The IASB issued IFRS 17 – Insurance Contracts – in May 2017. IFRS 17 establishes principles for the recognition, measurement, presentation and disclosure of insurance contracts issued, reinsurance contracts held and investment contracts with discretionary participation features issued. An Exposure Draft – ED/2019/4 Amendments to IFRS 17 – (the ED), was issued in June 2019 and proposes various changes to the standard. The ED is summarised at 18 below and its contents have been reflected in the various sections of the chapter as appropriate.
The previous IFRS standard on insurance contracts, IFRS 4 – Insurance Contracts, was an interim standard that allowed entities to use a wide variety of accounting practices for insurance contracts, reflecting national accounting requirements and variations of those requirements. The IASB had always intended to replace IFRS 4. The differences in accounting treatment across jurisdictions and practices have made it difficult for investors and analysts to understand and compare insurers' results. Most stakeholders agreed on the need for a common global insurance accounting standard even though opinions varied as to what it should be. Long-term and complex insurance risks are difficult to reflect in the measurement of insurance contracts. In addition, insurance contracts are subject to several measurement challenges. Some previous accounting practices under IFRS 4 did not adequately reflect the true underlying financial position or the financial performances of these insurance contracts. [IFRS 17.IN4]. IFRS 4 is discussed in Chapter 55.
IFRS 17 reflects the Board's view that an insurance contract combines features of both a financial instrument and a service contract. In addition, many insurance contracts generate cash flows with substantial variability over a long period. To provide useful information about these features the Board developed an approach that: [IFRS 17.IN5]
The measurement required by IFRS 17 results in: [IFRS 17.IN7]
An entity may apply a simplified measurement approach (the premium allocation approach) to some insurance contracts. This simplified measurement approach allows an entity to measure the amount relating to remaining service by allocating the premium over the coverage period. [IFRS 17.IN8].
IFRS 17 will have a significant effect on many insurers as their existing accounting policies for recognition and measurement under IFRS 4, usually derived from their local GAAP, are likely to differ from those required by IFRS 17. The costs involved in implementing IFRS 17 are likely to be substantial because of the need for significant systems development in order to capture the required information.
IFRS 17 is currently effective for annual accounting periods beginning on or after 1 January 2021 (although the ED proposes deferring the initial application until accounting periods beginning on or after 1 January 2022 – see 18 below). Early application is permitted for entities that apply both IFRS 9 – Financial Instruments – and IFRS 15 on or before the date of initial application.
IFRS 17's transition provisions require a full retrospective application of the standard unless it is impracticable, in which case entities should apply either a modified retrospective approach or a fair value approach (see 17 below).
Following issuance of IFRS 17, the IASB created a Transition Resource Group (TRG). The members of the TRG include financial-statement preparers and auditors with both practical and direct knowledge of implementing IFRS 17. The TRG members work in different countries and regions. The TRG's purpose is to:
The TRG met three times in 2018 and once in 2019. As of the date of the last TRG meeting, in April 2019, a total of 127 issues had been submitted by constituents of which the TRG discussed 22 in detail. The rest are questions that:
At the time of writing, there are no further TRG meetings scheduled although the TRG submission process remains open for stakeholders to submit questions that they believe meet the TRG submission criteria. The TRG members' views are non-authoritative, but entities should consider them as they implement the new standard.
During the period to May 2019, as a result of the TRG discussions and issues identified by constituents, the IASB discussed and agreed a number of amendments to IFRS 17. In June 2019, the IASB issued the ED containing the proposed amendments. The contents of the ED are summarised at 18 below and have been reflected throughout the applicable sections of this chapter where relevant. The comment period for the ED expired on 25 September 2019. The IASB will discuss comments received on the ED with a view to issuing finalised amendments to IFRS 17 in mid-2020.
The views expressed in this chapter may evolve as implementation continues and additional issues are identified. The conclusions described in our illustrations are also subject to change as views evolve. Conclusions in seemingly similar situations may differ from those reached in the illustrations due to differences in the underlying facts and circumstances.
The objective of IFRS 17 is to ensure that an entity provides relevant information that faithfully represents the recognition, measurement, presentation and disclosure principles for insurance contracts within its scope. This information gives a basis for users of financial statements to assess the effect that insurance contracts have on the entity's financial position, financial performance and cash flows. [IFRS 17.1].
The following definitions are relevant to the application of IFRS 17. [IFRS 17 Appendix A]. Included below are both the definitions per IFRS 17, as issued in May 2017, and the revised definitions proposed in the ED. The changes proposed by the ED are marked in italics.
Term | Definition |
Contractual service margin |
A component of the carrying amount of the asset or liability for a group of insurance contracts representing the unearned profit the entity will recognise as it provides services under the insurance contracts in the group (extant IFRS 17 text). A component of the carrying amount of the asset or liability for a group of insurance contracts representing the unearned profit the entity will recognise as it provides insurance contract services under the insurance contracts in the group (proposed text per ED). |
Coverage period |
The period during which the entity provides coverage for insured events. This period includes the coverage that relates to all premiums within the boundary of the insurance contract (extant IFRS 17 text). The period during which the entity provides insurance contract services |
Experience adjustment | A difference between:
|
Financial risk | The risk of a possible future change in one or more of a specified interest rate, financial instrument price, commodity price, currency exchange rate, index of prices or rates, credit rating or credit index or other variable, provided in the case of a non-financial variable that the variable is not specific to a party to the contract. |
Fulfilment cash flows | An explicit, unbiased and probability-weighted estimate (i.e. expected value) of the present value of the future cash outflows minus the present value of the future cash inflows that will arise as the entity fulfils insurance contracts, including a risk adjustment for non-financial risk. |
Group of insurance contracts |
A set of insurance contracts resulting from the division of a portfolio of insurance contracts into, at a minimum, contracts written within a period of no longer than one year and that, at initial recognition:
(extant IFRS 17 text). A set of insurance contracts resulting from the division of a portfolio of insurance contracts into, at a minimum, contracts issued or expected to be issued
|
Insurance acquisition cash flows | 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. Such cash flows include cash flows that are not directly attributable to individual contracts or groups of insurance contracts within the portfolio (extant IFRS 17 text).
Cash flows arising from the costs of selling, underwriting and starting a group of insurance contracts (issued or expected to be issued) that are directly attributable to the portfolio of insurance contracts to which the group belongs. Such cash flows include cash flows that are not directly attributable to individual contracts or groups of insurance contracts within the portfolio (proposed text per ED). |
Insurance contract | A contract under which one party (the issuer) accepts significant insurance risk from another party (the policyholder) by agreeing to compensate the policyholder if a specified uncertain future event (the insured event) adversely affects the policyholder. |
Insurance contract services |
The following services that an entity provides to a policyholder of an insurance contract:
(new definition proposed by ED) |
Insurance contract with direct participation features | An insurance contract for which, at inception:
|
Insurance contract without direct participation features | An insurance contract that is not an insurance contract with direct participation features. |
Insurance risk | Risk, other than financial risk, transferred from the holder of a contract to the issuer. |
Insured event | An uncertain future event covered by an insurance contract that creates insurance risk. |
Investment component |
The amounts that an insurance contract requires the entity to repay to a policyholder even if an insured event does not occur (extant IFRS 17 text). The amounts that an insurance contract requires the entity to repay to a policyholder in all circumstances, regardless of whether an insured event occurs |
Investment contract with discretionary participation features | A financial instrument that provides a particular investor with the contractual right to receive, as a supplement to an amount not subject to the discretion of the issuer, additional amounts:
|
Liability for incurred claims |
An entity's obligation to investigate and pay valid claims for insured events that have already occurred, including events that have occurred but for which claims have not been reported, and other incurred insurance expenses. (extant IFRS 17 text) An entity's obligation to:
(proposed text per ED) |
Liability for remaining coverage |
An entity's obligation to investigate and pay valid claims under existing insurance contracts for insured events that have not yet occurred (i.e. the obligation that relates to the unexpired portion of the coverage period). (extant IFRS 17 text) An entity's obligation to: nn (proposed text per ED) |
Policyholder | A party that has a right to compensation under an insurance contract if an insured event occurs. |
Portfolio of insurance contracts | Insurance contracts subject to similar risks and managed together. |
Reinsurance contract | An insurance contract issued by one entity (the reinsurer) to compensate another entity for claims arising from one or more insurance contracts issued by that other entity (underlying contracts). |
Reinsurance contract held that provides proportionate coverage |
A reinsurance contract held that provides an entity with the right to recover from the issuer a percentage of all claims incurred on groups of underlying insurance contracts. The percentage the entity has a right to recover is fixed for all contracts in a single group of underlying insurance contracts but can vary between groups of underlying insurance contracts. (new definition proposed by ED) |
Risk adjustment for non-financial risk | The compensation an 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 insurance contracts. |
Underlying items | Items that determine some of the amounts payable to a policyholder. Underlying items can comprise any items; for example, a reference portfolio of assets, the net assets of the entity, or a specified subset of the net assets of the entity. |
Figure 56.1: IFRS 17 Definitions and revised definitions per the ED
An entity should apply IFRS 17 to: [IFRS 17.3]
IFRS 17 is clear that all references to insurance contracts throughout the standard also apply to: [IFRS 17.4]
In addition, all references to insurance contracts also apply to insurance contracts acquired by an entity in a transfer of insurance contracts or a business combination other than reinsurance contracts held. [IFRS 17.5].
It can be seen from this that IFRS 17 applies to all insurance contracts (as defined in IFRS 17) throughout the duration of those contracts, regardless of the type of entity issuing the contracts. [IFRS 17.BC64]. Consistent with other IFRSs it is a transaction-based standard. Consequently, non-insurance entities will be within its scope if they issue contracts that meet the definition of an insurance contract.
The Board decided to base its approach on the type of activity rather than on the type of the entity because: [IFRS 17.BC63]
Conversely, contracts that fail to meet the definition of an insurance contract are within the scope of IFRS 9 if they meet the definition of a financial instrument (unless they contain discretionary participation features). This will be the case even if such contracts are regulated as insurance contracts under local legislation. Such contracts are commonly referred to as ‘investment contracts’. If an investment contract contains an insignificant amount of insurance risk, that insignificant insurance risk is not within the scope of IFRS 17 since the contract is an investment contract and not an insurance contract.
The assessment of whether a contract is an insurance contract will include an assessment of whether the contract contains significant insurance risk (discussed at 3.2 below). In addition, even if the contract contains significant insurance risk, embedded derivatives (discussed at 4.1 below), investment components (discussed at 4.2 below) or goods or non-insurance services (discussed at 4.3 below) contained within the insurance contract may need to be separated and accounted for under other standards.
Contracts within the scope of IFRS 17 are excluded from the scope of the following IFRSs (except for specific exceptions which are discussed separately elsewhere in this chapter):
Contracts within the scope of IFRS 17 are also excluded from the measurement provisions of IFRS 5 – Non-current Assets Held for Sale and Discontinued Operations.
Contracts within the scope of IFRS 17 are not excluded from the scope of IFRS 13 – Fair Value Measurement – which means that any reference to fair value in IFRS 17 should be fair value as defined and measured by IFRS 13. However, IFRS 17 does not generally require that insurance liabilities are measured at fair value except on transition in certain circumstances and, in those circumstances, IFRS 13's measurement requirements are modified to exclude the demand deposit floor (see 17.4 below).
IFRS 17 also describes transactions to which IFRS 17 is not applied. These are primarily transactions covered by other standards that could potentially meet the definition of an insurance contract. This list of excluded transactions is similar to that previously contained in IFRS 4 except for the addition of residual value guarantees provided by a manufacturer, dealer or retailer. These transactions are as follows: [IFRS 17.7]
In addition, the ED proposes additional scope exclusions for:
IFRS 17 does not address other aspects of accounting by insurers, such as accounting for financial assets held by insurers and financial liabilities issued by insurers which are within the scope of IFRS 7, IFRS 9 and IAS 32. However:
Warranties provided by a manufacturer, dealer or retailer in connection with the sale of its goods or services to a customer are outside the scope of IFRS 17. [IFRS 17.7(a)]. Such warranties might provide a customer with assurance that the related product will function as the parties intended because it complies with agreed-upon specifications, or they might provide the customer with a service in addition to the assurance that the product complies with agreed-upon specifications. [IFRS 17.BC89].
Without this exception, many product warranties would have been covered by IFRS 17 as they would normally meet the definition of an insurance contract. The Basis for Conclusions observes that the IASB has excluded them from the scope of IFRS 17 because if the standard were to apply, entities would generally apply the premium allocation approach to such contracts, which would result in accounting similar to that resulting from applying IFRS 15. Further, in the Board's view, accounting for such contracts in the same way as other contracts with customers would provide comparable information for the users of financial statements for the entities that issue such contracts. Hence, the Board concluded that changing the existing accounting for these contracts would impose costs and disruption for no significant benefit. [IFRS 17.BC90].
Conversely, a product warranty is within the scope of IFRS 17 if it is not issued by a manufacturer, dealer or retailer in connection with the sale of its goods or services to a customer. See 3.7.1 below.
Other types of warranty are not specifically excluded from the scope of IFRS 17.
Employers' assets and liabilities under employee benefit plans and retirement benefit obligations reported by defined benefit retirement plans are excluded from the scope of IFRS 17. These are accounted for under IAS 19 – Employee Benefits, IFRS 2 – Share-based Payment – and IAS 26 – Accounting and Reporting by Retirement Benefit Plans. [IFRS 17.7(b)].
Many defined benefit pension plans and similar post-employment benefits meet the definition of an insurance contract because the payments to pensioners are contingent on uncertain future events such as the continuing survival of current or retired employees. Without this exception they would have been within the scope of IFRS 17.
Contractual rights or contractual obligations that are contingent on the future use of, or right to use, a non-financial item (for example, some licence fees, royalties, variable and other lease payments and similar items) are excluded from the scope of IFRS 17. These are accounted for under IFRS 15, IFRS 16 – Leases – and IAS 38. [IFRS 17.7(c)].
Residual value guarantees provided by a manufacturer, dealer or retailer and a lessee's residual value guarantees when they are embedded in a lease are excluded from the scope of IFRS 17. They are accounted for under IFRS 15 and IFRS 16. [IFRS 17.7(d)].
However, stand-alone residual value guarantees that transfer insurance risk are not addressed by other IFRSs and are within the scope of IFRS 17. [IFRS 17.BC87(d)].
A financial guarantee contract is defined as a contract that requires the issuer to make specified payments to reimburse the holder for a loss it incurs because a specified debtor fails to make payment when due in accordance with the original or modified terms of a debt instrument. [IFRS 9 Appendix A]. These contracts transfer credit risk and may have various legal forms, such as a guarantee, some types of letter of credit, a credit default contract or an insurance contract. [IFRS 17.BC91].
Financial guarantee contracts are excluded from the scope of IFRS 17 unless the issuer has previously asserted explicitly that it regards such contracts as insurance contracts and has used accounting applicable to insurance contracts. If so, the issuer may elect to apply either IFRS 17 or IAS 32, IFRS 7 and IFRS 9 to the financial guarantee contracts. The issuer may make that choice contract by contract, but the choice for each contract is irrevocable. [IFRS 17.7(e)].
This accounting policy election is the same as that previously in IFRS 4. The Board decided to carry forward to IFRS 17 the option to account for a financial guarantee contract as if it were an insurance contract, without any substantive changes, because the option has worked in practice and results in consistent accounting for economically similar contracts issued by the same entity. The Board did not view it as a high priority to address the inconsistency that results from accounting for financial guarantee contracts differently depending on the issuer. [IFRS 17.BC93].
IFRS 17 does not elaborate on the phrase ‘previously asserted explicitly’. However, the application guidance to IFRS 9 states that assertions that an issuer regards contracts as insurance contracts are typically found throughout the issuer's communications with customers and regulators, contracts, business documentation and financial statements. Furthermore, insurance contracts are often subject to accounting requirements that are distinct from the requirements for other types of transaction, such as contracts issued by banks or commercial companies. In such cases, an issuer's financial statements typically include a statement that the issuer has used those accounting requirements. [IFRS 9.B2.6]. Therefore, it is likely that insurers that have previously issued financial guarantee contracts and accounted for them under an insurance accounting and regulatory framework will meet this requirement. It is unlikely that an entity not subject to an insurance accounting and regulatory framework and existing insurers that had not previously issued financial guarantee contracts would meet this requirement because they would not have previously made the necessary assertions.
