risk beyond the 10% absorbed by the entity/shareholders relating to insufficient funds to honour guarantees for the 90% policyholder share.

The risk adjustment should reflect the non-financial risks on the proportion (10%) of the cash flows to which the entity/shareholders are exposed, as well as an additional amount for the ‘burn-through risk’ – that is, the risk of the shareholders being exposed to more than 10% of losses if adverse experience occurs.

How should ‘contractual’ rights and obligations be interpreted and applied?

Reference to standard: IFRS 17 para BC69

As discussed in the Basis for Conclusions to IFRS 17, the standard explains that contracts can be written, oral or implied by an entity’s business practices. An entity is also required to consider all substantive rights and obligations, whether they arise from contract, law or regulation. Thus, when referring to contractual terms, the effects of law and regulation are also considered.

In many cases, there might be no established legal practice or principals related to an entity’s obligations. In such situations, the entity might need to exercise significant judgement to conclude whether an insurance contract has direct participation features.

What are some example terms that could meet the requirement for ‘a share’ of a clearly identified pool of underlying items?

Reference to standard: IFRS 17 para BC69

A direct participating contract should clearly identify a pool of underlying items, and how returns are shared between the entity and the policyholder. The following terms, to share returns between policyholder and shareholder, are generally expected to meet the requirement for ‘a share’:

·        Policyholder shares only in gains but not in losses from the underlying items; otherwise, the entity has full discretion over the amount of gains that it shares with the policyholder.

·        Amount of benefits cannot reduce the amount of invested premiums; otherwise, the entity has full discretion over the amount of gains that it shares with the policyholder.

·        Participation share is defined in regulation and not directly in the contract.

In addition to the assessment of whether the contractual terms specify that the policyholder participates in a share of a clearly identified pool of underlying items, entities should also ensure that the other criteria for classification as a direct participating contract are met. Therefore, where entities have significant contractual discretion over the future payments, they should also assess whether a substantial share of the fair value returns on the underlying items is expected to be paid, and whether a substantial proportion of any change in the amounts to be paid to the policyholder is expected to vary with the change in fair value of the underlying items.

Level for assessing variability in the VFA eligibility test

Reference to standard: IFRS 17 para B107

Background

Insurance contracts with direct participation features are defined in paragraph B101 of IFRS 17. Paragraph B101 requires the entity to assess whether it expects to pay a substantial share of fair value returns to ‘the policyholder’, and whether a substantial proportion of changes in amounts paid to ‘the policyholder’ are expected to vary with changes in the fair value of the underlying items. Paragraph B107(b)(i) of IFRS 17 clarifies how to assess the variability, and it notes that the variability should be assessed “over the duration of the group of insurance contracts”.

Many participating contracts have terms under which the cash flows affect, or could be affected by, cash flows from other contracts (including future contracts). For example, a contract might currently credit to a particular group of policyholders the amortised cost return of an identified pool of invested assets and, over time, it would ultimately pay a substantial share of the fair value returns on those underlying items to current or future policyholders in the same or other groups. Some have questioned whether the ‘group’ level requirement in paragraph B107(b)(i) of IFRS 17 implies that changes in fair value of the underlying items must be allocated at the group level in order to qualify for the variable fee approach (VFA), which would be contrary to the mutualisation concept inherent in participating contracts.

Questions

How should the requirement in paragraph B107(b) of IFRS 17 to assess variability in amounts ‘over the duration of the group of insurance contracts’ be interpreted when analysing the eligibility of a contract for the VFA?

Specifically:

Question 1:

Does paragraph B107(b) of IFRS 17 require the analysis of the paragraph B101 criteria to be done at the group level (or could this be done at a broader level)?

Question 2:

Can a contract qualify for the VFA if it currently credits, to a particular group of policyholders, the amortised cost return of an identified pool of invested assets and, over time, it will ultimately pay a substantial share of the fair value returns on those underlying items to current or future policyholders in the same or other groups?

