Under the PAA, when a contract within a group meets any of the derecognition criteria, should the derecognition have an immediate impact on the amount recognised in profit or loss?

Reference to standard: IFRS 17 para 76 Reference to standing text: 50A.185 Industry: Insurance

Yes. The PAA is a simplification of the general measurement model, under which the liability for remaining coverage (LFRC) recognised under the PAA is not separated between fulfilment cash flows and the CSM. As a result, there is no CSM to adjust for changes in future fulfilment cash flows, because the amounts recognised as the LFRC under the PAA are based on premium received rather than the fulfilment cash flows. Therefore, the application of IFRS 17 for an insurance contract accounted for under the PAA requires the difference in fulfilment cash flows (that is, derecognised LFRC less premiums refunded) to be recognised in profit or loss. For example, an annual contract within a larger group of contracts has total premium that has been paid upfront of CU500, a portion of which will be refunded if the contract is cancelled during the coverage period. After six months, the contract is cancelled and CU240 is refunded to the policyholder. The LFRC of CU250 would be reversed, cash of CU240 would be refunded, and profit or loss would be credited for CU10. Under the general model, the CSM rather than profit or loss would be credited for CU10, as required by IFRS 17.

Accounting for business combinations and transfers of insurance contracts between third parties that do not meet the definition of a business (portfolio transfers)

Reference to standard: IFRS 17 para 5

Question 1

Is an acquiring entity required to reassess the classification of insurance contracts acquired in a business combination or in the purchase of a portfolio of insurance contracts that does not meet the definition of a business?

Answer

Yes. IFRS 17 resulted in a consequential amendment to IFRS 3 which deletes the previous exception from the main principle in IFRS 3 to classify contracts based on the terms and conditions that exist at the acquisition date. Consequently, under IFRS 17 and IFRS 3, as amended, the acquirer will need to classify contracts based on the terms and conditions that exist at the acquisition date.

For example, a contract with an account balance component might have included insurance coverage for a specified period of time. If, at the acquisition date, the insurance coverage period has expired but the investment component is still outstanding, the contract is a financial instrument which would not be accounted for under IFRS 17 in the financial statements of the acquirer.

Question 2

Is an acquiring entity required to reassess eligibility for the modified IFRS 17 accounting models – variable fee approach (VFA) or premium allocation approach (PAA) – at the time of the acquisition in a business combination or in the purchase of a portfolio of insurance contracts that does not meet the definition of a business?

Answer

Yes. IFRS 17 indicates that all references to insurance contracts issued also apply to contracts acquired by an entity in a transfer of insurance contracts or a business combination. Therefore, entities are required to assess whether, for example, the VFA model or the PAA model is appropriate for acquired contracts.

Assume that an entity purchased a business where the acquiree had determined that a group of contracts qualified for the VFA model at contract inception. The acquirer would need to assess whether the group of contracts is eligible for the VFA model as of the acquisition date. The presence of minimum interest rate guarantees, combined with a low interest rate environment at the acquisition date, might result in the acquirer concluding that the group of contracts is not eligible to be accounted for under the VFA model by the acquirer. This is because it does not expect that a substantial proportion of any change in the amounts to be paid to the policyholder will vary with the change in the fair value of the underlying items.

Alternatively, assume that an entity purchased a business where the underlying contracts have a one-year coverage period and are accounted for applying the PAA model in the financial statements of the acquired company. Some of these contracts might be outside the coverage period, but they still have claims in settlement. For these groups of contracts, the acquirer is providing coverage relating to the uncertainty of the ultimate settlement amount (in accordance with IFRS 17), and therefore the insured event is the determination of the ultimate cost of those claims. Consequently, for contracts where the claims settlement is expected to be longer than a year after the acquisition date, the entity cannot automatically apply the one-year PAA exemption, and it would instead need to demonstrate PAA eligibility by applying the requirements in IFRS 17.

Question 3

Is an acquiring entity required to calculate a new contractual service margin (CSM) for insurance contracts purchased in a business combination or in the purchase of a portfolio of insurance contracts that does not meet the definition of a business?

Answer

Yes. IFRS 17 indicates that an acquirer should identify the groups of contracts acquired as if it had entered into the contracts at the date of the transaction. Unless the group is eligible and has chosen the PAA model, a CSM is calculated at the date of the acquisition. The consideration received or paid for the contract should be used as a proxy for premiums received. In a business combination, the fair value of the insurance contracts acquired should be used as the consideration paid or received for these insurance contracts. In the determination of fair value, entities should not apply the deposit floor in IFRS 13 (which requires that the fair value of a financial liability with a demand feature should not be less than the amount payable on demand).