In our view, on transition to IFRS 17, an entity that has previously asserted explicitly that it regards such contracts as insurance contracts and has used accounting applicable to insurance contracts may reconsider its previous election regarding accounting for financial guarantee contracts made under IFRS 4 and decide whether it would prefer to account for those contracts under IFRS 17 or IFRS 9. This is because there are no specific transition provisions either within IFRS 17 or IFRS 9 as to whether previous elections made under a different standard, i.e. IFRS 4, should be continued. Hence, IFRS 17 would not prevent an entity from making new elections on application of IFRS 17. An entity which had not previously asserted explicitly that it regards such contracts as insurance contracts or which had not previously used accounting applicable to insurance contracts (i.e. IAS 39 – Financial Instruments: Recognition and Measurement – or IFRS 9 accounting was applied under IFRS 4) may not reconsider its previous election.
It is observed in the Basis for Conclusions that some credit-related contracts lack the precondition for payment that the holder has suffered a loss. One example of such a contract is one that requires payments in response to changes in a specified credit rating or credit index. The Board concluded that those contracts are derivatives and do not meet the definition of an insurance contract. Therefore, such contracts will continue to be accounted for as derivatives under IFRS 9. The Board noted that these contracts were outside the scope of the policy choice in IFRS 4 carried forward into IFRS 17, so continuing to account for them as derivatives would not create further diversity. [IFRS 17.BC94].
Accounting for financial guarantee contracts by issuers that have not elected to use IFRS 17 is discussed in Chapter 45 at 3.4.2.
Contingent consideration payable or receivable in a business combination is outside the scope of IFRS 17. [IFRS 17.7(f)]. Contingent consideration in a business combination is required to be recognised at fair value at the acquisition date with subsequent remeasurements of non-equity consideration included in profit or loss (see Chapter 9 at 7.1.3). [IFRS 3.58].
Accounting by policyholders of direct insurance contracts (i.e. those that are not reinsurance contracts) is excluded from the scope of IFRS 17. However, holders of reinsurance contracts (cedants) are required to apply IFRS 17. [IFRS 17.7(g)].
The IASB originally intended to address accounting by policyholders of direct insurance contracts in IFRS 17 but changed its mind. The Basis for Conclusions observes that other IFRSs include requirements that may apply to some aspects of contracts in which the entity is the policyholder. For example, IAS 37 sets requirements for reimbursements from insurance contracts held that provide cover for expenditure required to settle a provision and IAS 16 – Property, Plant and Equipment – sets requirements for some aspects of reimbursement under an insurance contract held that provides coverage for the impairment or loss of property, plant and equipment. Furthermore, IAS 8 – Accounting Policies, Changes in Accounting Estimates and Errors – specifies a hierarchy that an entity should use when developing an accounting policy if no IFRS standard applies specifically to an item. Accordingly, the Board did not view work on policyholder accounting as a high priority. [IFRS 17.BC66].
The consequential amendments made to IFRS 7, IFRS 9 and IAS 32 by IFRS 17 do not exclude insurance contracts held from the scope of those standards. Therefore, to achieve the intended interaction between the scope of these financial instrument standards and IFRS 17 the ED proposes narrow-scope amendments to IFRS 7, IFRS 9 and IAS 32 in order to exclude insurance contracts held from the scope of those standards. See 18 below.
After the issuance of IFRS 17, some stakeholders expressed concern that the standard requires entities to account for some credit card contracts as insurance contracts.
An example of this type of contract is one which the regulation of the jurisdiction where the entity issuing the credit card operates requires the entity to provide coverage for some purchases made by the customer using the credit card. Under this coverage the entity:
As a result, the entity and the supplier are jointly and severally liable to the customer, i.e. the customer can choose whether to claim from the entity or from the supplier. In addition, subject to a maximum amount, the customer can claim from the entity or from the supplier an amount in excess of the amount paid using the specific credit card (for example, the entire purchase price, even if only part of the purchase price was paid using the credit card, and any additional costs reasonably incurred as a result of the supplier failure). Normally, the entity does not charge any fee to the customer or charges an annual fee to the customer that does not reflect an assessment of the insurance risk associated with that individual customer.1
The IASB agreed that it would be justified to exclude some credit card contracts that provide insurance coverage from the scope of IFRS 17 in order to address concerns and implementation challenges and ease IFRS 17 implementation for some entities. In particular, the Board concluded that when an entity does not reflect the assessment of insurance risk associated when setting the price of the contract with that customer, the Board concluded that IFRS 9 would provide more useful information about those contracts.
Consequently, the ED proposes to exclude from IFRS 17, credit card contracts that meet the definition of an insurance contract if, and only if, the entity does not reflect an assessment of the insurance risk associated with an individual customer in setting the price of the contract with that customer. If excluded from IFRS 17, these contracts would be within the scope of IFRS 9.
The IASB staff did not think an option to apply either IFRS 9 or IFRS 17 was justified as such an option might introduce diversity in practice in the absence of evidence that entities issuing credit card contracts that provide insurance coverage also issue other insurance contracts.2
The proposed changes apply only to credit cards and not to debit cards or other similar types of payment schemes.
After the issuance of IFRS 17, some stakeholders expressed concern that the standard requires entities to account for some loans that transfer significant insurance risk as insurance contracts. These contracts typically combine a loan with an agreement from the entity to compensate the borrower if a specified uncertain event adversely affects the borrower (for example, death) by waiving some or all of the payments due under the contract (for example, repayment of the loan balance and payment of interest). It was observed by the IASB staff that:
Examples of such contracts are:
The IASB agreed with the concerns raised by stakeholders and concluded that requiring an entity to apply IFRS 17 to those contracts, when the entity had previously been applying an accounting policy consistent with IFRS 9 or IAS 39 (or vice versa) could impose cost without corresponding benefit and more useful information to users of financial statements might be provided if an entity were to apply the same standard to those contracts as it applies to other similar contracts that it issues.
Consequently, the ED proposes that, for those contracts which meet the definition of an insurance contract but limit the compensation for insured events to the amount required to settle the policyholder's obligation created by the contract (for example, loans with death waivers), an entity can elect to apply either IFRS 17 or IFRS 9 to such contracts that it issues. The choice should be made for each portfolio (see 5 below) of insurance contracts, and the choice for such portfolio is irrevocable.5
A fixed-fee service contract is a contract in which the level of service depends on an uncertain event but the fee does not. Examples include roadside assistance programmes and maintenance contracts in which the service provider agrees to repair specified equipment after a malfunction. It is stated in the Basis for Conclusions that such contracts meet the definition of an insurance contract because: [IFRS 17.BC95]
Although these are insurance contracts their primary purpose is the provision of services for a fixed fee. Consequently, IFRS 17 permits entities a choice of applying IFRS 15 instead of IFRS 17 to such contracts that it issues if, and only if, specified conditions are met. The entity may make that choice contract by contract, but the choice for each contract is irrevocable. The conditions are: [IFRS 17.8]
The Board had proposed originally to exclude fixed fee service contracts whose primary purpose is the provision of services from the scope of IFRS 17. However, some stakeholders noted that some entities issue both fixed-fee service contracts and other insurance contracts. For example, some entities issue both roadside assistance contracts and insurance contracts for damage arising from accidents. Therefore, the Board decided to allow entities a choice of whether to apply IFRS 15 or IFRS 17 to fixed-fee service contracts to enable such entities to account for both types of contract in the same way. In the view of the Board, if IFRS 17 is applied to fixed-fee service contracts, entities would generally apply the premium allocation approach (see 9 below) to such contracts which would result in accounting similar to that resulting from applying IFRS 15. [IFRS 17.BC96‑97].
In many cases service agreements are priced using some form of risk assessment and therefore the conditions above which require that IFRS 17 must be applied (and the entity would not have a choice between IFRS 17 and IFRS 15) to fixed fee service contracts may require the exercise of judgement. Despite the comment in the Basis for Conclusions that the choice of whether to apply IFRS 15 or IFRS 17 was introduced to assist entities that issue both roadside assistance contracts and insurance contracts, it is possible that other types of service contracts are within the scope of IFRS 17.
The election described above is in respect of fixed fee service contracts (i.e. contracts where the fee is fixed regardless of the level of service required during the contract period). IFRS 17 does not refer to service contracts in which the level of fee varies according to the level of service. These contracts are within the scope of IFRS 15 as they should not contain significant insurance risk.
The definition of an insurance contract in IFRS 17 is:
‘A contract under which one party (the insurer) accepts significant insurance risk from another party (the policyholder) by agreeing to compensate the policyholder if a specified uncertain future event (the insured event) adversely affects the policyholder’. [IFRS 17 Appendix A].
This definition determines which contracts are within the scope of IFRS 17 as opposed to other standards.
The definition of an insurance contract is, in essence, the same as in IFRS 4. Therefore, in many cases, contracts that were insurance contracts under IFRS 4 are expected to be insurance contracts under IFRS 17 although IFRS 17 contains no transitional provisions which ‘grandfather’ conclusions made under IFRS 4 (except for the consequential amendments to IFRS 3 – Business Combinations – see 13 below).
However, there have been clarifications to the related application guidance explaining the definition to require that: [IFRS 17.BC67]
Both of these clarifications are intended to ensure that the determination of insurance risk is made on a present value basis as it was considered that IFRS 4 was unclear on the matter. Additionally, the definition of significant insurance risk (see 3.2 below) uses the word ‘amounts’ instead of ‘benefits’ in order to capture payments that may not necessarily be payable to policyholders (for example claim handling expenses).
While the definition of an insurance contract has not changed much from IFRS 4, the consequences of qualifying as an insurance contract have changed. This is because IFRS 4 allowed entities to use their previous accounting policies for contracts that qualified as insurance contracts. Hence, under IFRS 4, many non-insurance entities, such as banks and service companies, applied guidance from other standards, such as IFRS 9 and IFRS 15, to recognise and measure insurance contracts. This will no longer be possible since IFRS 17 has specific recognition, measurement and presentation requirements for financial statements. As discussed at 2.3.1.H and 2.3.1.I above, the ED proposes a scope exemption for certain credit card contracts that provide insurance coverage and an accounting policy choice to apply either IFRS 9 or IFRS 17 to loan contracts that transfer significant insurance risk only on settlement of the policyholder's obligation created by the contract.
An entity should consider its substantive rights and obligations, whether they arise from a contract, law or regulation, when applying IFRS 17. A contract is an agreement between two or more parties that creates enforceable rights and obligations. Enforceability of the rights and obligations in a contract is a matter of law. Contracts can be written, oral or implied by an entity's customary business practices. Contractual terms include all terms in a contract, explicit or implied, but an entity should disregard terms that have no commercial substance (i.e. no discernible effect on the economics of the contract). Implied terms in a contract include those imposed by law or regulation. The practices and processes for establishing contracts with customers vary across legal jurisdictions, industries and entities. In addition, they may vary within an entity (for example, they may depend on the class of customer or the nature of the promised goods or services). [IFRS 17.2]. The Basis for Conclusions observes that these considerations are consistent with IFRS 15 and apply when an entity classifies a contract and when it assesses the substantive rights and obligations for determining the boundary of a contract. [IFRS 17.BC69].
In a paper submitted to the TRG in September 2018, the IASB staff discussed whether a service fee contract for hotel management services which also guarantees the hotel owner a specified level of EBITDA was an insurance contract because the amount payable under the guarantee may exceed the service fee receivable. The IASB staff noted that IFRS 17 includes a scope exclusion for warranties provided by a manufacturer, dealer or retailer in connection with the sale of its services to a customer and also excludes contractual obligations contingent on the future use of a non-financial item (for example contingent payments)6 – see 2.3.1.C above. The implication from the IASB staff's response is that the EBITDA guarantee is excluded from the scope of IFRS 17 as it is a guarantee given by a retailer in connection with the sale of its services to a customer.
The definition of an insurance contract is discussed in more detail as follows:
A contract is an insurance contract only if it transfers ‘significant insurance risk’. [IFRS 17.B17].
Insurance risk is ‘significant’ if, and only if, an insured event could cause an insurer to pay significant additional amounts in any scenario, excluding scenarios that lack commercial substance (i.e. have no discernible effect on the economics of the transaction). If an insured event could mean significant additional amounts would be payable in scenarios that have commercial substance, this condition may be met even if the insured event is extremely unlikely or even if the expected (i.e. probability-weighted) present value of contingent cash flows is a small proportion of the expected present value of all the remaining contractual cash flows. [IFRS 17.B18].
In addition, a contract transfers significant insurance risk only if there is a scenario that has commercial substance in which the issuer has a possibility of a loss on a present value basis. However, even if a reinsurance contract does not expose the issuer to the possibility of a significant loss, that contract is deemed to transfer significant insurance risk if it transfers to the reinsurer substantially all the insurance risk relating to the reinsured portions of the underlying insurance contracts. [IFRS 17.B19].
The additional amounts described above are determined on a present value basis. If an insurance contract requires payment when an event with uncertain timing occurs and if the payment is not adjusted for the time value of money, there may be scenarios in which the present value of the payment increases, even if its nominal value is fixed. An example is insurance that provides a fixed death benefit when the policyholder dies, with no expiry date for the cover (often referred to as whole-life insurance for a fixed amount). It is certain that the policyholder will die, but the date of death is uncertain. Payments may be made when an individual policyholder dies earlier than expected. Because those payments are not adjusted for the time value of money, significant insurance risk could exist even if there is no overall loss on the portfolio of contracts. Similarly, contractual terms that delay timely reimbursement to the policyholder can eliminate significant insurance risk. An entity should use the discount rates required as discussed at 8.3 below to determine the present value of the additional amounts. [IFRS 17.B20].
IFRS 17 does not prohibit a contract from being an insurance contract if there are restrictions on the timing of payments or receipts. However, the existence of restrictions on the timing of payments may mean that the policy does not transfer significant insurance risk if it results in the lack of a scenario that has commercial substance in which the issuer has a possibility of a loss on a present value basis.
No quantitative guidance supports the determination of ‘significant’ in IFRS 17. This was a deliberate decision because the IASB considered that if quantitative guidance was provided it would create an arbitrary dividing line that would result in different accounting treatments for similar transactions that fall marginally on different sides of that line and would therefore create opportunities for accounting arbitrage. [IFRS 17.BC78].
The IASB also rejected defining the significance of insurance risk by reference to the definition of materiality within the Conceptual Framework for Financial Reporting because, in its opinion, a single contract, or even a single book of similar contracts, would rarely generate a loss that would be material to the financial statements as a whole. Consequently, IFRS 17 defines the significance of insurance risk in relation to individual contracts (see 3.2.2 below). [IFRS 17.BC79].
The IASB also rejected the notion of defining the significance of insurance risk by expressing the expected (probability weighted) average of the present values of the adverse outcomes as a proportion of the expected present value of all outcomes, or as a proportion of the premium. This definition would mean that a contract could start as a financial liability and become an insurance contract as time passes or probabilities are reassessed. This idea would have required the constant monitoring of contracts over their life to see whether they continued to transfer insurance risk. The IASB considered that it would be too burdensome to require an entity to continuously monitor whether a contract meets the definition of an insurance contract over its duration. Consequently, as discussed at 3.3 below, an assessment of whether significant insurance risk has been transferred is normally required only at the inception of a contract. [IFRS 17.BC80].
IFRS 4 contained an illustrative example which implied insured benefits must be greater than 101% of the benefits payable if the insured event did not occur for there to be insurance risk in an insurance contract. [IFRS 4.IG2.E1.3]. However, no equivalent example has been included in IFRS 17.