Answers

Answer 1: No, the standard does not require the paragraph B101 analysis to be performed at the ‘group of insurance contracts’ level. Paragraph B103 of IFRS 17 clarifies that, when performing the assessment in paragraph B101 (and, by extension, para B107 which refers back to para B101), “an entity shall assess whether the conditions in paragraph B101 are met by considering the cash flows that the entity expects to pay the policyholders determined applying paragraphs B68–B70”. Paragraph B68 notes that “the fulfilment cash flows for a group … include payments arising from the terms of existing contracts to policyholders of contracts in other groups, regardless of whether those payments are expected to be made to current or future policyholders”. Therefore, when performing the paragraph B101 analysis, the criteria should be applied at the level at which the contract specifies that returns on underlying items are shared, which might include sharing with policyholders of contracts in other groups, including both current and future policyholders.

Answer 2: Yes, a contract that provides a return to current policyholders based on amortised cost but, over the life of the underlying items, is expected to pay the entire fair value return to the current group of policyholders or policyholders in other groups (including future policyholders) can qualify for the VFA. Consistent with the answer to Question 1, when performing the paragraph B101 analysis, the criteria should be applied at the level at which the contract specifies that returns on underlying items are shared, which might include sharing with policyholders of contracts in other groups, including both current and future policyholders.

What are the differences between the measurement of the CSM using the general model and the requirements for contracts with direct participation features?

Reference to standard: IFRS 17 paras 45, B113, B114

The diagram below summarises the differences between the measurement of the contractual service margin (CSM) using the general model and the requirements for contracts with direct participation features:

* No explicit adjustment is required for each component; there might be just one adjustment for all components to the CSM.

** No effect on measurement of assets/ liabilities from insurance contracts in general model.

*** Under the variable fee approach (VFA), adjustments to the CSM use current discount rates; under the general model, they use discount rates locked in at inception of a group of insurance contracts.

When would it be considered that credit risk dominates the economic offset?

Reference to standard: IFRS 17 para B116

This example demonstrates criterion (c) of paragraph B116 of IFRS 17 for using an exception to the general requirements of the variable fee approach for risk mitigating activities.

An entity manages the risk of changes in interest rates (financial risk) for a portfolio of contracts with direct participation features with a derivative instrument. The parties do not provide any collateral to secure payments on the derivative instrument. If there is a significant increase in credit risk of the counterparty to that derivative in the future, the effect of the changes in the counterparty’s credit risk might outweigh the effect of other changes in financial risk on the fair value of the derivative, whereas changes in the value of the portfolio of contracts with direct participation features depend on these other changes in financial risk. In such a situation, there might be little to no offset of gains and losses from the derivative and the portfolio of contracts with direct participation features. The exception to the general requirements for accounting for the contractual service margin of contracts with direct participation features cannot be used.

How can economic hedging and risk mitigation techniques be presented in the financial statements?

Reference to standard: IFRS 17 para B116

Entities using economic hedging and risk mitigation techniques usually want to present information about this in the financial statements in a way that reflects management practices. IFRS currently has two solutions to achieve this: the risk mitigation exception in IFRS 17 for insurance liabilities measured under the variable fee approach; and hedge accounting in IFRS 9. However, it is likely that entities might not be able to reflect all economic risk mitigation in the financial statements in line with the risk management practices. An example of such a situation is the macroeconomic management of economic risks. The measurement exception under the risk mitigation exception in IFRS 17 applies only to contracts measured under the variable fee approach, and it does not apply to the contracts to which the general model applies. Entities might choose to use non-GAAP measures in such situations, to explain risk management practices to the users of the financial statements, in common with entities in other industries.

What would be an example of mutualisation?