Business combinations, capital reorganisations and other transactions between entities under common control under IFRS 17

Reference to standard: IFRS 17 paras B93–B95

Background

IFRS 17 contain guidance relating to insurance contracts acquired in a transfer of insurance contracts or a business combination. These paragraphs require the contracts to be treated as if the transferee had entered into them on the date of the transaction. This means that the contracts need to be newly analysed and classified as under the general model, the variable fee approach or the premium allocation approach, based on the facts and circumstances at the acquisition date. An entity is further required to remeasure insurance liabilities (that is, liability for remaining coverage) using the consideration received or paid as a proxy for premiums in the contracts acquired. The standard does not distinguish between transfers of insurance contracts or business combinations between entities that are under common control, on the one hand, and transfers of insurance contracts or business combinations between third parties on the other. Care will need to be taken to assess the specific facts and circumstances, to determine whether the transaction meets the definition of a business or a capital reorganisation.

Questions 1 and 2 of this FAQ respectively deal with business combinations between entities under common control and capital reorganisations, as described in Appendix 1 to this Manual. Question 3 of this FAQ deals with transfers of insurance contracts that do not meet the definition of a business combination between entities under common control or a capital reorganisation.

Question 1:

Transactions that are business combinations between entities under common control When accounting for a business combination between two entities that are under common control, are the related insurance contracts required to be recognised and measured in accordance with IFRS 17?

Answer

No. Entities are permitted, but not required, to follow the guidance in IFRS 17 for business combinations between entities under common control. We believe that the reference in IFRS 17 to ‘business combinations’ can be interpreted as business combinations within the scope of IFRS 3. IFRS 3 notes that the guidance in IFRS 3 applies to transactions or other events that meet the definition of a business combination, and that it does not apply to a combination of entities or businesses under common control. This interpretation is supported by the fact that, in other standards, business combinations are sometimes referenced ‘as defined in IFRS 3’ and sometimes referred to only as ‘business combinations. Where, in other standards, the reference is unclear, it is usually interpreted to be a business combination within the scope of IFRS 3.

Currently, because business combinations under common control are not covered by any IFRS, entities have the ability under IAS 8 to select an appropriate accounting policy for these transactions. One such policy would be to adopt the IFRS 3 acquisition method, which would include applying the remeasurement requirements in IFRS 17. Another option would be to apply predecessor accounting (see Appendix 1 to this Manual). If predecessor accounting is elected, because other items relating to the business combination would not be remeasured (for example, identifiable intangible assets such as customer lists and distribution channels), it would be inconsistent for an entity to use predecessor accounting for all other items in the business combination and require remeasurement of the insurance contracts under IFRS 17. As a result, we believe that remeasurement under IFRS 17 would not be appropriate if predecessor accounting is elected, because this would not enhance the comparability, as noted by the Conceptual Framework under ‘qualitative characteristics of useful financial information’ in paragraphs 2.24–2.29.

Question 2:

Transactions that are capital reorganisations In some situations involving a combination of companies, one of the entities might not meet the definition of a business in IFRS 3, with the result that the transaction is not a business combination. For example, as described, the acquisition of a business by a newly established single reporting entity does not meet the definition of a business combination. Should the related insurance contracts transferred in such transactions be recognised and measured in accordance with the requirements of IFRS 17 for transfers of insurance contracts?

Answer

No. In a capital reorganisation where only the legal form of the entities within the group has changed, the substance of the group is not changed. This transaction does not represent a substantive economic change. It would therefore be inappropriate to remeasure the assets and liabilities within the scope of IFRS 17. The pre-combination book values of all assets and liabilities of the existing entity are transferred into the new entity’s financial statements.

Question 3:

Transactions that are neither a business combination between entities under common control nor a capital reorganisation When accounting for insurance contracts acquired in a transfer of insurance contracts between entities that are under common control that is neither a business combination nor a capital reorganisation, are the related insurance contracts required to be recognised and measured in accordance with the guidance in IFRS 17?

Answer

Yes. Where the acquisition/transfer of the portfolio of insurance contracts does not constitute a business combination, and the transaction is not a capital reorganisation, IFRS 17 applies, requiring the remeasurement of the contracts as described. For example, where a portfolio of insurance contracts is acquired from one entity by another entity within the same insurance group and both entities continue as before the transaction, IFRS 17 would apply.

When are claims incurred for contracts that cover adverse development of claims and for contracts acquired in their settlement period?

Reference to standard: IFRS 17 para B5

Question

When are claims incurred for contracts that cover adverse development of claims and for contracts acquired in their settlement period?

Answer

As noted in the May 2018 TRG paper describing other issues submitted (issue #S32 in the submissions log), acquiring contracts in the settlement period after insurance coverage has expired is essentially providing coverage for the adverse development of the settlement of the claims.

For insurance contracts that cover events that have already occurred, but the financial effect of which is still uncertain, the claims are incurred when the financial effect is determined, applying IFRS 17. This is not the point at which an entity has a reliable estimate if there is still uncertainty involved. Conversely, this is not necessarily when the claims are paid, if certainty has been achieved prior to the actual payment.