Some jurisdictions have their own guidance as to what constitutes significant insurance risk. However, other jurisdictions offer no quantitative guidance. Some US GAAP practitioners apply a guideline that a reasonable possibility of a significant loss is a 10% probability of a 10% loss, although this guideline does not appear in US GAAP itself. [IFRS 17.BC77]. It is not disputed in the Basis for Conclusions that a 10% chance of a 10% loss results in a transfer of significant insurance risk and, indeed, the words ‘extremely unlikely’ and ‘a small proportion’ (see 3.2 above) suggests that the IASB envisages that significant insurance risk could exist at a different threshold than a 10% probability of a 10% loss.
This lack of a quantitative definition means that insurers must apply their own judgement as to what constitutes significant insurance risk. Although the IASB did not want to create an ‘arbitrary dividing line’, the practical impact of this lack of guidance is that insurers have to apply their own criteria to determine what constitutes significant insurance risk and there will probably be inconsistency in practice as to what these dividing lines are, at least at the margins.
There is no specific requirement under IFRS 17 for insurers to disclose any thresholds used in determining whether a contract contains significant insurance risk. However, IFRS 17 requires an entity to disclose the significant judgements made in applying IFRS 17 (see 16.2 below) whilst IAS 1 – Presentation of Financial Statements – requires an entity to disclose the judgements that management has made in the process of applying the entity's accounting policies that have the most significant effect on the amounts recognised in the financial statements (see Chapter 3 at 5.1.1.B).
Significant insurance risk must be assessed by individual contract, rather than by portfolios or groups of contracts or by reference to materiality to the financial statements. Thus, insurance risk may be significant even if there is a minimal probability of significant losses for a portfolio or group of contracts. [IFRS 17.B22]. There is no exception to the requirement for assessment at an individual contract level, unlike IFRS 4 which permitted an insurer to make an assessment based on a small book of contracts if those contracts were relatively homogeneous.
The IASB decided to define significant insurance risk in relation to a single contract rather than at a higher level of aggregation because, although contracts are usually managed on a portfolio basis, the contractual rights and obligations arise from individual contracts. Materiality by reference to the financial statements was considered an inappropriate basis to define significant insurance risk because a single contract, or even a single book of similar contracts, would rarely generate a material loss in relation to the financial statements as a whole. [IFRS 17.BC79].
A set or series of insurance contracts with the same or a related counterparty may achieve, or be designed to achieve, an overall commercial effect. In those circumstances, it may be necessary to treat the set or series of contracts as a whole in order to report the substance of such contracts. For example, if the rights or obligations in one contract do nothing other than entirely negate the rights or obligations of another contract entered into at the same time with the same counterparty, the combined effect is that no rights or obligations exist. [IFRS 17.9]. This requirement is intended to prevent entities entering into contracts that individually transfer significant insurance risk, but collectively do not, and accounting for part(s) of what is effectively a single arrangement as (an) insurance contract(s).
If an insurance contract is separated into non-insurance components and insurance components (see 4 below) the significance of insurance risk transferred is assessed by reference only to the remaining components of the host insurance contract. [IFRS 17.13].
An insurer can accept significant insurance risk from a policyholder only if it issues an insurance contract to an entity separate from itself. Therefore, ‘self insurance’, such as a self-insured deductible where the insured cannot claim for losses below the excess limit of an insurance policy, is not insurance because there is no insurance contract with a third party. [IFRS 17.B27(c)]. Accounting for self insurance and related provisions is covered by IAS 37 which requires that a provision is recognised only if there is a present obligation as a result of a past event, if it is probable that an outflow of resources will occur and a reliable estimate can be determined. [IAS 37.14].
A mutual insurer accepts risk from each policyholder and pools that risk. Although policyholders bear the pooled risk collectively in their capacity as owners, the mutual has still accepted the risk that is the essence of an insurance contract and therefore IFRS 17 applies to those contracts. [IFRS 17.B16]. Accounting for insurance contracts issued by mutual entities is discussed at 8.11 below.
Where there are insurance contracts between entities in the same group, these would be eliminated in the consolidated financial statements as required by IFRS 10 – Consolidated Financial Statements. If any intragroup insurance contract is reinsured with a third party that is not part of the group, this third party reinsurance contract should be accounted for as a direct insurance contract in the consolidated financial statements of a non-insurer because the intragroup contract will be eliminated on consolidation. This residual direct insurance contract (i.e. the policy with the third party) is outside the scope of IFRS 17 from the viewpoint of the consolidated financial statements of a non-insurer because policyholder accounting is excluded from IFRS 17 as discussed at 2.3.1.G above.
The ‘significant additional amounts’ described at 3.2 above refer to the present value of amounts that exceed those that would be payable if no insured event occurred (excluding scenarios that lack commercial substance). These additional amounts include claims handling and claims assessment costs, but exclude: [IFRS 17.B21]
It follows from this that if a contract pays a death benefit exceeding the amount payable on survival (excluding any waiver or surrender charges as per (b) above), the contract is an insurance contract unless the additional death benefit is insignificant (judged by reference to the contract rather than to an entire portfolio of contracts). Similarly, an annuity contract that pays out regular sums for the rest of a policyholder's life is an insurance contract, unless the aggregate life-contingent payments are insignificant. In this case, the insurer could suffer a significant loss on an individual contract if the annuitant survives longer than expected. [IFRS 17.B23].
In September 2018, the TRG members considered an IASB staff paper which discussed whether a contract that contains a provision that waives the payment of a premium under certain circumstances is an insurance contract. In these cases, the main insured event in the contract differs from the event triggering a premium waiver (for example, the primary coverage may be a term life contract coverage mortality risk and premiums are waived if the policyholder has been disabled for six consecutive months, although the policyholder continues to receive the benefits originally promised under the insurance contract despite the waiver of premiums). The TRG members agreed with the IASB staff analysis and observed that:
This is because the risk of the events giving rise to the waiver exists before the contract is issued. It is not a risk created by the contract and the contract does not increase the potential adverse effects. In addition, the events that trigger a waiver are contractual pre-conditions without which the entity can deny the waiver.
The TRG members observed that the consequences of such a waiver of premiums are:
In April 2019, in response to a submission to the TRG, the IASB staff clarified that, to the extent that a premium waiver results from an insured event, it is a claim and therefore recognised as an insurance service expense.8
IFRS 17 requires the assessment of whether a contract transfers significant insurance risk to be made only once. The Basis for Conclusions states that this assessment is made ‘at inception’. [IFRS 17.BC80]. We interpret this phrase to mean that the assessment is made when the contract is issued rather than the start of the coverage period since a contract can be recognised at an earlier date than the start of the coverage period (see 6 below).
As the assessment of significant insurance risk is made only once, a contract that qualifies as an insurance contract remains an insurance contract until all rights and obligations are extinguished, i.e. discharged, cancelled or expired, unless the contract is derecognised because of a modification (see 12.1 below). [IFRS 17.B25]. This applies even if circumstances have changed such that insurance contingent rights and obligations have expired. The IASB considered that requiring insurers to set up systems to continually assess whether contracts continue to transfer significant insurance risk imposed a cost that far outweighed the benefit that would be gained from going through the exercise. [IFRS 17.BC80]. For a contract acquired in a business combination or transfer, the assessment of whether the contract transfers significant insurance risk is made at the date of acquisition or transfer (see 13 below).
For some contracts, the transfer of insurance risk to the issuer occurs after a period of time, as explained in the following example: [IFRS 17.B24]
In April 2019, an IASB staff paper presented to the TRG, confirmed that contracts that transfer insurance risk only after an option is exercised does not meet the definition of an insurance contract at inception and an entity should consider the requirements of other IFRSs in order to account for such contracts until they become insurance contracts. A contract which only transfers insurance risk after a period of time is different to an insurance contract that provides an option to add further insurance coverage.9
Some stakeholders suggested to the IASB that a contract should not be accounted for as an insurance contract if the insurance-contingent rights and obligations expire after a very short time. IFRS 17 addresses aspects of this by requiring scenarios that lack commercial substance are ignored in the assessment of significant insurance risk and stating that there is no significant transfer of insurance risk in some contracts that waive surrender penalties on death (see 3.2.3 above). [IFRS 17.BC81].
Uncertainty (or risk) is the essence of an insurance contract. Accordingly, IFRS 17 requires at least one of the following to be uncertain at the inception of an insurance contract: [IFRS 17.B3]
An insured event will be one of the following:
This last type of insured event above arises from ‘retroactive’ contracts, i.e. those providing insurance coverage against events which have occurred prior to the policy inception date. An example is a reinsurance contract that covers a direct policyholder against adverse development of claims already reported by policyholders. In those contracts, the insured event is the determination of the ultimate cost of those claims. The implications of this on measurement is discussed at 8.9.2 below.
Some insurance contracts require or permit payments to be made in kind. In such cases, the entity provides goods or services to the policyholder to settle the entity's obligation to compensate the policyholder for insured events. Such contracts are insurance contracts, even though the claims are settled in kind, and are treated the same way as insurance contracts when payment is made directly to the policyholder. For example, some insurers replace a stolen article directly rather than compensating the policyholder for the amount of its loss. Another example is when an entity uses its own hospitals and medical staff to provide medical services covered by the insurance contract. [IFRS 17.B6].
Although these are insurance contracts, if they meet the conditions for fixed-fee service contracts (see 2.3.2 above) entities can elect to apply either IFRS 15 or IFRS 17.
The definition of an insurance contract refers to ‘insurance risk’ which is defined as ‘risk, other than financial risk, transferred from the holder of a contract to the issuer’. [IFRS 17 Appendix A].
A contract that exposes the reporting entity to financial risk without significant insurance risk is not an insurance contract. [IFRS 17.B7]. ‘Financial risk’ is defined as ‘the risk of a possible future change in one or more of a specified interest rate, financial instrument price, foreign exchange rate, index of prices or rates, credit rating or credit index or other variable, provided in the case of a non-financial variable that variable is not specific to a party to the contract’. [IFRS 4 Appendix A].
An example of a non-financial variable that is not specific to a party to the contract is an index of earthquake losses in a particular region or an index of temperatures in a particular city. An example of a non-financial variable that is specific to a party to the contract is the occurrence or non-occurrence of a fire that damages or destroys an asset of that party. Furthermore, the risk of changes in the fair value of a non-financial asset is not a financial risk if the fair value reflects changes in the market prices for such assets (i.e. a financial variable) and the condition of a specific non-financial asset held by a party to the contract (i.e. a non-financial variable). For example, if a guarantee of the residual value of a specific car exposes the guarantor to the risk of changes in that car's condition, that risk is insurance risk, not financial risk. [IFRS 17.B8]. This is illustrated by the following example:
Contracts that expose the issuer to both financial risk and significant insurance risk can be insurance contracts. For example, many life insurance contracts guarantee a minimum rate of return to policyholders, creating financial risk, and at the same time promise death benefits that may significantly exceed the policyholder's account balance, creating insurance risk in the form of mortality risk. Such contracts are insurance contracts. [IFRS 17.B9].
Under some contracts, an insured event triggers the payment of an amount linked to a price index. Such contracts are insurance contracts provided that the payment contingent on the insured event could be significant. This is illustrated by the following example: [IFRS 17.B10]
The definition of an insurance contract requires that risk is transferred from the policyholder to the insurer. This means that the insurer must accept, from the policyholder, a risk to which the policyholder was already exposed. Any new risk created by the contract for the entity or the policyholder is not insurance risk. [IFRS 17.B11].
For a contract to be an insurance contract the insured event must have an adverse effect on the policyholder. [IFRS 17.B12]. In other words, there must be an ‘insurable interest’. [IFRS 17.BC73].
The IASB considered whether it should eliminate the notion of insurable interest and replace it with the notion that insurance involves assembling risks into a pool in which they can be managed together. [IFRS 17.BC74]. However, the IASB decided to retain the notion of insurable interest contained in IFRS 4 because without the reference to ‘adverse effect’ the definition might have captured any prepaid contract to provide services with uncertain costs. In addition, the notion of insurable interest is needed to avoid including gambling in the definition of insurance. Furthermore, the definition of an insurance contract is a principle-based distinction, particularly between insurance contracts and those used for hedging. [IFRS 17.BC75].
The adverse effect on the policyholder is not limited to an amount equal to the financial impact of the adverse event. So, for example, the definition includes ‘new for old’ insurance coverage that pays the policyholder an amount that permits the replacement of a used or damaged asset with a new asset. Similarly, the definition does not limit payment under a life insurance contract to the financial loss suffered by a deceased's dependents, nor does it preclude the payment of predetermined amounts to quantify the loss caused by a death or accident. [IFRS 17.B12].
A contract that requires a payment if a specified uncertain event occurs which does not require an adverse effect on the policyholder as a precondition for payment is not an insurance contract. Such contracts are not insurance contracts even if the holder of the contract uses the contract to mitigate an underlying risk exposure. For example, if the holder of the contract uses a derivative to hedge an underlying financial or non-financial variable correlated with the cash flows from an asset of the entity, the derivative is not conditional on whether the holder is adversely affected by a reduction in the cash flows from the asset. Conversely, the definition of an insurance contract refers to an uncertain future event for which an adverse effect on the policyholder is a contractual precondition for payment. This contractual precondition does not require the insurer to investigate whether the uncertain event actually caused an adverse effect, but it does permit the insurer to deny payment if it is not satisfied that the event caused an adverse effect. [IFRS 17.B13].
The following example illustrates the concept of an adverse effect on the policyholder:
Lapse or persistency risk (the risk that the policyholder will cancel the contract earlier or later than the issuer had expected in pricing the contract) is not insurance risk. This is because the resulting variability in the payment to the policyholder is not contingent on an uncertain future event that adversely affects the policyholder. [IFRS 17.B14].
Similarly, expense risk (the risk of unexpected increases in the administrative costs incurred by the issuer associated with the serving of a contract, rather than in the costs associated with insured events) is not insurance risk because an unexpected increase in expenses does not adversely affect the policyholder. [IFRS 17.B14].
Therefore, a contract that exposes an entity to lapse risk, persistency risk or expense risk is not an insurance contract unless it also exposes the entity to significant insurance risk. [IFRS 17.B15].
If the issuer of a contract which does not contain significant insurance risk mitigates the risk of that contract by using a second contract to transfer part of that first contract's risk to another party, this second contract exposes that other party to insurance risk. This is because the policyholder of the second contract (the issuer of the first contract) is subject to an uncertain event that adversely affects it and thus it meets the definition of an insurance contract. [IFRS 17.B15]. This is illustrated by the following example:
This section contains examples given in IFRS 17 of insurance and non-insurance contracts.
The following are examples of contracts that are insurance contracts, if the transfer of insurance risk is significant: [IFRS 17.B26]
These examples are not intended to be an exhaustive list.
The following illustrative examples, based on examples contained previously in IFRS 4, provide further guidance on situations where there is significant insurance risk:
The following are examples of transactions that are not insurance contracts: [IFRS 17.B27]
An entity should apply other IFRSs, such as IFRS 9 and IFRS 15, to the contracts described above. [IFRS 17.B28].
The credit-related guarantees and credit insurance contracts referred to above can have various legal forms, such as that of a guarantee, some types of letters of credit, a credit default contract or an insurance contract. As discussed at 2.3.1.E above, those contracts are insurance contracts if they require the issuer to make specified payments to reimburse the holder for a loss that the holder incurs because a specified debtor fails to make payment when due to the policyholder applying the original or modified terms of a debt instrument. However, such insurance contracts are excluded from the scope of IFRS 17 unless the issuer has previously asserted explicitly that it regards the contracts as insurance contracts and has used accounting applicable to insurance contracts. [IFRS 17.B29].
Credit-related guarantees and credit insurance contracts that require payment, even if the policyholder has not incurred a loss on the failure of the debtor to make payments when due, are outside the scope of IFRS 17 because they do not transfer significant insurance risk. Such contracts include those that require payment: [IFRS 17.B30]
The following examples, based on examples contained previously in IFRS 4, illustrate further situations where IFRS 17 is not applicable.