Reference to standard: IFRS 17 para B67

An entity issues participating contracts to two policyholders that share in the same pool of underlying items. The terms of the contracts are the same, except for the minimum return guarantee which is 5% for policyholder 1 and 2% for policyholder 2. The actual return from the underlying items is 4%. For policyholder 1, the actual return from the underlying items of 4% is below the minimum return guarantee of 5%. For policyholder 2, the actual return from the underlying items of 4% is above the minimum return guarantee of 2%. Based on the contractual terms for both policyholders, policyholder 1 receives 5% (minimum return guarantee), and policyholder 2 receives the residual return of 3% (4% less 1% additional return paid to policyholder 1). The entity pays out only the returns generated from the underlying items to both policyholders, and it does not pay the difference between the actual returns from the underlying items and the minimum return guarantee to policyholder 1.

The entity would have to contribute its own funds to make payments to the policyholders only if returns from the assets are not sufficient to pay the minimum return guarantee to both policyholders. For example, when the actual returns from the underlying items are 2%, the entity will have to make payments to policyholder 1 for the difference between the minimum return guarantee of 5% and the actual return from the underlying items of 2%. Policyholder 2 in this case cannot absorb additional losses, because the minimum return guarantee is the same as the actual returns from the underlying items.

At what level should contracts with mutualisation be aggregated?

Reference to standard: IFRS 17 para BC 138

As discussed in the Basis for Conclusions to IFRS 17, there are no exceptions to the level of aggregation requirements for contracts with mutualisation. Such contracts should be disaggregated in different groups, so that there are no contracts issued more than one year apart in one group (annual cohorts). However, entities can avoid disaggregation of portfolios into annual cohorts if there is no difference in the measurement of insurance contracts when they are disaggregated into annual cohorts and when they are not disaggregated.

It is expected that, in many circumstances, disaggregation of portfolios into annual cohorts will result in different measurement outcomes; however, there could be circumstances where there will be no difference, such as contracts which participate 100% in returns of the company and thus have no contractual service margin.

Determining the initial recognition date and annual cohort for contracts that provide retrospective cover

Reference to standard: IFRS 17 App, para 62(b)

Background

Some reinsurance contracts held might assume risks that relate to a period before the reinsurance contract is agreed. For example, an entity’s financial year end closes on 31 December. On 1 March 20X1, the entity signed a reinsurance contract held that provides excess of loss coverage. This contract assumes risks starting from 1 August 20X0 to a future date. The entity does not have any other reinsurance contracts held on 1 March 20X1, and so the entity identifies the group of reinsurance contracts held as the above single contract.

Question

Is the date of initial recognition of the reinsurance contract held 1 March 20X1?

Answer

Yes. The initial recognition date is 1 March 20X1 and, assuming that the entity divides its group of contracts based on calendar year, this contract is allocated to the 20X1 Cohort.

IFRS 17 specifies that an entity should recognise a group of reinsurance contracts held that does not provide proportionate coverage at the beginning of the coverage period.

Coverage period is defined in Appendix A to IFRS 17 as the period during which the entity provides coverage for insured events. The fact that the reinsurance contract held covers risks arising from underlying insurance contracts written from 1 August 20X0 onwards does not mean that the coverage period for the reinsurance contract held is earlier than the existence of the reinsurance contract (that is, the signing date of 1 March 20X1).

This reinsurance contract includes both retrospective cover and prospective insurance cover. IFRS 17 notes that the insured event for a contract that provides retrospective coverage is the determination of the ultimate cost of the claim, which will happen only after 1 March 20X1. Accordingly, the coverage period during which coverage for insured events is provided starts from the existence of the reinsurance contract. Hence, the beginning of the coverage period is 1 March 20X1.

Since the date of issue of this reinsurance contract held is the date of initial recognition (1 March 20X1), it follows that this group of contracts should be allotted to the 20X1 Cohort.

Where could differences arise between insurance and associated reinsurance contracts, and what mismatches could this create in the income statement?

Reference to standard: IFRS 17 paras 29(b), 60

The IASB regards reinsurance contracts held as being separate from the underlying insurance contracts for recognition, measurement, presentation and disclosure. Under IFRS 17, the matching of gains and losses from underlying insurance contracts and reinsurance contracts held will not always be possible. The following requirements for reinsurance contracts held could cause mismatches in the income statement:

·        Reinsurance contracts held cannot meet the definition of an insurance contract with direct participation features, so they are measured using either the general model or the premium allocation approach (PAA), while the underlying insurance contracts with direct participation features are measured using the variable fee approach.