How should insurance contracts that have been acquired in their settlement period in a business combination or a portfolio transfer be accounted for at and subsequent to the acquisition date?

Reference to standard: IFRS 17 para B5

In a business combination, the acquirer often assumes insurance obligations relating to past insurable events. For example, in a business combination involving the purchase of a property/casualty (or general insurance) entity, the insurance contracts acquired might include those for which the coverage to the policyholder has fully or partially expired. Similarly, an entity might acquire a group of contracts that do not form a business but instead are a ‘portfolio transfer’ that results in the acquiring entity assuming the remaining obligation from the original direct writer, and the direct writer’s obligation to the policyholder being extinguished.

While a business combination involves the purchase of an entire business, that business will include a number of individual-acquired insurance contracts. For accounting purposes, those acquired contracts are treated as if the acquirer (or reinsurer) had entered into those contracts on the date of the transaction, similar to how an assuming reinsurer would account for reinsurance of insurance contracts, including contracts for which the coverage period has expired. Consistent with IFRS 17, the insurance contract is providing coverage against adverse development of events that have already occurred. Paragraph B5 notes that “in such contracts, the insured event is the discovery of the ultimate cost of those claims”. Therefore, the coverage period of the contracts will extend until the final settlement amount of all claims under the contract is known.

How should insurance contracts in their settlement period acquired in a business combination or a portfolio transfer be characterised at the acquisition date?

Reference to standard: IFRS 17 para B5

While the seller would have classified these obligations as part of the ‘liability for incurred claims’, acquiring contracts in their settlement period is essentially providing coverage for the adverse development of claims. Under the general model, the fulfilment cash flows are considered a liability for remaining coverage, with any remaining positive difference between the consideration received for the contracts at the acquisition date and the fulfilment cash flows recognised as a contractual service margin. If the premium allocation approach is used (for example, for claims with very short payout periods), the entire consideration would initially be classified as a liability for remaining coverage.

What is the period of coverage for insurance contracts that have been acquired in their settlement period in conjunction with a business combination or a portfolio transfer?

Reference to standard: IFRS 17 para B5

Consistent with paragraph B5 of IFRS 17, the contracts acquired are providing coverage against adverse development of insured events that have already occurred. Paragraph B5 notes that “in such contracts, the insured event is the discovery of the ultimate cost of those claims”. Therefore, the coverage period of each contract will extend through to when the financial effect of the claim is certain. This will often be the final settlement date of all claims under each contract. However, if certainty has been achieved prior to the actual payment, the coverage period will end earlier than the date when the claim is settled.

How should insurance revenue be presented for insurance contracts that have been acquired in their settlement period in conjunction with a business combination or a portfolio transfer?

Reference to standard: IFRS 17 paras 41, B5

In the submission log (S04) prepared by the IASB staff for the February 2018 TRG meeting, the staff noted that, for these contracts, the insured event is the determination of the ultimate cost of the claim. Consistent with paragraph B5 of IFRS 17, acquiring contracts in their settlement period is essentially providing coverage for the adverse development of claims. Citing paragraph 41 of IFRS 17, the submission log notes that, accordingly, revenue would reflect the entire expected claims. If some cash flows meet the definition of an investment component, those cash flows will not be reflected in revenue or expenses.

Revenue would also be recognised as the risk adjustment expires, and as the contractual service margin (CSM) is recognised over the coverage period of the contract, which would extend through to when the final settlement amount of all claims under the contract is known.

If the general model is used for insurance contracts that have been acquired in their settlement period in conjunction with a business combination or a portfolio transfer, how is the contractual service margin (CSM) recognised in subsequent periods?

Reference to standard: IFRS 17 paras B5, B94

IFRS 17 notes that the consideration received for assuming a portfolio transfer and the fair value of the contracts acquired in a business combination is considered the premium received for purposes of establishing the CSM. The CSM is recognised over the coverage period of the insurance contract, which extends through to the date when the final settlement amount of all claims under the contract is known. Judgement should be applied when developing coverage units used to amortise the CSM.

What are considered to be ‘changes in fulfilment cash flows relating to future service’ that adjust the CSM under IFRS 17 for insurance contracts that have been acquired in their settlement period in conjunction with a business combination or a portfolio transfer?

Reference to standard: IFRS 17 paras 42(a), 44(c), B5

Any changes in estimate (unless they are actual claim settlements) are considered ‘changes in fulfilment cash flows relating to future service’ in IFRS 17. The actual occurrence of a claim is deemed to occur only when the final settlement amount of the claim is known. Changes in estimates of fulfilment cash flows relating to future service adjust the CSM, unless the CSM is no longer a positive amount. In contrast, differences between the amounts for claims expected to be settled in a period and the amounts for claims actually settled in a period are recognised in profit and loss under IFRS 17, given that the settled claims represent incurred claims for the acquired contracts.