Insurance contracts may contain one or more components that would be within the scope of another IFRS if they were separate contracts. Such components may be embedded derivatives, distinct investment components or promises to provide distinct goods and non-insurance service components.
IFRS 17 requires an insurer to identify and separate distinct components in certain circumstances. When separated, those components must be accounted for under the relevant IFRS instead of under IFRS 17. [IFRS 17.10]. The IASB considers that accounting for such components separately using other applicable IFRSs makes them more comparable to similar contracts that are issued as separate contracts and allows users of financial statements to better compare the risks undertaken by entities in different business or industries. [IFRS 17.BC99].
Therefore, an insurer should:
After separating the distinct components described above, an entity should apply IFRS 17 to all remaining components of the host insurance contract. [IFRS 17.13]. The recognition and measurement criteria of IFRS 17 are discussed at 6 below.
This is illustrated by the following decision tree:
IFRS 17 requires an entity to apply IFRS 9 to determine whether to account separately for some derivatives embedded in hybrid contracts.
IFRS 9 requires that an embedded derivative should be separated from its host contract and accounted for as a derivative if, and only if:
A derivative embedded in an insurance contract is considered to be closely related to the host insurance contract if the embedded derivative and host insurance contract are so interdependent that an entity cannot measure the embedded derivative separately (i.e. without considering the host contract). [IFRS 9.B4.3.8(h)].
The diagram below illustrates the embedded derivative decision tree.
The Board believes that accounting separately for some embedded derivatives in insurance contracts: [IFRS 17.BC104]
IFRS 4 had previously required IAS 39 to be applied to derivatives embedded in a host insurance contract unless the embedded derivative was itself an insurance contract. [IFRS 4.7]. By applying IFRS 9 to determine whether an embedded derivative needs to be separated, the Board replaced this option of separating an embedded derivative that was an insurance contract with a prohibition from separating such closely related embedded derivatives from the host contract. This is because the Board concluded that when embedded derivatives are closely related to the host insurance contract, the benefits of separating those embedded derivatives fail to outweigh the costs (and, under IFRS 17 such embedded derivatives are measured using current market-consistent information). [IFRS 17.BC105(a)]. In practice, this change is unlikely to have a measurement impact because any separated insurance component would also be measured under IFRS 17.
IFRS 17 has also removed the exception in IFRS 4 which allowed an insurer not to separate and measure at fair value, a policyholder's option to surrender an insurance contract for a fixed amount (or for an amount based on a fixed amount and an interest rate), even if the exercise price differed from the carrying amount of the host insurance liability. [IFRS 4.8]. Instead, the requirements of IFRS 9 are used to determine whether an entity needs to separate a surrender option. [IFRS 17.BC105(b)]. However, the value of a typical surrender option and the host insurance contract are likely to be interdependent because one component cannot be measured without the other. Therefore, in practice, this change may not result in separation of the surrender option.
A derivative is a financial instrument within the scope of IFRS 9 with all three of the following characteristics:
An embedded derivative is a component of a hybrid contract that also includes a non-derivative host with the effect that some of the cash flows of the combined instrument vary in a way similar to a stand-alone derivative. An embedded derivative causes some or all of the cash flows that otherwise would be required by the contract to be modified according to a specified interest rate, financial instrument price, commodity price, foreign exchange rate, index of prices or rates, credit rating or credit index, or other variable, provided in the case of a non-financial variable that the variable is not specific to a party to the contract. A derivative that is attached to a financial instrument but is contractually transferable independently of that instrument, or has a different counterparty, is not an embedded derivative, but a separate financial instrument. [IFRS 9.4.3.1].
The following are examples of embedded derivatives that may be found in insurance contracts:
The following example illustrates an embedded derivative in an insurance contract that is not required to be separated and accounted for under IFRS 9.
The following example illustrates an embedded derivative in an insurance contract that is required to be separated and accounted for under IFRS 9.
The meaning of ‘closely related’ is discussed more generally in Chapter 46 at 5.
A unit-linking feature (i.e. a contractual term that requires payments denominated in units of an internal or external investment fund) embedded in a host financial instrument or host insurance contract is closely related to the host instrument or host contract if the unit-denominated payments are measured at current unit values that reflect the fair values of the assets of the fund. [IFRS 9.B4.3.8(g)].
IFRS 9 also considers that unit-linked investment liabilities should normally be regarded as puttable instruments that can be put back to the issuer at any time for cash equal to a proportionate share of the net asset value of an entity, i.e. they are not closely related. Nevertheless, the effect of separating an embedded derivative and accounting for each component is to measure the hybrid contract at the redemption amount that is payable at the reporting date if the unit holder had exercised its right to put the instrument back to the issuer. [IFRS 9.B4.3.7]. This seems somewhat to contradict the fact that the unit-linked feature is regarded as closely related (which means no separation of the feature is required) but the accounting treatment is substantially the same.
IFRS 4 referred to the notion of a deposit component, [IFRS 4.10‑12]. IFRS 17 does not refer to a deposit component but, instead, introduces the new concept of an investment component.
IFRS 17 requires distinct investment components to be separated from the host insurance contract and accounted for under IFRS 9. Investment components that are not distinct are accounted for under IFRS 17. However, investment components accounted for under IFRS 17 are excluded from the insurance service result (i.e. they are not accounted for as either insurance revenue or insurance service expenses). [IFRS 17.85].
The ED proposes that the definition of an investment component be amended to state that an investment component is ‘the amounts that an insurance contract requires the entity to repay to a policyholder in all circumstances, regardless of whether an insured event occurs.’ The existing definition is that an investment component ‘is the amounts that an insurance contract requires the entity to repay to a policyholder even if an insured event does not occur’. [IFRS 17 Appendix A]. The Board decided to amend the definition because the explanation of an insurance component in the Basis for Conclusions was not entirely captured by the wording of the definition. For example, a contract may require an entity to pay an amount to a policyholder if the policyholder surrenders the contract during the coverage period. However, no amount is payable to the policyholder if the contract continues to the end of the coverage period without a claim being made. If the policyholder surrenders the contract, a payment is made even if the insured event does not occur. It was not the IASB's intention that such a contract should be regarded as including an investment component10
At the April 2019 meeting of the TRG, the TRG members considered that, in assessing whether a contract requires the entity to repay amounts in all circumstances, an entity considers the following factors:
The following examples illustrate how the revised definition proposed in the ED applies in practice:12
Many insurance contracts have an implicit or explicit investment component that would, if it were a separable financial instrument, be within the scope of IFRS 9. However, the Board decided that it would be difficult to routinely separate such investment components from insurance contracts. [IFRS 17.BC108].
Accordingly, IFRS 17 requires an entity to separate from a host insurance contract an investment component if, and only if, that investment component is distinct from the host insurance contract. [IFRS 17.11(b)]. The Board concluded that, in all cases, entities would be able to measure the stand-alone value for a separated investment component by applying IFRS 9. [IFRS 17.BC109].
The words ‘if, and only if’ mean that voluntary separation of investment components which are not distinct is prohibited. This is a change from IFRS 4, which permitted voluntary unbundling of deposit components if the deposit component could be measured separately. The Board considered whether to permit an entity to separate a non-insurance component when not required to do so by IFRS 17; for example, some investment components with interrelated cash flows, such as policy loans. Such components may have been separated when applying previous accounting practices. However, the Board concluded that it would not be possible to separate in a non-arbitrary way a component that is not distinct from the insurance contract nor would such a result be desirable. The Board also noted that when separation ignores interdependencies between insurance and non-insurance components, the sum of the values of the components may not always equal the value of the contract as a whole, even on initial recognition. That would reduce the comparability of the financial statements across entities. [IFRS 17.BC114].
An investment component is distinct if, and only if, both the following conditions are met: [IFRS 17.B31]
An investment component and an insurance component are highly interrelated if, and only if: [IFRS 17.B32]
The requirements above are illustrated by the following examples.
The following example is taken from Example 4 accompanying IFRS 17: [IFRS 17.IE43‑51].
At the April 2019 meeting of the TRG, the TRG members observed that, in their view, the hurdle for separation of investments components from an insurance contract is high.13
The requirements in IFRS 17 for separating investment components do not specifically address the issue of contracts artificially separated through the use of side letters, the separate components of which should be considered together. However, IFRS 17 does state that it may be necessary to treat a set or series of contracts as a whole in order to report the substance of such contracts. For example, if the rights or obligations in one contract do nothing other than entirely negate the rights or obligations of another contract entered into at the same time with the same counterparty, the combined effect is that no rights or obligations exist (see 3.2.2 above). [IFRS 17.9].
Although an entity applies IFRS 17 to account for both the combined investment and insurance components of an insurance contract if those components are highly interrelated, insurance revenue and insurance service expenses presented in profit or loss must exclude any non-separated investment component. [IFRS 17.85, BC108(b)].
IFRS 17 does not explain how to determine the amount of non-distinct investment components that an entity is required to exclude from insurance revenue and insurance service expense.
This issue was discussed at the April 2019 meeting of the TRG. The IASB staff observed that there could be circumstances in which the investment component is not explicitly identified by the contractual terms or where the amount of the investment component varies over time. The staff observed that, in these circumstances an approach for determining the investment component that is based on a present value basis as at the time of making this determination would be consistent with the requirements of paragraph B21 of IFRS 17, which refers to the present value of significant additional amounts that result in a contract being defined as an insurance contract (see 3.2.3 above). The staff consider that if the amounts that would be payable if no insurance event had occurred are determined on a present value basis, it would be consistent to determine the investment component on a present value basis too.
The TRG members observed that:
The TRG members also observed that if an entity uses an explicit surrender amount for determining the amounts to be excluded from insurance revenue and insurance service expense, it should not be required to determine whether a part of that amount reflects a premium refund. The TRG members noted that both an investment component and a premium refund will be excluded from revenue and expenses recognised from a contract in these circumstances.14
It is observed in the Basis for Conclusions that non-distinct investment components need be identified only at the time revenue and incurred claims are recognised, so as to exclude the investment components so identified. [IFRS 17.BC34]. However, as a result of the proposal in the ED that the contractual service margin in the general model may be determined by considering both insurance coverage and investment return service, if any (see 8.7.2 below), for some contracts an entity might also need to determine whether an insurance contract includes a non-distinct investment component before an incurred claim is recognised.
However, despite the fact that insurance revenue and insurance service expenses excludes any non-distinct investment component, the contractual service margin for a group of insurance contracts without direct participation features is adjusted for any differences between any investment component expected to become payable in the period and the investment component that becomes payable in the period (except for the effect of the time value of money and financial risk) measured at the discount rates applying at the date of initial recognition (see 8.6.3 below). [IFRS 17.B96].
After applying IFRS 9 to embedded derivatives and separating a distinct investment component from a host insurance contract, an entity is required to separate from the host insurance contract any promise to transfer distinct goods or services other than insurance contract services (words in italics proposed by ED) to a policyholder by applying the requirements of IFRS 15 for a contract that is partially within the scope of IFRS 15 and partially within the scope of other standards. [IFRS 17.12]. See Chapter 27 at 3.5.
This means that, on initial recognition, an entity should: [IFRS 17.12]
The allocation of the cash flows between the host insurance contract and the distinct good or non-insurance service should be based on the stand-alone selling price of the components. The Board believes that in most cases entities would be able to determine an observable stand-alone selling price for the bundled goods or services if those components meet the separation criteria. [IFRS 17.BC111]. If the stand-alone selling price is not directly observable, an entity would need to estimate the stand-alone selling price of each component to allocate the transaction price. This stand-alone selling price might not be directly observable if the entity does not sell the insurance and the goods or components separately, or if the consideration charged for the two components together differs from the stand-alone selling prices for each component. In this case, applying IFRS 15 results in any discounts and cross-subsidies being allocated to components proportionately or on the basis of observable evidence. [IFRS 17.BC112]. IFRS 17 requires that cash outflows should be allocated to their related component, and that cash outflows not clearly related to one of the components should be systematically and rationally allocated between components. Insurance acquisition cash flows and some fulfilment cash flows relating to overhead costs do not clearly relate to one of the components. A systematic and rational allocation of such cash flows is consistent with the requirements in IFRS 17 for allocating acquisition and fulfilment cash flows that cover more than one group of insurance contracts to the individual groups of contracts, and is also consistent with the requirements in other IFRSs for allocating the costs of production – the requirements in IFRS 15 and IAS 2 – Inventories, for example. [IFRS 17.BC113].
For the purpose of separation an entity should not consider activities that an entity must undertake to fulfil a contract unless the entity transfers a good or service to the policyholder as those activities occur. For example, an entity may need to perform various administrative tasks to set up a contract. The performance of those tasks does not transfer a service to the policyholder as the tasks are performed. [IFRS 17.B33].
A good or non-insurance service promised to a policyholder is distinct if the policyholder can benefit from the good or service either on its own or together with other resources readily available to the policyholder. Readily available resources are goods or services that are sold separately (by the entity or by another entity), or resources that the policyholder has already got (from the entity or from other transactions or events). [IFRS 17.B34].
A good or non-insurance service that is promised to the policyholder is not distinct if: [IFRS 17.B35]
The Board considered, but rejected, the possibility to separate non-insurance components that are not distinct because it would not be possible to separate in a non-arbitrary way a component that is not distinct from the insurance contract nor would such a result be desirable. [IFRS 17.BC114].
The following example, based on Example 5 accompanying IFRS 17, illustrates the requirements for separating non-insurance components from insurance contracts. [IFRS 17.IE51‑55].
IFRS 17 defines the level of aggregation to be used for measuring insurance contracts and their related profitability. This is a key issue in identifying onerous contracts and in determining the recognition of profit or loss and presentation in the financial statements.
The starting point for aggregation is a portfolio of insurance contracts. A portfolio comprises contracts that are subject to similar risks and are managed together. [IFRS 17.14].
Once an entity has identified its portfolios of insurance contracts it should divide, on initial recognition, each portfolio, at a minimum, into the following three ‘buckets’ referred to as groups: [IFRS 17.16]
This can be illustrated as follows:
Groups of contracts are established at initial recognition and are not reassessed. [IFRS 17.24]. An entity is permitted, but not required to subdivide contracts into further groups based on information from its internal reporting, if that information meets certain criteria. [IFRS 17.21].
An entity is prohibited from grouping contracts issued more than one year apart (except in certain circumstances when applying IFRS 17 for the first time – see 17.3 and 17.4 below).
Current practices applied under IFRS 4 for recognising losses from onerous contracts are likely to be based on wider groupings of contracts than those required by IFRS 17. For example, liability adequacy tests are often applied at product or legal entity level. We believe the level of aggregation requirements under IFRS 17 will lead to a more granular grouping and, as such, the requirements under IFRS 17 are likely to result in earlier identification of losses compared to current reporting under IFRS 4.
A portfolio comprises contracts that are subject to similar risks and managed together. Contracts have similar risks if the entity expects their cash flows will respond similarly in amount and timing to changes in key assumptions. Contracts within a product line would be expected to have similar risks and, thus, would be in the same portfolio if they are managed together. Contracts in different product lines (for example, single premium fixed annuities as opposed to regular-term life assurance) would not be expected to have similar risks and would be in different portfolios. [IFRS 17.14].
Deciding which contracts have ‘similar risks’ will be a matter of judgement. Many insurance products provide a basic level of insurance cover with optional ‘add-ons’ (or ‘riders’) at the discretion of the policyholder. For example, a home contents insurance policy may provide legal costs protection or additional accidental damage cover at the policyholder's discretion in return for additional premiums. The question therefore arises as to the point at which policies of a similar basic type have been tailored to the level at which the risks have become dissimilar. Riders that are issued and priced separately from the host insurance contract may need to be accounted for as separate contracts.