·        Some reinsurance contracts might not be eligible for the PAA, while the underlying contracts might be eligible due to the different coverage periods.

·        Day 1 gains and costs are deferred for reinsurance contracts held (unless the coverage relates to past events), while only day 1 gains are deferred for the underlying insurance contracts, and day 1 losses are recognised immediately in profit or loss.

·        The period for release of the contractual service margin for underlying insurance contracts, and of the negative or positive contractual service margin relating to the day 1 costs or gain for reinsurance contracts held, might be different due to the different coverage periods.

How do you assess the coverage period of reinsurance contracts?

Reference to standard: IFRS 17 para 34

Some reinsurance contracts cover underlying direct business that begins during a one-year coverage period of the reinsurance contract (risk-attaching reinsurance contracts). Because of this feature, the coverage period of these reinsurance contracts can effectively be more than one year.

For example, a reinsurance contract covers risks from all underlying direct motor insurance contracts signed during a calendar year. The coverage period of each underlying direct motor insurance contract is one year. However, the reinsurance contract will provide cover for claims that arise within two years, because it covers the claims during the coverage period of one year on underlying direct contracts written in the year. The coverage period of the reinsurance contract ends when the coverage periods of all underlying contracts are expected to end.

How does the existence of an open-ended contractual termination clause affect the contract boundary?

Reference to standard: IFRS 17 para 34

Question

Will the contract boundary for a reinsurance contract held be affected by the existence of an open-ended contractual termination clause?

Illustration

An insurance company purchases a proportional reinsurance contract, which contains the following clauses:

·        X% proportional coverage for all risks.

·        All underlying contracts written in the period from 1 January 20X1 to 31 December 20X1 are covered.

·        The reinsurer and the insurance company issuing the underlying contracts each have the right to unilaterally terminate the contract with regard to accepting new policies issued by the insurance company on 90 days’ written notice.

Answer

Yes. The termination clause will have an impact on the determination of the boundary of the reinsurance contract. Under IFRS 17, cash flows are within the boundary of the contract if they arise from rights and obligations where the issuer can compel the policyholder to pay the premium or where the issuer has a substantive obligation to provide a service to the entity. The substantive obligation to provide services ends when the entity has the practical ability to reassess the risk and set a premium that fully reflects this risk. In this case, the reinsurance company (issuer of the contract) has the practical ability to reassess the risk by terminating the contract with regard to accepting new policies issued by the insurance company on 90 days’ notice. Consequently, cash flows that are within the boundary of the reinsurance contract on day 0 are restricted to those relating to reinsurance of underlying contracts written from 1 January 20X1 to 31 March 20X1.

Cash flows arising from underlying contracts issued on 1 April 20X1 would not be included in this contract but, in accordance with IFRS 17, would belong to a new contract. This new contract would not be recognised until the criteria in IFRS 17 are met. IFRS 17 allows entities to group contracts issued within one year together and, as such, the different reinsurance contracts held established in this scenario could be grouped together, provided that they meet the criteria set out in IFRS 17 (as modified for reinsurance contracts held by IFRS 17).

A similar example was discussed at the IASB Transition Resource Group for IFRS 17 Insurance Contracts (‘TRG’) September 2018 meeting, where it was also noted that IFRS 17 would not apply to this fact pattern. That is, there is no reassessment and extension of the original 90-day accounting contract, because it applies only where there are matters considered related to determination of the original contract boundary that have since changed (such as a change in facts and circumstances relating to pricing constraints).

Is the discount rate in a reinsurance contract held required to be identical to the discount rate applied in the underlying ceded contracts that have been reinsured?

Reference to standard: IFRS 17 para 34

No. This question was raised in a submission to the IASB Transition Resource Group for IFRS 17 Insurance Contracts (‘TRG’) and noted as another question in February 2018. IFRS 17 requires an entity to use consistent assumptions to measure the estimates of the present value of the future cash flows for the group of reinsurance contracts held and the estimates of the present value of the future cash flows for the group(s) of underlying insurance contracts (ceded contracts). This requirement does not require the entity to use identical discount rates for measuring the reinsurance contract held and the ceded contracts. The extent of the dependency between the cash flows of the reinsurance contract held and the ceded contracts should be evaluated in applying IFRS 17. Thus, the discount rate applied in the measurement of the reinsurance contract held should meet the criteria set out in IFRS 17. If, for example, the liquidity characteristics of the ceded contracts are not the same as the reinsurance contract held, the discount rates applied in the measurement of the ceded contracts and the reinsurance contract would be different.

How is the boundary of a reinsurance contract held determined?

Reference to standard: IFRS 17 para 4

This issue was discussed by the IASB Transition Resource Group for IFRS 17 Insurance Contracts (‘TRG’) in February 2018. The application of IFRS 17’s contract boundary requirements to reinsurance contracts held means that cash flows within the boundary of the contract arise from the substantive rights and obligations of the holder of the contract (for example, the substantive rights to receive services from the reinsurer and the substantive obligation to pay amounts to the reinsurer).

A substantive right to receive services from the reinsurer ends either when the reinsurer can reprice the contract to fully reflect the reinsured risk or when the reinsurer has a substantive right to terminate coverage.

In responding to a TRG submission (S75) in agenda paper 11 for the September 2018 TRG meeting, the IASB staff confirmed that a symmetrical treatment of the contract boundary would be expected from the perspective of the cedant and the reinsurer, noting:

“The contract boundary is the same from each perspective because:

·        when the cedant has a right to receive services, the reinsurer has an obligation to provide services; and

·        when the cedant has an obligation to pay premiums, the reinsurer has a right to compel premiums.

Determination of coverage units for reinsurance contracts held

Reference to standard: IFRS 17 paras 66(e), B119

Question

For reinsurance contracts held, are the coverage units determined based on the services provided by the reinsurer, or should a ‘look-through’ approach based on the coverage units of the underlying insurance contracts be used?

Answer

As noted in the May 2018 IASB Transition Resource Group for IFRS 17 Insurance Contracts (‘TRG’) paper describing other issues submitted (issue #S41 in the submissions log), according to IFRS 17, the coverage units for a group of reinsurance contracts held are determined based on the quantity of coverage provided by the reinsurance contracts held in the group. The quantity of coverage is the coverage received by the insurer from the reinsurance contracts held, and not the coverage provided by the insurer to its policyholders through the underlying insurance contracts.

When determining the quantity of benefits received from a reinsurance contract held, entities should consider the relevant facts and circumstances related to the underlying insurance contracts.

Examples of how to determine coverage units for reinsurance contracts held were provided in Example 8 of Appendix B to Agenda Paper 5 of the May 2018 TRG meeting. It was noted that, for an adverse development cover with a contractual maximum, methods for determining the quantity of benefits could include: (1) comparing the contractual maximum amount that could have been claimed in the period with the remaining contractual maximum amount that can be claimed as a constant amount for each future coverage period; or (2) comparing the expected amount of underlying claims covered in the period with the expected amount of underlying claims remaining to be covered in future periods. For an adverse development cover without a contractual maximum, methods could include: (a) assuming equal benefits in each coverage period, which would end at the date of the last expected settlement payment; or (b) using method (2) as noted above.

In determining the fulfilment cash flows for reinsurance contracts held, should an entity include cash flows expected to arise from underlying contracts that are expected to be issued in the future?

Reference to standard: IFRS 17 paras 34, 62(a)

Yes, provided that these underlying contracts will be covered by the reinsurance contract. One of the main principles of IFRS 17 is that both insurance contracts issued and reinsurance contracts that an entity holds are measured applying the measurement criteria in IFRS 17. However, IFRS 17 has some modifications to the measurement model for reinsurance contracts held to reflect that such contracts are not issued by the entity (for example, related to the date of initial recognition).