Insurers may combine different types of products or coverages that have different risks into one insurance contract. Examples include a contract that includes both life insurance and motor insurance and a contract that includes both pet insurance and home insurance. In some situations, separation of a single insurance contract into separate risk components may be required for regulatory reporting purposes. Although IFRS 17 provides guidance on separating non-insurance components within an insurance contract (see 4 above) the standard is silent as to whether an insurance contract can be separated into different insurance components (i.e. allocated to different portfolios for aggregation purposes) and, if so, the basis for such a separation.15
This issue was discussed at the February 2018 meeting of the TRG. The TRG members discussed the analysis of an IASB staff paper and observed that:
The TRG members also observed that considerations that might be relevant in the assessment of whether the legal form of a single contract reflects the substance of its contractual rights and contractual obligations include:
The TRG members considered that an example of when it may be appropriate to override the presumption that a single legal contract is the lowest unit of account is when more than one type of insurance cover is included in one legal contract solely for the administrative convenience of the policyholder and the price is simply the aggregate of the standalone prices for the different insurance covers provided.16
The inverse situation of separating components of insurance contracts (see 5.1.1 above) is consideration as to when insurance contracts might need to be combined.
This issue was discussed at the May 2018 meeting of the TRG. The TRG members discussed the analysis of an IASB staff paper and observed that:
The TRG members also observed that the principles for combining insurance contracts in paragraph 9 of IFRS 17 are consistent with the principles for separating insurance components from a single contract, as discussed at the February 2018 meeting of the TRG (see 5.1.1 above).
A group of insurance contracts is the main unit of account which determines measurement and presentation. Measurement of insurance contracts occurs at the group level within each portfolio (see 7 below) and each portfolio, to the extent relevant, will consist usually of a minimum of three separate groups. IFRS 17, as issued in May 2017, also requires that insurance contracts are aggregated in the statement of financial position at group level. However, the ED proposes that contracts are aggregated in the statement of financial position at portfolio level (see 14 below).
An entity will typically enter into transactions for individual contracts, not groups, and therefore IFRS 17 includes requirements that specify how to recognise groups that include contracts issued in more than one reporting period (see 6 below) and how to derecognise contracts from within a group (see 12.3 below). [IFRS 17.BC139].
The Board concluded that groups should be established on the basis of profitability in order to avoid offsetting of profitable and unprofitable contracts because information about onerous contracts provided useful information about an entity's pricing decisions. [IFRS 17.BC119].
Once groups are established at initial recognition an entity should not reassess the composition of the groups subsequently. [IFRS 17.24]. A group of contracts should comprise a single contract if that is the result of applying the requirements. [IFRS 17.23].
An entity need not determine the grouping of each contract individually. If an entity has reasonable and supportable information to conclude that all contracts in a set of contracts will be in the same group, it may perform the classification based on a measurement of this set of contracts (‘top-down’). If the entity does not have such reasonable and supportable information, it must determine the group to which contracts belong by evaluating individual contracts (‘bottom-up’). [IFRS 17.17].
Dividing a portfolio into the three minimum groups on inception based on an assessment of profitability will require judgement, using quantitative factors, qualitative factors or a combination of such factors. For example, identifying (sets of) contracts that can be grouped together could require some form of expected probability-weighted basis of assessment as insurance contracts are measured on this basis (see 8 below). Alternatively, it may be possible to do this assessment based on the characteristics of the types of policyholders that are more or less prone to make claims than other types of policyholders (e.g. based on age, gender, geographical location or occupation). This assessment is therefore likely to represent a significant effort for insurers and is likely to be different to any form of aggregation used previously under IFRS 4 when many entities will not have performed aggregation at a level lower than portfolio.
ium allocation approach, an entity should assess whether contracts that are not onerous at initial recognition or have no significant possibility of becoming onerous: [IFRS 17.19]
The objective of the requirement to identify contracts that are onerous at initial recognition is to identify contracts that are onerous measured as individual contracts. An entity typically issues individual contracts and it is the characteristics of the individual contracts that determine how they should be grouped. However, the Board concluded this does not mean that the contracts must be measured individually. If an entity can determine, using reasonable and supportable information, that a set of contracts will all be in the same group, the entity can measure that set to determine whether the contracts are onerous or not, because there will be no offsetting effects in the measurement of the set. The same principle applies to the identification of contracts that are not onerous at initial recognition and that have no significant possibility of becoming onerous subsequently – the objective is to identify such contracts at an individual contract level, but this objective can be achieved by assessing a set of contracts if the entity can conclude using reasonable and supportable information that the contracts in the set will all be in the same group. [IFRS 17.BC129].
In a paper submitted to the TRG in May 2018, the IASB staff observed that the term ‘no significant possibility’ (of becoming onerous) should be interpreted in the context of the objective of the requirement. The objective is to identify contracts with no significant possibility of becoming onerous at initial recognition in order to group such contracts separately from contracts that are onerous at initial recognition and any remaining contracts in the portfolio that are not onerous at initial recognition. ‘No significant possibility of becoming onerous’ is different from ‘significant insurance risk’ and the concept of significant insurance risk should not be used by analogy.17
If contracts within a portfolio would fall into different groups only because law or regulation specifically constrains the entity's practical ability to set a different price or level of benefits for policyholders with different characteristics, the entity may include these contracts in the same group. [IFRS 17.20]. This expedient has been provided because the Board concluded that it would not provide useful information to group separately contracts that an entity is required by law or regulation to group together for determining the pricing or level of benefits. In the Board's opinion, all market participants will be constrained in the same way, particularly if such entities are unable to provide insurance coverage solely on the basis of differences in that characteristic. [IFRS 17.BC132]. However, the expedient should not be applied by analogy to other items. [IFRS 17.20]. For example, an entity might set the price for contracts without considering differences in a specific characteristic because it believes using that characteristic in pricing may result in a law or regulation prohibiting its use in the future or because doing so is likely to fulfil a public policy objective. These practices, sometimes referred to as ‘self-regulatory practices’, do not qualify for grouping exception caused by regulatory constraints. [IFRS 17.BC133].
An entity is permitted, but not required, to subdivide the above groups into further groups based on information from its internal reporting, if that information meets certain criteria. For example, an entity may choose to divide portfolios into more groups that are not onerous at initial recognition if the entity's internal reporting provides information that distinguishes different levels of profitability or different possibilities of contracts becoming onerous after initial recognition. [IFRS 17.21].
This can be illustrated as follows:
Each group (or sub-group) of insurance contracts is measured separately (whether under the general model discussed at 8 below, the premium allocation approach discussed at 9 below, reinsurance contracts held discussed at 10 below or the variable fee approach discussed at 11.2 below).
An entity is prohibited from grouping contracts issued (emphasis added) more than one year apart (except in certain circumstances when grouping insurance contracts on transition using either the modified retrospective approach or the fair value approach – see 17.3 and 17.4 below, respectively). To achieve this, the entity should, if necessary, further divide the minimum groups based on profitability. [IFRS 17.22]. One way to divide the groups is to use an annual period that coincides with an entity's financial reporting period (e.g. contracts issued between 1 January and 31 December comprise a group for an entity with an annual reporting period ending 31 December). This is illustrated below. However, IFRS 17 does not require any particular approach and entities are also not required to use a twelve-month period when grouping insurance contracts.
In April 2019, the IASB discussed the inclusion of the word ‘issued’ and agreed with a staff proposal to reject a change from ‘issued’ to ‘recognised’. In doing so, the Board confirmed that it intended annual cohorts to be determined based on the date of issue of the contract and not the date of recognition. If an entity issues profitable contracts for coverage that does not start for several years and premiums are not due until the coverage starts, the date of recognition will be several years after the date of issue. This means, for example, that a profitable contract issued on 1 January 2022 which has a one-year coverage period beginning 1 January 2022 will be in the same annual cohort (i.e. group) as a profitable contract issued on 1 January 2022 which has a one-year coverage period beginning on 1 January 2025 (assuming both contracts are part of the same portfolio). However, a profitable contract issued on 1 January 2023 (within the same portfolio) with a one-year coverage period will be in a different group to the other contracts as it was issued more than one year apart from the issue date of the other two contracts.
The IASB staff acknowledge that the use of the term ‘issued’ has consequences for the practical relief available for determining the discount rate at the date of initial recognition of the group, since the weighted average discount rates used only cover the period that the contracts were issued which cannot exceed one year (see 8.3 below). The IASB staff observed that these effects are a consequence of the unit of account being the group of insurance contracts rather than the individual contract, and an entity could choose to further divide the annual cohort and thereby avoid these effects.18
The prohibition on grouping together contracts issued more than one year apart is one of the more contentious requirements of IFRS 17. It was included because the Board was concerned that, without it, entities could have perpetually open portfolios and this could lead to a loss of information about the development of profitability over time, could result in the contractual service margin persisting beyond the duration of contracts in the group and consequently could result in profits not being recognised in the correct periods. [IFRS 17.BC136]. Some stakeholders have expressed the view that the level of aggregation requirements artificially segregate portfolios and will not properly depict business performance, and this particularly applies to applying the annual cohort requirement to insurance contracts with risk sharing between different generations of policyholders. As a result, the IASB reconsidered the IFRS 17 aggregation requirements in March 2019 but tentatively decided that the requirements should be unchanged.19
To measure a group of contracts, an entity may estimate the fulfilment cash flows (see 8.1 below) at a higher level of aggregation than the group or portfolio provided the entity is able to include the appropriate fulfilment cash flows in the measurement of the group by allocating such estimates to groups of contracts. [IFRS 17.24].
For a group of insurance contracts to which the premium allocation approach applies (see 9 below), an entity assesses aggregation of insurance contracts as discussed at 5.2 above except that the entity should assume that no contracts in the portfolio are onerous at initial recognition unless facts and circumstances indicate otherwise. [IFRS 17.18].
An entity should assess whether contracts that are not onerous at initial recognition have no significant possibility of becoming onerous subsequently by assessing the likelihood of changes in applicable facts and circumstances.
An entity should recognise a group of insurance contracts (and reinsurance contracts) it issues from the earliest of the following: [IFRS 17.25]
If there is no contractual due date, the first payment from the policyholder is deemed to be due when it is received. An entity is required to determine whether any contracts form a group of onerous contracts before the earlier of the first two dates above (i.e. before the earlier of the beginning of the coverage period and the date when the first payment from a policyholder in the group is due) if facts and circumstances indicate there is such a group. [IFRS 17.26]. IFRS 17, as issued in May 2017, states that in recognising a group of insurance contracts in a reporting period, an entity should include only those contracts issued by the end of the reporting period. [IFRS 17.28]. The word ‘issued’ is a drafting error of the original standard and the ED proposes that in recognising a group of insurance contracts in a reporting period an entity shall include only contracts that individually meet one of the recognition criteria (see above) applied to each contract. This clarifies that an individual contract has to initially be recognised and measured at a time which is specific to the contract. This means that the date of initial recognition of an individual contract added to a group of insurance contracts has to be determined for that individual insurance contract using the measurement assumptions at that date rather than determined by the date of initial recognition of the group to which individual contracts will be added.
An entity may include (proposed ED text in italics) more contracts in the group after the end of a reporting period (subject to the constraint that contracts within a group cannot be issued more than a year apart – see 5.2.1 above). An entity shall add contracts to the group in the reporting period in which the contracts meet the recognition criteria set out above, applied to each contract individually subject to the guidance on the level of aggregation discussed at 5 above. [IFRS 17.28]. For reinsurance contracts issued and held, the group consists of the reinsurance contracts, not the underlying direct contracts which are subject to the reinsurance.
This can be illustrated by the following examples.
Examples 56.22 to 56.24 above demonstrate how the period of a group of insurance contracts may differ from year to year depending on whether the group is onerous and when the first contract premium is due. This is important because contracts issued more than one year apart cannot be in the same group (see 5.2.1 above). This means that groups of insurance contracts (which, in substance, contain the same policyholders being insured for the same risk) may have slightly different coverage periods from year to year.
An entity may include more contracts in a group after the end of a reporting period. This could result in a change to the determination of the discount rates at the date of initial recognition since discount rates may be determined using weighted average rates over the period that contracts in the group are issued (see 8.3 below). An entity should apply the revised discount rates from the start of the reporting period in which the new contracts are added to the group. There is no retrospective ‘catch-up’ adjustment. [IFRS 17.28]. The effect of any change in average discount rates is recognised prospectively.
IFRS 17, as issued in May 2017, states that, in some cases, an entity will pay or receive insurance acquisition cash flows for contracts issued or expected to be issued prior to the date of recognition of the group of insurance contracts to which those insurance acquisition cash flows are attributable (unless the insurer chooses to recognise these as expenses or income under the premium allocation approach – see 9.1 below). In these circumstances an insurer should recognise an asset or a liability for these cash flows (i.e. a prepayment or an accrual). When the group of insurance contracts to which the insurance acquisition cash flows are allocated is recognised the prepayment or accrual should be derecognised (because the insurance acquisition cash flows are now recognised as part of the cash flows of the group of insurance contracts). [IFRS 17.27].
As a result of concerns expressed by stakeholders regarding the accounting for non-refundable commissions (see 8.1.4 below), the ED proposes to delete paragraph 27 of IFRS 17 (above) and require an entity to recognise the following insurance acquisition cash flows as assets:
An entity should derecognise an asset initially recognised applying the requirements above when insurance acquisition cash flows allocated to the group of insurance contracts are included in the measurement of the group. If the entity recognises in a reporting period only some of the insurance contracts expected to be included in the group, the entity should determine the related portion of the asset for insurance acquisition cash flows for the group on a systematic and rational basis considering the expected timing of the recognition of contracts in the group. The entity should derecognise that portion of the asset and include it in the measurement of the group of insurance contracts as discussed at 8.5 below.20
Impairment of insurance acquisition cash flow assets is discussed at 8.10 below.
It should be observed that, except for certain contracts accounted for using the premium allocation approach, these proposed requirements would be mandatory (i.e. insurers must defer such costs and recognise an asset).
IFRS 17 has a default approach to measuring groups of insurance contracts (which is the unit of account for measurement as discussed at 5 above) described in this publication as the ‘general model’. The general model does not distinguish between so-called short duration and long duration (or life and non-life) insurance contracts. It also does not distinguish between insurance products.
IFRS 17 also includes modifications and a simplification to the general model that are applicable in specific circumstances.
The basic revenue recognition principle under IFRS 17 is that no profit is recognised on initial recognition of a group of insurance contracts, but that a loss must be recognised if the group of contracts is onerous (see 6 above for the timing of initial recognition). Subsequently, profit is recognised as services are performed under the contract.
The general model measures a group of insurance contracts as the sum of the following components, or ‘building blocks’, for each group of insurance contracts: [IFRS 17.32]
This can be illustrated in the diagram below.
After initial recognition of a group of insurance contracts, the carrying amount of the group at each reporting date is the sum of:
the group at that date; and
The components of the liability for remaining coverage and the liability for incurred claims are as follows:
The general model is discussed further at 8 below.
An entity should apply the general model to all groups of insurance contracts except as follows: [IFRS 17.29]
IFRS 17 states that when applying IAS 21 – The Effects of Changes in Foreign Exchange Rates – to a group of insurance contracts that generate cash flows in a foreign currency, an entity should treat the group of contracts, including the contractual service margin, as a monetary item. [IFRS 17.30]. The Basis for Conclusions observes that the contractual service margin (see 8.5 below) might otherwise be classified as non-monetary, because it is similar to a prepayment for goods and services. However, in the Board's view, it was simpler to treat all components of the measurement of an insurance contract in the same way and, since the measurement in IFRS 17 is largely based on cash flow estimates, the Board concluded that it was more appropriate to view the insurance contract as a whole as a monetary item. [IFRS 17.BC277].The Board's conclusion that the insurance contract is a monetary item does not change if an entity measures a group of insurance contracts using the simplified approach (i.e. the premium allocation approach) for the measurement of the liability for the remaining coverage. [IFRS 17.BC278].
Treating insurance contracts as monetary items means that groups of insurance contracts in a foreign currency are retranslated to the entity's functional currency using the exchange rate applying at each reporting date. Exchange differences arising on retranslation are accounted for in profit or loss. IFRS 4 contained no similar assertion and therefore many insurers, following the guidance on monetary and non-monetary items in IAS 21, treated unearned premium provisions (i.e. deferred revenue) and deferred acquisition costs in a foreign currency as non-monetary items and did not retranslate these balances subsequent to initial recognition.