In measuring a reinsurance contract held, an entity applies the contract boundary requirements in IFRS 17 for both the direct insurance contracts that it issues and the reinsurance contracts that it holds. As noted, the cash flows within the boundary of a reinsurance contract held arise from the entity’s substantive rights and substantive obligations under that contract. This means that the entity has a substantive right to receive services from, and has an obligation to pay amounts to, the issuer of that contract (the reinsurer). Therefore, if an entity has a substantive right to receive services from the reinsurer for underlying contracts that are expected to be issued in the future, cash flows within the boundary of the reinsurance contract held will include cash flows relating to those future underlying contracts.

For example, an entity holds a one-year risk attaching reinsurance contract that covers claims arising from motor insurance contracts that it issues between 1 January 20X2 and 31 December 20X2. For the reinsurance contract, the contract boundary is cash flows arising from contracts issued in that one year. The coverage period for the underlying motor contract is one year from when it is issued. The coverage period of the reinsurance contract held would therefore be from 1 January 20X2 to the end of the coverage period of the last underlying insurance contract, which could be up to 31 December 20X3. The initial recognition date of that reinsurance contract is, in accordance with IFRS 17, determined to be 1 January 20X2. Applying IFRS 17 for this contract means that the future cash flows for all expected underlying motor contracts to be covered by the reinsurance contract from 1 January to 31 December are included in the measurement of the reinsurance contract on that initial recognition date.

Some stakeholders have raised concerns with this requirement, because it is considered operationally complex compared to current accounting treatments. The IASB addressed the concerns in its December 2018 Board meeting and agreed to retain the existing requirements in IFRS 17.

How should the risk adjustment for reinsurance contracts held be calculated?

Reference to standard: IFRS 17 para 64

There are no specific requirements in IFRS 17 regarding the approaches that should be used to determine the amount of risk being transferred by the holder to the issuer of a reinsurance contract. It is possible to directly calculate the risk inherent in the portion of the risk that is ceded, similar to how a reinsurer would calculate its risk adjustment for the business assumed (also known as ‘gross less ceded equals net’), or as the difference between the risk adjustment on the gross underlying contracts and the risk adjustment for the net risk retained after considering the reinsurance (also known as ‘gross less net equals ceded’). The IASB acknowledged at a public meeting that it does not intend to require any specific approaches for the calculation of the risk adjustment for non-financial risk for reinsurance contracts held, even though the results of the different approaches might be different in practice.

How is the discount rate applied to the CSM on reinsurance held?

Reference to standard: IFRS 17 para 66(c)

Question

How should an entity determine the discount rate to be applied to adjust the contractual service margin (CSM) on reinsurance contracts held when applying paragraph 66(c) of IFRS 17?

Answer

IFRS 17, which provides guidance on how to measure the CSM at the end of the reporting period for a group of reinsurance contracts held, does not specify the discount rate that an entity should apply to the measurement of the changes to the CSM on reinsurance contracts held. This was acknowledged at the IASB Transition Resource Group for IFRS 17 Insurance Contracts February 2018 meeting by the IASB that a technical editorial correction is required. As a result, the IASB is expected to propose amending IFRS 17 to include a reference, which specifies that reinsurance contracts held will require the use of the discount rate determined on initial recognition in measuring the changes to the CSM.

Comprehensive example: initial recognition and measurement of an excess loss reinsurance contract held

Reference to standard: IFRS 17 paras 29(b), 60

Excess loss reinsurance contract held This example assumes that the reinsurance contract held is accounted for using the general model rather than the premium allocation approach.