IFRS 17 does not provide any further guidance on accounting for the contractual service margin if a group of contracts generates cash flows in multiple currencies.
Neither IAS 21 nor IFRS 17 specify where exchange differences on insurance contract liabilities should be presented in the statement of financial performance and, as discussed in Chapter 15 at 10.1, entities should apply judgement to determine the appropriate line item(s) in which exchange differences are recorded.
As explained at 7.1 above, the general model is based on the following building blocks for each group of insurance contracts: [IFRS 17.32]
The contractual service margin is released to profit or loss over the period that services are provided to the policyholder. Therefore, at initial recognition, no profit will be recognised. However, a loss will be recognised if the group of contracts is onerous at the date that the group is determined to be onerous (see 6 above). Onerous contracts are discussed at 8.8 below. The contractual service margin for insurance contracts with direct participation features is adjusted over the service period in a different way from the contractual service margin for insurance contracts without direct participation features. Contracts with direct participation features are discussed at 11.2 below. Once the contractual service margin is utilised, the group of insurance contracts will be measured using only the fulfilment cash flows.
The following diagram illustrates the relationship of the movements in the components of the general model and their relationship with the presentation in profit or loss (discussed at 15 below).
Establishing the boundary of a contract is crucial as it determines the cash flows that will be included in its measurement.
Estimates of cash flows in a scenario should include all cash flows within the boundary of an existing contract and no other cash flows. In determining the boundary of a contract an entity should consider its substantive rights and obligations and whether they arise from a contract, law or regulation (see 3.1 above). [IFRS 17.B61].
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 insurance contract services. A substantive obligation to provide insurance contract services (words in italics proposed by ED) ends when: [IFRS 17.34]
A liability or asset relating to expected premiums or expected claims outside the boundary of the insurance contract should not be recognised. Such amounts relate to future insurance contracts. [IFRS 17.35]. However, the ED proposes that an asset may be recognised for acquisition cash flows that relate to the insurance contracts that are expected to arise from renewal of insurance contracts in that group (see 8.1.4 below).
IFRS 17 does not explicitly state whether the boundary condition relating to repricing for risk refers to insurance risk only or whether it also reflects other types of risk under the contract. At the February 2018 meeting of the TRG, the TRG members noted that paragraph (b) above should be read as an extension of the risk assessment in paragraph (a) above from the individual to portfolio level, without extending policyholder risks to all types of risks and considerations applied by an entity when pricing a contract. The TRG members observed that the IASB staff noted that policyholder risk includes both the insurance risk and the financial risk transferred from the policyholder to the entity and therefore excludes lapse risk and expense risk as these are not risks which are transferred by the policyholder.21
In April 2019, the IASB staff responded to a TRG submission by confirming that the reference to a ‘portfolio of insurance contracts’ in the substantive obligation criteria above means the same as a ‘portfolio of insurance contracts’ as defined in IFRS 17 (i.e. it should not be interpreted at a more granular level).22
When an issuer of an insurance contract is required by the contract to renew or otherwise continue the contract, it should assess whether premiums and related cash flows that arise from the renewed contract are within the boundary of the original contract. [IFRS 17.B63].
An entity has the practical ability to set a price at a future date (a renewal date) that fully reflects the risk in the contract from that date in the absence of constraints that prevent the entity from setting the same price it would for a new contract with the same characteristics as the existing contract issued on that date, or if it can amend the benefits to be consistent with the price it will charge. Similarly, an entity has the practical ability to set a price when it can reprice an existing contract so that the price reflects overall changes in the risks in a portfolio of insurance contracts, even if the price set for each individual policyholder does not reflect the change in risk for that specific policyholder. When assessing whether the entity has the practical ability to set a price that fully reflects the risks in the contract or portfolio, it should consider all the risks that it would consider when underwriting equivalent contracts on the renewal date for the remaining coverage. In determining the estimates of future cash flows at the end of a reporting period, an entity should reassess the boundary of an insurance contract to include the effect of changes in circumstances on the entity's substantive rights and obligations. [IFRS 17.B64].
It is acknowledged in the Basis for Conclusions that it may be more difficult to decide the contract boundary if the contract binds one party more tightly than the other. Examples of circumstances in which it is more difficult are: [IFRS 17.BC162]
The assessment of the contract boundary is made in each reporting period. This is because an entity updates the measurement of the group of insurance contracts to which the individual contract belongs and, hence, the portfolio of contracts in each reporting period. For example, in one reporting period an entity may decide that a renewal premium for a portfolio of contracts is outside the contract boundary because the restriction on the entity's ability to reprice the contract has no commercial substance. However, if circumstances change so that the same restrictions on the entity's ability to reprice the portfolio take on commercial substance, the entity may conclude that future renewal premiums for that portfolio of contracts are within the boundary of the contract. [IFRS 17.BC164].
The following examples illustrate the application of the contract boundary.
In February 2018, the TRG discussed an IASB staff paper which analysed specific fact patterns of two insurance contracts where the insurance entity assesses the risk at the level of a portfolio of insurance contracts and not at an individual contract level. The TRG members noted that, in the specific fact patterns, the entity can reset the premiums of the portfolios to which both of the example contracts belong annually to reflect the reassessed risk of those portfolios. The entity has the practical ability to reassess the risks of the specific portfolio of insurance contracts that contains the contract and, as a result, can set a price that fully reflects the risk of that portfolio and therefore meets the requirements of (b)(i) above. Additionally, premiums increase in line with age each year based on the step-rated table – i.e. the contract does not charge level premiums, consequently the staff analysis assumes that the requirements in (b)(ii) above are also met. Accordingly, for those two situations discussed at the TRG meeting, the cash flows resulting from the renewal terms should not be included within the boundary of the existing insurance contract. However, the TRG members observed that if, conversely, the fact patterns of the two contracts described in the submission was changed such that the entity instead has a practical ability to reassess risks only at a general level (for example, at a portfolio level) and, as a result, can set a price for the portfolio of insurance contracts that contains the contract (for example, using a step-rate table for the portfolio) then this would provide the individual policyholders within the portfolios with a substantive right and consequently, the cash flows resulting from these renewal terms should be included within the boundary of the existing contract. The TRG members also observed that the two situations described in the IASB staff paper are for specific fact patterns. In practice, the features of contracts and their repricing might be different from those examples. The facts and circumstance of each contract should be assessed to reach an appropriate conclusion applying the requirements of IFRS 17.23
In September 2018, the TRG members discussed an IASB staff paper which considered how to account for cash flows of an insurance contract issued that, at initial recognition, are outside the boundary of the contract when facts or circumstances change over time. In particular, the staff paper considered the interaction between the statement in paragraph 35 of IFRS 17 that cash flows outside the boundary of a contract at initial recognition are cash flows of a new contract and the final sentence of paragraph B64 which permits an entity to re-assess the boundary of an insurance contract to include the effect of changes in circumstances. The IASB staff observed that:
The TRG members agreed with the IASB staff observations, but noted the apparent conflict between the two paragraphs which stems from a lack of clarity of the meaning of paragraph B64. IASB staff observed that the meaning of the last sentence in paragraph B64 should be considered in the context of the preceding sentences in paragraph B64, paragraphs B61-B63 and the Basis for Conclusions. The TRG members also expressed different views as to the applicability of the distinction between paragraphs 35 and B64 of IFRS 17 in circumstances where cash flows that are outside the contract boundary at initial recognition relate to an additional type of coverage that may be provided over the coverage period of the contract.24
In September 2018, the IASB staff discussed a question submitted to the TRG regarding a type of entity in which parties become members by purchasing an insurance contract. Members of the entity are also provided with free additional insurance coverage. The entity can cancel the free additional insurance coverage at any time and the question arises as to whether cash flows related to the free additional coverage are within the boundary of the insurance contracts purchased by policyholders. The IASB staff concluded that the right of an entity to cancel coverage at any time means that the entity does not have a substantive obligation to provide future service related to the free additional insurance coverage. The expected cash flows related to future free additional insurance coverage are therefore not included in the boundary of the insurance contract and are not included in the liability for remaining coverage. If the entity has a substantive obligation for the free additional insurance coverage that has already been provided, such as unpaid claims, the cash flows related to that coverage are within the boundary of the contract and are included in the liability for incurred claims.25
In May 2018, the TRG discussed an IASB staff paper that analysed how to determine the contract boundary of insurance contracts that include an option to add insurance coverage at a later date. The TRG members observed that:
In April 2019, the IASB staff considered a TRG submission which described a feature that provides a policyholder of a contract that lapsed (due to failure to pay premiums) an option to reinstate the contract within a contractually specified period, as long as the contract had not been surrendered. In the fact pattern, the entity may agree to reinstate the contract only after new underwriting, but once agreed the contractual premium is not repriced, the premiums for previous periods are paid and the coverage is reinstated. The IASB staff declined to provide further analysis of the specific transaction but observed that an entity should assess whether its substantive obligation to provide services ends when a contract with such features lapses applying the criteria set out at 8.1 above (and discussed further above) and that cash flows related to the unexpired portion of the coverage period, such as the expected reinstatement of contracts, are part of the liability for remaining coverage.27
In May 2018, the TRG discussed an IASB staff paper which addresses what constraint or limitations, other than those arising from the terms of an insurance contract, would be relevant in assessing the practical ability of an entity to reassess the risks of the particular policyholder (or of the portfolio of insurance contracts that contains the contract) and set a price or level of benefits that fully reflects those risks. The TRG members observed that:
The TRG members also observed that an entity should apply judgement to decide whether commercial considerations are relevant when considering the contract boundary requirements of IFRS 17.28
In September 2018, the TRG members considered an IASB staff paper which discussed a submission about the boundary of a contract for an agreement between an entity and an association or bank (referred to as a group insurance policy) under which the entity provides insurance coverage to members of an association or to customers of a bank (referred to as ‘certificate holders’).
In the case of group association policies, the insurance entity has a policy with an association or bank to sell insurance coverage to individual members or customers. Although the legal contract is between the entity and the association or bank, the insurance coverage for each certificate holder is priced as if it were an individual contract. In the case of group creditor policies with a bank, the entity can sell insurance coverage to individual customers of the bank. These policies have the same facts and circumstances as the group association policy, other than insurance cover being linked to the remaining outstanding balance of the loan or mortgage issued by the bank to the certificate holder. The entity pays the remining outstanding loan balance to the bank when an insured event occurs (rather than the certificate holder or their beneficiaries who are liable for paying the outstanding balances). In the fact pattern submitted, the entity can terminate the policy with a 90-day notice period. In such arrangements, the question arises as to whether the cash flows related to periods after the notice period of 90 days are within the boundary of an insurance contract and is the policyholder the bank or association or is it the individual certificate holders?
The TRG members agreed with the analysis and conclusion of the staff paper including the steps that an entity should perform in its analysis and observed that:
The TRG members also observed that in practice there are many group insurance contracts with different terms and the assessment of whether a group insurance policy arrangement reflects a single insurance contract or multiple insurance contracts should be applied to group insurance policies considering all relevant facts and circumstances.29
Accounting for the payment of insurance acquisition cash flows on insurance contracts which are expected to last for many years but where the contract boundary is much shorter may cause a profit or loss mismatch. For example, an insurer may pay significant up-front insurance acquisition cash flows in the first year of a contract on the basis that the contract will last for a number of years but the contract boundary may be only one year (for example, because of the reasons explained in Example 56.25 above). In some cases, part of the commission is refundable from the agent if the future renewals do not occur as expected. In other circumstances the commission is not refundable.
A discussion at the February 2018 TRG meeting identified that some stakeholders were concerned about the effect of the IFRS 17 requirement to attribute such non-refundable commissions only to the group which contained the new contract (the impact of which was to make the group of contracts onerous).30 Consequently, the issue was re-debated by the IASB in January 2019. The Board was persuaded that an amendment to IFRS 17, so that an entity allocates insurance acquisition cash flows to expected future renewals of contracts, would provide useful information to users and that the payment of these commissions creates an asset that is expected to be recovered through expected renewals of contracts.
Therefore, the ED proposes to amend IFRS 17 to require an entity to:
The IASB did not develop specific requirements on how to allocate part of the acquisition cash flows to anticipated contract renewals. This on the grounds that IFRS 17 already provides guidance on allocating cash flows and the benefits of developing additional further requirements would risk adding complexity for both preparers and users of financial statements and might result in a rules-based approach that would achieve an outcome that is appropriate only in some circumstances.31
This results in an accounting outcome similar to that of IFRS 15, which requires the recognition of an asset for the incremental costs of obtaining a contract with a customer. However, the proposal results in an entity recognising an asset for a wider range of costs compared to IFRS 15 due to the different definition of insurance acquisition cash flows in IFRS 17 (which the IASB did not want to modify).
A distinction can be made when an insurer has paid an intermediary separately for exclusivity or future services as these costs are not attributable to an insurance contract and these payments would be outside the scope of IFRS 17 and may be within the scope of another IFRS.
Contract boundary issues related to reinsurance contracts held are discussed at 10.2 below.
The first element of the building blocks in the general model discussed at 8 above is an estimate of the future cash flows over the life of each contract.
This assessment should include all the future cash flows within the boundary of each contract (see 8.1 above). [IFRS 17.33]. However, the fulfilment cash flows should not reflect the non-performance risk (i.e. own credit) of the entity. [IFRS 17.31]. As discussed at 5 above, an entity is permitted to estimate the future cash flows at a higher level of aggregation than a group and then allocate the resulting fulfilment cash flows to individual groups of contracts.
The estimates of future cash flows should: [IFRS 17.33]
The objective of estimating future cash flows is to determine the expected value, or probability-weighted mean, of the full range of possible outcomes, considering all reasonable and supportable information available at the reporting date without undue cost or effort. Reasonable and supportable information available at the reporting date without undue cost or effort includes information about past events and current conditions, and forecasts of future conditions. Information available from an entity's own information systems is considered to be available without undue cost or effort. [IFRS 17.B37].
The estimates of future cash flows must be on an expected value basis and therefore should be unbiased. This means that they should not include any additional estimates above the probability-weighted mean for ‘uncertainty’, ‘prudence’ or what is sometimes described as a ‘management loading’. Separately, a risk adjustment for non-financial risk (see 8.4 below) is determined to reflect the compensation for bearing the non-financial risk resulting from the uncertain amount and the timing of the cash flows.
The starting point for an estimate of future cash flows is a range of scenarios that reflects the full range of possible outcomes. Each scenario specifies the amount and timing of the cash flows for a particular outcome, and the estimated probability of that outcome. The cash flows from each scenario are discounted and weighted by the estimated probability of that outcome to derive an expected present value. Consequently, the objective is not to develop a most likely outcome, or a more-likely-than-not outcome, for future cash flows. [IFRS 17.B38].
When considering the full range of possible outcomes, the objective is to incorporate all reasonable and supportable information available without undue cost or effort in an unbiased way, rather than to identify every possible scenario. In practice, developing explicit scenarios is unnecessary if the resulting estimate is consistent with the measurement objective of considering all reasonable and supportable information available without undue cost or effort when determining the mean. For example, if an entity estimates that the probability distribution of outcomes is broadly consistent with a probability distribution that can be described completely with a small number of parameters, it will be sufficient to estimate the smaller number of parameters. Similarly, in some cases, relatively simple modelling may give an answer within an acceptable range of precision, without the need for many detailed simulations. However, in some cases, the cash flows may be driven by complex underlying factors and may respond in a non-linear fashion to changes in economic conditions. This may happen if, for example, the cash flows reflect a series of interrelated options that are implicit or explicit. In such cases, more sophisticated stochastic modelling is likely to be necessary to satisfy the measurement objective. [IFRS 17.B39].