An insurer cedes losses from a motor insurance portfolio to a reinsurer in accordance with an excess loss reinsurance contract held. The reinsurance contract represents a single contract in the group. Reinsurance coverage is provided for claims arising from policies that are underwritten during the period to which the reinsurance relates, starting from 1 January 20X1 and ending on 31 December 20X1. There is coverage during the whole period of the underlying insurance contract, even if claims are only discovered after the expiration date of the reinsurance contract held. Direct insurance contracts that are underwritten before inception (1 January 20X1) or after expiry of the reinsurance contract are not covered, even if claims occur during the period of the reinsurance contract held (risk-attaching basis). There are no pre-coverage cash flows and no cash flows at the date when the reinsurance contract held is initially recognised. The premium paid for the reinsurance contract held on 1 January 20X1 is CU1,000. The excess point is CU3,500 loss from the underlying portfolio. The risk adjustment for non-financial risk and discounting component is assumed to be nil for this example.

The expectations for the ceded direct insurance contracts at inception are presented in the table below:

Question 1: What is the date of initial recognition of the reinsurance contract held?

A group of reinsurance contracts held that provide excess loss coverage should be initially recognised on the date when reinsurance coverage of any reinsurance contract in the group starts. The date when the coverage of the reinsurance contract held starts is 1 January 20X1, so this is the date of initial recognition of the reinsurance contract held.

Question 2: What is the CSM of the reinsurance contract held at the date of initial recognition?

Premiums paid on the date of initial recognition of the reinsurance contract held on 1 January 20X1 are CU1,000. Expected claims are CU955, calculated as expected claims from the underlying portfolio of CU4,455 less excess point of CU3,500. Total fulfilment cash flows on 1 January 20X1 are CU45. Similar to the initial recognition of the contractual service margin (CSM) for insurance contracts issued, the CSM for reinsurance contracts held at inception is the amount of the fulfilment cash flows less cash flows paid at the date when coverage starts. So, the CSM is CU45 (debits are presented as negative amounts, and credits as positive):

Question 3: What is the coverage period of the reinsurance contract held?

The coverage period for risk-attaching contracts starts with the initial recognition of the reinsurance contract held and ends when the coverage period of the last underlying insurance contract ends. The coverage period represents the period when the reinsurer has the contractual obligation to reimburse losses to the insurer if they incur during this period. The coverage period of the reinsurance contract held is from 1 January 20X1 to 10 October 20X2. The end of the coverage period represents the entity’s expectation at inception. The CSM of CU45 for the reinsurance contract held should be released to expenses over that period, based on coverage units, if the general model is used.

Comprehensive example: reinsurance of onerous underlying contracts

Reference to standard: IFRS 17 paras 29(b), 60

An insurer purchases a facultative proportional reinsurance contract to cede 50% of risks from an underlying property insurance contract covering losses from an office building in exchange for ceding 50% of the premiums. The direct underlying insurance contract is onerous at inception. The reinsurance consideration reflects a ceding commission which takes into account the fact that the direct contract is onerous, such that the reinsurance contract is profitable to the reinsurer. Both the reinsurance and insurance contracts are the only contracts in the respective groups. Set out below is information about the reinsurance contract and the underlying insurance contract at initial recognition of the reinsurance contract held:

Underlying insurance contract Reinsurance contract held CU CU Fulfilment cash flows 1,000 (liabilities) 500 (asset) CSM/ day 1 gain or loss – 100 (asset) At inception, the underlying insurance contract is onerous, so no CSM is recognised. No gain or loss should be recognised for a reinsurance contract held in the statement of comprehensive income at inception of the reinsurance contract, so the excess of fulfilment outflows over inflows from the reinsurance contract held of CU100 is recognised in the statement of financial position as an asset. At the end of the reporting period, fulfilment cash flows related to the underlying insurance contract change to CU1,080. The change relates to future coverage; however, because the contract is onerous, it is recognised in profit or loss as an increase of the loss component of the liability for remaining coverage. The fulfilment cash flows for the reinsurance contract held also change to CU540, due to the change related to the underlying insurance contract. The change of CU40 relating to the reinsurance contract held is recognised immediately in profit or loss rather than increasing the CSM, because it occurred subsequent to reinsurance contract inception and it results from a change in the underlying insurance contract that is also recognised in profit or loss. The CSM for the reinsurance contract held (CU100) continues to be allocated to profit or loss, based on the coverage units.