The scenarios developed should include unbiased estimates of the probability of catastrophic losses under existing contracts. Those scenarios exclude possible claims under possible future contracts. [IFRS 17.B40]. Therefore, consistent with IFRS 4 (see Chapter 55 at 7.2.1), catastrophe provisions and equalisation provisions (provisions generally build up over years following a prescribed regulatory formula which are permitted to be released in years when claims experience is high or abnormal) are not permitted to the extent that they relate to contracts that are not in force at the reporting date. Although IFRS 17 prohibits the recognition of these provisions as a liability, it does not prohibit their segregation as a component of equity. Consequently, insurers are free to designate a proportion of their equity as an equalisation or catastrophe provision. When a catastrophe or equalisation provision has a tax base but is not recognised in the IFRS financial statements, then a taxable temporary difference will arise that should be accounted for under IAS 12 – Income Taxes.
An entity should estimate the probabilities and amounts of future payments under existing contracts on the basis of information obtained including: [IFRS 17.B41]
Many insurance contracts have features that enable policyholders to take actions that change the amount, timing, nature or uncertainty of the amounts they will receive. Such features include renewal options, surrender options, conversion options and options to stop paying premiums while still receiving benefits under the contracts. The measurement of a group of insurance contracts should reflect, on an expected value basis, the entity's current estimates of how the policyholders in the group will exercise the options available, and the risk adjustment for non-financial risk (see 8.4 below) should reflect the entity's current estimates of how the actual behaviour of the policyholders may differ from the expected behaviour. This requirement to determine the expected value applies regardless of the number of contracts in a group; for example it applies even if the group comprises a single contract. Thus, the measurement of a group of insurance contracts should not assume a 100 per cent probability that policyholders will: [IFRS 17.B62]
It is observed in the Basis for Conclusions that IFRS 17 does not require or allow the application of a deposit floor when measuring insurance contracts. If a deposit floor were to be applied the resulting measurement would ignore all scenarios other than those involving the exercise of policyholder options in the way that is least favourable to the entity. This would contradict the principle that an entity should incorporate in the measurement of an insurance contract future cash flows on a probability-weighted basis. [IFRS 17.BC166]. The expected cash outflows include outflows over which the entity has discretion. [IFRS 17.BC168]. The Board considered whether payments that are subject to the entity's discretion meet the definition of a liability in the Conceptual Framework for Financial Reporting (the Conceptual Framework). The contract, when considered as a whole, clearly meets the Conceptual Framework's definition of a liability. Some components, if viewed in isolation, may not meet the definition of a liability. However, in the Board's view, including such components in the measurement of insurance contracts would generate more useful information for users of financial statements. [IFRS 17.BC169].
IFRS 17 identifies two types of variables that can affect estimates of cash flows: [IFRS 17.B42]
Market variables will generally give rise to financial risk (for example, observable interest rates) and non-market variables will generally give rise to non-financial risk (for example, mortality rates). However, this will not always be the case, there may be assumptions that relate to financial risks for which variables cannot be observed in, or derived directly from, markets (for example, interest rates that cannot be observed in, or derived directly from, markets). [IFRS 17.B43]. Market variables and non-market variables are discussed at 8.2.3.A and 8.2.3.B below, respectively.
Cash flows within the boundary of an insurance contract are those that relate directly to the fulfilment of the contract, including cash flows for which the entity has discretion over the amount or timing.
IFRS 17 provides the following examples of such cash flows: [IFRS 17.B65]
The list of examples of cash flows within the boundary of an insurance contract is more extensive than permitted under many local GAAPs (and hence applied previously under IFRS 4). For example, some local GAAP's permit only incremental costs to be included. Some local GAAPs also permit entities an accounting policy choice in whether or not to treat certain costs as insurance acquisition cash flows (and hence deferred over the policy period). IFRS 17 does not allow a choice as to whether or not to include these cash flows that are within the boundary of the insurance contract.
The Board decided not to include only insurance cash flows that are incremental at a contract level as that would mean that entities would recognise different contractual service margins and expenses depending on the way they structure their acquisition activities. [IFRS 17.BC182(a)]. For example, there would be different liabilities reported if the entity had an internal sales department rather than outsourcing sales to external agents as the costs of an internal sales department, such as fixed salaries, are less likely to be incremental than amounts paid to an agent.
At initial recognition of an insurance contract, the fulfilment cash flows will include estimates for these cash flows. Subsequently, as services are provided under the contract, the liability for remaining coverage is reduced and insurance revenue is recognised except for those changes that do not relate to services provided in the period (premiums received, investment component changes, changes related to transaction-based taxes, insurance finance income or expenses, and insurance acquisition cash flows) – see 15.1 below.
In September 2018, the IASB staff considered a submission to the TRG which asked whether cash flows from insurance contracts with direct participation features that relate to periods when insurance coverage is no longer provided and the policyholder bears all of the risks related to the investment related services are within the boundary of the contract. In particular, if the cash flows within the boundary of the contract extends to include the period in which the investment component exists but no insurance coverage is provided. The IASB staff observed that cash flows within the boundary of a contract may relate to periods in which coverage is no longer provided, such as when claims are expected to be settled in the future that relate to premium within the boundary of the contract and that periods of coverage may be outside the boundary of a contract if, for example, an entity can fully reprice premiums.32
Premium cash flows include premium adjustments and instalment premiums from a policyholder, and any additional cash flows that result from those premiums.
These payments include claims that have already been reported but have not yet been paid (i.e. reported claims), incurred claims for future events that have occurred but for which claims have not been reported (i.e. incurred but not reported or IBNR claims) and all future claims for which an entity has a substantive obligation.
Some insurance contracts give policyholders the right to share in the returns on specified underlying items. Underlying items are items that determine some of the amounts payable to a policyholder. Underlying items can comprise any items; for example, a reference portfolio of assets, the net assets of the entity, or a specified subset of the net assets of the entity. [IFRS 17 Appendix A].
Payments to policyholders that vary depending on returns from underlying items are found most frequently in contracts with participation features. These are discussed at 11 below.
Examples of such derivatives include options and guarantees embedded into the contract, to the extent that those options and guarantees are not separated from the contract (see 4.1 above).
These cash flows comprise an allocation of insurance acquisition cash flows attributable to the portfolio to which the contract belongs.
Insurance acquisition cash flows are 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. Such cash flows include cash flows that are not directly attributable to individual contracts or groups of insurance contracts within the portfolio. [IFRS 17 Appendix A]. See 8.1.4 above for acquisition cash flows outside of the contract boundary.
Based on the proposals in the ED (see 8.1.4 above), an entity allocates insurance acquisition cash flows that are directly attributable to a group of insurance contracts:
There is no restriction of insurance acquisition cash flows to those resulting from successful efforts. So, for example the directly attributable costs of an underwriter of a portfolio of motor insurance contracts do not need to be apportioned between those costs relating to efforts that result in the issuance of a contract and those relating to unsuccessful efforts. The Basis for Conclusions observes that the Board considered whether to restrict insurance acquisition cash flows included in the measurement of a group of insurance contracts to those cash flows directly related to the successful acquisition of new or renewed insurance contracts. However, it was concluded that this was not consistent with an approach that measured profitability of a group of contracts over the duration of the group and, in addition, the Board wanted to avoid measuring liabilities and expenses at different amounts depending on how an entity structures its insurance activities. [IFRS 17.BC183].
Changes in estimates of insurance acquisition cash flows are adjusted against the liability for remaining coverage but do not adjust insurance revenue as they do not relate to services provided by the entity. [IFRS 17.B123]. Separately, insurance revenue related to insurance acquisition cash flows is determined by allocating (or amortising) the portion of the premiums that relates to recovering these cash flows to each reporting period in a systematic way on the basis of passage of time, with a corresponding entry to insurance service expenses (i.e. DR insurance service expense, CR insurance revenue). [IFRS 17.B125]. See 15.1 below.
These are costs that an entity will incur in investigating, processing and resolving claims under existing insurance contracts (as opposed to claim payments to policyholders – see 8.2.1.B above). Claims handling costs include legal and loss adjusters' fees and the internal costs of investigating claims and processing claims payments.
These costs are those related to the type of payments in kind discussed at 3.5 above.
These costs include the costs of billing premiums and handling policy changes (for example, conversions and reinstatements). Such costs also include recurring commissions that are expected to be paid to intermediaries if a particular policyholder continues to pay the premiums within the boundary of the insurance contract.
These include such taxes as premium tax, value added taxes and goods and service taxes and levies (such as fire service levies and guarantee fund assessments) that arise directly from existing insurance contracts, or that can be attributed to them on a reasonable and consistent basis. See also 8.2.1.J below.
Premium or sales taxes are typically billed to the policyholder and then passed onto the tax authorities with the insurer usually acting as an agent for the tax authorities. The cash flows within the contract boundary would therefore include both the tax in-flow and the tax out-flow. Guarantee fund or similar assessments are usually billed to the insurer directly based on a calculation made by the tax authority often derived from the insurer's market share of particular types of insurance business. There is usually only a cash out-flow for these assessments.
Changes in cash flows that relate to transaction-based taxes collected on behalf of third parties (such as premium taxes, value added taxes and goods and services taxes) adjust the liability for remaining coverage but do not adjust insurance revenue as these do not relate to services expected to be covered by the consideration received by the entity. [IFRS 17.B123].
These are payments (and related receipts) made by the insurer to meet tax obligations of the policyholder. In some jurisdictions, the insurer is required to make these payments (e.g. to pay the policyholder's tax on gains made on underlying items). Income tax obligations which are not paid in a fiduciary capacity (e.g. the insurer's own income tax obligations) are not cash flows within the boundary of an insurance contracts. See 8.2.2 below.
Some insurance contracts permit the insurer to sell, usually damaged, property acquired in settling the claim (salvage). The insurer may also have the right to pursue third parties for payment of some or all costs (subrogation). Potential cash inflows from both salvage and subrogation are included with the cash flows of the boundary of an insurance contract and, to the extent that they do not qualify for recognition as separate assets, potential cash inflows from recoveries on past claims.
Fixed and variable overheads included with the cash flows of the boundary of an insurance contract include the directly attributable costs of:
These overheads should be allocated to groups of contracts using methods that are systematic and rational, and are consistently applied to all costs that have similar characteristics.
During deliberations on the ED, the IASB discussed whether the costs of managing assets that form part of underlying items for insurance contracts should be included in the fulfilment cash flows of insurance contracts without direct participation features or insurance contracts with direct participation features. For insurance contracts with direct participation features, an entity is regarded as managing assets on behalf of policyholders. It follows that asset management costs should be regarded as part of the cost of fulfilling the contracts and hence included in the fulfilment cash flows. Similarly, the Board concluded that to the extent an entity determines an investment-return service exists in insurance contracts without direct participation features (see 8.7.2 below), the entity should include cash flows related to the fulfilment of that service in the fulfilment cash flows.34
These are any other costs specifically chargeable to the policyholder under the insurance contract.
Having provided a list of cash flows that are within the boundary of an insurance contract, IFRS 17 then provides a list of cash flows that should not be included when estimating the cash flows that will arise as an entity fulfils an existing insurance contract. These are as follows:
As discussed at 8.2 above, IFRS 17 identifies two types of variables that can affect estimates of cash flows: market variables and non-market variables.
Market variables are variables that can be observed in, or derived directly from markets (for example, prices of publicly traded securities and interest rates).
Estimates of market variables should be consistent with observable market prices at the measurement date. An entity should maximise the use of observable inputs and should not substitute its own estimates for observable market data except in the limited circumstances as permitted by IFRS 13 (see Chapter 14 at 17.1). Consistent with IFRS 13, if variables need to be derived (for example, because no observable market variables exist) they should be as consistent as possible with observable market variables. [IFRS 17.B44].
Market prices blend a range of views about possible future outcomes and also reflect the risk preferences of market participants. Consequently, they are not a single-point forecast of the future outcome. If the actual outcome differs from the previous market price, IFRS 17 argues that this does not mean that the market price was ‘wrong’. [IFRS 17.B45].
An important application of market variables is the notion of a replicating asset or a replicating portfolio of assets. A replicating asset is one whose cash flows exactly match, in all scenarios, the contractual cash flows of a group of insurance contracts in amount, timing and uncertainty. In some cases, a replicating asset may exist for some of the cash flows that arise from a group of insurance contracts. The fair value of that asset reflects both the expected present value of the cash flows from the asset and the risk associated with those cash flows. If a replicating portfolio of assets exists for some of the cash flows that arise from a group of insurance contracts, the entity can use the fair value of those assets to measure the relevant fulfilment cash flows instead of explicitly estimating the cash flows and discount rate. [IFRS 17.B46]. IFRS 17 does not require an entity to use a replicating portfolio technique. However, if a replicating asset or portfolio does exist for some of the cash flows that arise from insurance contracts and an entity chooses to use a different technique, the entity should satisfy itself that a replicating portfolio technique would be unlikely to lead to a materially different measurement of those cash flows. [IFRS 17.B47]. In practice, we believe that the use of a replicating portfolio is likely to be rare as IFRS 17 refers to an asset whose cash flows exactly match those of the liability.
Techniques other than a replicating portfolio technique, such as stochastic modelling techniques, may be more robust or easier to implement if there are significant interdependencies between cash flows that vary based on returns on assets and other cash flows. Judgement is required to determine the technique that best meets the objective of consistency with observable market variables in specific circumstances. In particular, the technique used must result in the measurement of any options and guarantees included in the insurance contracts being consistent with observable market prices (if any) for such options and guarantees. [IFRS 17.B48].
In May 2018, the IASB staff responded to a submission to the TRG which asked whether ‘risk neutral’ (i.e. based on an assumed distribution of scenarios that is intended to reflect realistic assumptions about actual future asset returns) or ‘real world’ (i.e. based on an underlying assumption that, on average, all assets earn the same risk-free return, with a range of scenarios analysed reflecting the assumed volatility of returns for an asset price consistent with volatility implied by option prices) scenarios should be used for stochastic modelling techniques to project future returns on assets. The IASB staff clarified that IFRS 17 does not require an entity to divide estimated cash flows into those that vary based on the returns on underlying items and those that do not (see 8.3 below) and, if not divided, the discount rate should be appropriate for the cash flows as a whole. The IASB staff observed that any consideration beyond this is actuarial (i.e. operational measurement implementation) in nature and therefore does not fall within the remit of the TRG. The TRG members did not disagree with the IASB staff's observations.35
Non-market variables are all other variables (other than market variables) such as the frequency and severity of insurance claims and mortality.
Estimates of non-market variables should reflect all reasonable and supportable evidence available without undue cost or effort, both external and internal. [IFRS 17.B49].
Non-market external data (for example, national mortality statistics) may have more or less relevance than internal data (for example, internally developed mortality statistics), depending on the circumstances. For example, an entity that issues life insurance contracts should not rely solely on national mortality statistics, but should consider all other reasonable and supportable internal and external sources of information available without undue cost or effort when developing unbiased estimates of probabilities for mortality scenarios for its insurance contracts. In developing those probabilities, an entity should give more weight to the more persuasive information. For example: [IFRS 17.B50]
Estimated probabilities for non-market variables should not contradict observable market variables. For example, estimated probabilities for future inflation rate scenarios should be as consistent as possible with probabilities implied by market interest rates. [IFRS 17.B51].
In some cases, an entity may conclude that market variables vary independently of non-market variables. If so, the entity should consider scenarios that reflect the range of outcomes for the non-market variables, with each scenario using the same observed value of the market variable. [IFRS 17.B52].
In other cases, market variables and non-market variables may be correlated. For example, there may be evidence that lapse rates (a non-market variable) are correlated with interest rates (a market variable). Similarly, there may be evidence that claim levels for house or car insurance are correlated with economic cycles and therefore with interest rates and expense amounts. The entity should ensure that the probabilities for the scenarios and the risk adjustments for the non-financial risk that relates to the market variables are consistent with the observed market prices that depend on those market variables. [IFRS 17.B53].
In estimating each cash flow scenario and its probability, an entity should use all reasonable and supportable information available without undue cost or effort. [IFRS 17.B54]. Undue cost and effort is discussed at 17.3 below. [IFRS 17.B54].
An entity should review the estimates that it made at the end of the previous reporting period and update them. In doing so, an entity should consider whether: [IFRS 17.B55]
The probability assigned to each scenario should reflect the conditions at the end of the reporting period. Consequently, applying IAS 10 – Events after the Reporting Period, an event occurring after the end of the reporting period that resolves an uncertainty that existed at the end of the reporting period does not provide evidence of the conditions that existed at that date. For example, there may be a 20 per cent probability at the end of the reporting period that a major storm will strike during the remaining six months of an insurance contract. After the end of the reporting period but before the financial statements are authorised for issue, a major storm strikes. The fulfilment cash flows under that contract should not reflect the storm that, with hindsight, is known to have occurred. Instead, the cash flows included in the measurement include the 20 per cent probability apparent at the end of the reporting period (with disclosure applying IAS 10 that a non-adjusting event occurred after the end of the reporting period). [IFRS 17.B56].
Current estimates of expected cash flows are not necessarily identical to the most recent actual experience. For example, suppose that mortality experience in the reporting period was 20 per cent worse than the previous mortality experience and previous expectations of mortality experience. Several factors could have caused the sudden change in experience, including: [IFRS 17.B57]
An entity should investigate the reasons for the change in experience and develop new estimates of cash flows and probabilities in the light of the most recent experience, the earlier experience and other information. The result for the example above when mortality experience worsened by 20 per cent in the reporting period would typically be that the expected present value of death benefits changes, but not by as much as 20 per cent. However, if mortality rates continue to be significantly higher than the previous estimates for reasons that are expected to continue, the estimated probability assigned to the high-mortality scenarios will increase. [IFRS 17.B57].
Estimates of non-market variables should include information about the current level of insured events and information about trends. For example, mortality rates have consistently declined over long periods in many countries. The determination of the fulfilment cash flows reflects the probabilities that would be assigned to each possible trend scenario, taking account of all reasonable and supportable information available without undue cost or effort. [IFRS 17.B58].
In a similar manner, if cash flows allocated to a group of insurance contracts are sensitive to inflation, the determination of the fulfilment cash flows should reflect current estimates of possible future inflation rates. Because inflation rates are likely to be correlated with interest rates, the measurement of fulfilment cash flows should reflect the probabilities for each inflation scenario in a way that is consistent with the probabilities implied by the market interest rates used in estimating the discount rate (see 8.2.3.A above). [IFRS 17.B59].
When estimating the cash flows, an entity should take into account current expectations of future events that might affect those cash flows. The entity should develop cash flow scenarios that reflect those future events, as well as unbiased estimates of the probability of each scenario. However, an entity should not take into account current expectations of future changes in legislation that would change or discharge the present obligation or create new obligations under the existing insurance contract until the change in legislation is substantively enacted. [IFRS 17.B60].
The second element of the building blocks in the general model (discussed at 8 above) is an adjustment (i.e. discount) to the estimates of future cash flows to reflect the time value of money and the financial risks related to those cash flows, to the extent that the financial risks are not included in the estimates of cash flows.
The discount rates applied to the estimates of the future cash flows should: [IFRS 17.36]
The discount rates calculated according to the requirements above should be determined as follows: [IFRS 17.B72]
Insurance liability measurement component | Discount rate |
Fulfilment cash flows. | Current rate at reporting date. |
Contractual service margin interest accretion for contracts without direct participation features (including insurance and reinsurance contracts issued and reinsurance contracts held). | Rate at date of initial recognition of group. |
Changes in the contractual service margin for contracts without direct participation features (including insurance and reinsurance contracts issued and reinsurance contracts held). | Rate at date of initial recognition of group. |
Changes in the contractual margin for contracts with direct participation features. | A rate consistent with that used for the allocation of finance income or expenses. |
Liability for remaining coverage under premium allocation approach. | Rate at date of initial recognition of group. |
Disaggregated insurance finance income included in profit or loss for groups of contracts for which changes in financial risk do not have a significant effect on amounts paid to policyholders (see 15.3.1 below). | Rate at date of initial recognition of group. |
Disaggregated insurance finance income included in profit or loss for groups of contracts for which changes in financial risk assumptions have a significant effect on amounts paid to policyholders (see 15.3.2 below). | Rate that allocates the remaining revised finance income or expense over the duration of the group at a constant rate or, for contracts that use a crediting rate, uses an allocation based on the amounts credited in the period and expected to be credited in future periods. |
Disaggregated insurance finance income included in profit or loss for groups of contracts applying the premium allocation approach (see 15.3.2 below). | Rate at date of incurred claim. |
For insurance contracts with direct participation features, the contractual service margin is adjusted based on changes in the fair value of underlying items, which includes the impact of discount rate changes (see 11.2 below).
To determine the discount rates at the date of initial recognition of a group of contracts described above an entity may use weighted-average discount rates over the period that contracts in the group are issued, which cannot exceed one year. [IFRS 17.B73]. As explained at 6 above, this can result in a change in the discount rates during the period of the contracts. When contracts are added to a group in a subsequent reporting period (because the period of the group spans two reporting periods) and discount rates are revised, an entity should apply the revised discount rates from the start of the reporting period in which the new contracts are added to the group. [IFRS 17.28]. This means that there is no retrospective catch-up adjustment.
In April 2019, the IASB staff responded to a submission to the TRG which asked how to account for a discrepancy between:
The IASB staff observed that entities which apply the other comprehensive income disaggregation option use the discount rates determined at the date of initial recognition to determine the amounts recognised in profit or loss using a systematic allocation. An entity is permitted to use weighted-average discount rates over the period that contracts in a group are issued to determine the discount rate at the date of initial recognition of a group of contracts. The weighted average discount rate used should achieve the outcome that the amounts recognised in other comprehensive income over the duration of the group of contracts total zero.36
In May 2018, the IASB staff responded to a submission to the TRG which asked whether, for a group of insurance contracts for which changes in financial risk do not have a substantial effect on the amounts paid to policyholders (and the entity chooses to disaggregate insurance finance income or expenses between profit or loss and other comprehensive income) an entity should use an effective yield rate or a yield curve. The IASB staff stated that, in using the discount rate determined at the date of initial recognition to nominal cash flows that do not vary based on returns from underlying items, IFRS 17 does not mandate the use of an effective yield rate or a yield curve. In response to the IASB staff, a few TRG members commented that using an effective yield compared to using a yield curve could result in a significant difference to insurance finance income or expense to be included in profit or loss over the reporting periods subsequent to initial recognition.37
Estimates of discount rates should be consistent with other estimates used to measure insurance contracts to avoid double counting or omissions; for example: [IFRS 17.B74]
However, discount rates should not reflect the non-performance (i.e. own credit) risk of the entity. [IFRS 17.31].
As explained in the second bullet point above, cash flows that vary based on the returns on underlying items should be discounted using rates that reflect that variability, or to be adjusted for the effect of that variability and discounted at a rate that reflects the adjustment made. The variability is a relevant factor regardless of whether it arises because of contractual terms or because the entity exercises discretion, and regardless of whether the entity holds the underlying items. [IFRS 17.B75].
Cash flows that vary with returns on underlying items with variable returns, but that are subject to a guarantee of a minimum return, do not vary solely based on the returns on the underlying items, even when the guaranteed amount is lower than the expected return on the underlying items. Hence, an entity should adjust the rate that reflects the variability of the returns on the underlying items for the effect of the guarantee, even when the guaranteed amount is lower than the expected return on the underlying items. [IFRS 17.B76]. In May 2018, in response to a submission to the TRG which had asked whether minimum guarantees are reflected through adjusting the discount rate (rather than through adjustments to the cash flows) the IASB staff stated that although IFRS 17 requires the time value of a guarantee to be reflected in the measurement of fulfilment cash flows, it does not require the use of a specific approach to achieve this objective. Financial risk is included in the estimates of future cash flows or the discount rate used to adjust the cash flows. Judgement is required to determine the technique for measuring market variables and that the technique must result in the measurement of any options and guarantees being consistent with observable market prices for such options and guarantees. Any consideration beyond this is actuarial (i.e. operational measurement implementation) in nature. The TRG members did not disagree with the IASB staff's observations.38
IFRS 17 does not require an entity to divide estimated cash flows into those that vary based on the returns on underlying items and those that do not. If an entity does not divide the estimated cash flows in this way, the entity should apply discount rates appropriate for the estimated cash flows as a whole; for example, using stochastic modelling techniques or risk-neutral measurement techniques. [IFRS 17.B77].
Discount rates should include only relevant factors, i.e. factors that arise from the time value of money, the characteristics of the cash flows and the liquidity characteristics of the insurance contracts. Such discount rates may not be directly observable in the market. Hence, when observable market rates for an instrument with the same characteristics are not available, or observable market rates for similar instruments are available but do not separately identify the factors that distinguish the instrument from the insurance contracts, an entity should estimate the appropriate rates. IFRS 17 does not require a particular estimation technique for determining discount rates. In applying an estimation technique, an entity should: [IFRS 17.B78]
For cash flows of insurance contracts that do not vary based on the returns on underlying items, the discount rate reflects the yield curve in the appropriate currency for instruments that expose the holder to no or negligible credit risk, adjusted to reflect the liquidity characteristics of the group of insurance contracts. That adjustment should reflect the difference between the liquidity characteristics of the group of insurance contracts and the liquidity characteristics of the assets used to determine the yield curve. Yield curves reflect assets traded in active markets that the holder can typically sell readily at any time without incurring significant costs. In contrast, under some insurance contracts the entity cannot be forced to make payments earlier than the occurrence of insured events, or dates specified in the contracts. [IFRS 17.B79].
IFRS 17 proposes two methods for determining discount rates for cash flows of insurance contracts that do not vary based on the returns on underlying items as follows:
The ‘bottom-up’ approach determines discount rates by adjusting a liquid risk-free yield curve to reflect the differences between the liquidity characteristics of the financial instruments that underlie the rates observed in the market and the liquidity characteristics of the insurance contracts. [IFRS 17.B80].
The ‘top-down’ approach determines the appropriate discount rates for insurance contracts based on a yield curve that reflects the current market rates of return implicit in a fair value measurement of a reference portfolio of assets. An entity should adjust that yield curve to eliminate any factors that are not relevant to the insurance contracts, but is not required to adjust the yield curve for differences in liquidity characteristics of the insurance contracts and the reference portfolio. [IFRS 17.B81].
In theory, both the ‘top-down’ and ‘bottom-up’ approaches should give the same result although in practice this is not necessarily the case. An example of the approaches giving the same result is illustrated below where the overall liability discount rate is 2.5% in each case. The ‘top down’ approach starts with a current asset yielding 4% and this rate is reduced by 1.5% for expected and unexpected losses while the ‘bottom up’ approach stats with a risk-free rate of 2% which is increased by a liquidity premium of 0.5%.
Assume a current asset yield of a reference instrument of 4% composed of:
In estimating the yield curve on a ‘top down’ basis an entity should use measurement bases consistent with IFRS 13 as follows: [IFRS 17.B82]
In adjusting the yield curve, an entity should adjust market rates observed in recent transactions in instruments with similar characteristics for movements in market factors since the transaction date, and should adjust observed market rates to reflect the degree of dissimilarity between the instrument being measured and the instrument for which transaction prices are observable. For cash flows of insurance contracts that do not vary based on the returns on the assets in the reference portfolio, such adjustments include: [IFRS 17.B83]
In principle, for cash flows of insurance contracts that do not vary based on the returns of the assets in the reference portfolio, there should be a single illiquid risk-free yield curve that eliminates all uncertainty about the amount and timing of cash flows. However, in practice the top-down approach and the bottom-up approach may result in different yield curves, even in the same currency. This is because of the inherent limitations in estimating the adjustments made under each approach, and the possible lack of an adjustment for different liquidity characteristics in the top-down approach. An entity is not required to reconcile the discount rate determined under its chosen approach with the discount rate that would have been determined under the other approach. [IFRS 17.B84].
No restrictions are specified on the reference portfolio of assets used in the top-down approach. However, fewer adjustments would be required to eliminate factors that are not relevant to the insurance contracts when the reference portfolio of assets has similar characteristics. For example, if the cash flows from the insurance contracts do not vary based on the returns on underlying items, fewer adjustments would be required if an entity used debt instruments as a starting point rather than equity instruments. For debt instruments, the objective would be to eliminate from the total bond yield the effect of credit risk and other factors that are not relevant to the insurance contracts. One way to estimate the effect of credit risk is to use the market price of a credit derivative as a reference point. [IFRS 17.B85].
In September 2018, the TRG members discussed an IASB staff paper which responded to a submission that asked whether, in applying a top-down approach to determine the discount rates for insurance contracts with cash flows that do not vary based on the returns of underlying items:
The TRG members agreed with the IASB staff analysis and conclusion in this paper that an entity can use the assets it holds as a reference portfolio when determining a top-down discount rate to measure its insurance liabilities. The TRG members observed that:
Both the IASB staff and the TRG members note that IFRS 17 contains disclosure requirements for qualitative and quantitative information about the significant judgements and changes in those judgements (see 16.2 below) and consider that, if the effect of illiquidity were to be significant, entities would be expected to disclose such information in their financial statements.39
In April 2019, in response to a submission to the TRG, the IASB staff further observed that identifying a reference portfolio that will enable an entity to meet the objectives required for setting a discount rate is dependent on specific facts and circumstances and providing specific application guidance is not within the remit of the TRG.40
Some insurance contracts will have a contract boundary which extends beyond the period for which observable market data is available. In these situations, the entity will have to determine an extrapolation of the discount rate yield curve beyond that period. IFRS 17 provides no specific guidance on the estimation techniques for interest rates in these circumstances. The general guidance above for unobservable inputs is that an entity should use the best information available in the circumstances and adjust that data to reflect all information about market participant assumptions that is reasonably available.
The third element of the building blocks in the general model discussed at 8 above is the risk adjustment for non-financial risk.
The risk adjustment for non-financial risk is the compensation that the entity requires for bearing the uncertainty about the amount and timing of cash flows that arises from non-financial risk. [IFRS 17.37]. Non-financial risk is risk arising from insurance contracts other than financial risk, which is included in the estimates of future cash flows or the discount rate used to adjust the cash flows. The risks covered by the risk adjustment for non-financial risk are insurance risk and other non-financial risks such as lapse rate and expense risk. [IFRS 17.B86].
In theory, the risk adjustment for non-financial risk for insurance contracts measures the compensation that the entity would require to make the entity indifferent between: [IFRS 17.B87]
In developing the objective of the risk adjustment for non-financial risk, the Board concluded that a risk adjustment for non-financial risk should not represent: [IFRS 17.BC209]
To illustrate the objective, the Application Guidance explains that a risk adjustment for non-financial risk would measure the compensation the entity would require to make it indifferent between fulfilling a liability that, because of non-financial risk, has a 50% probability of being CU90 and a 50% probability of being CU110, and fulfilling a liability that is fixed at CU100. As a result, the risk adjustment for non-financial risk conveys information to users of financial statements about the amount charged by the entity for the uncertainty arising from non-financial risk about the amount and timing of cash flows. [IFRS 17.B87].
In addition, because the risk adjustment for non-financial risk reflects the compensation the entity would require for bearing the non-financial risk arising from the uncertain amount and timing of the cash flows, the risk adjustment for non-financial risk also reflects: [IFRS 17.B88]
The purpose of the risk adjustment for non-financial risk is to measure the effect of uncertainty in the cash flows that arise from insurance contracts, other than uncertainty arising from financial risk. Consequently, the risk adjustment for non-financial risk should reflect all non-financial risks associated with the insurance contracts. It should not reflect the risks that do not arise from the insurance contracts, such as general operational risk. [IFRS 17.B89].
The risk adjustment for non-financial risk should be included in the measurement in an explicit way. The risk adjustment for non-financial risk is conceptually separate from the estimates of future cash flows and the discount rates that adjust those cash flows. The entity should not double-count the risk adjustment for non-financial risk by, for example, also including the risk adjustment for non-financial risk implicitly when determining the estimates of future cash flows or the discount rates. The yield curve (or range of yield curves) used to discount cash flows that do not vary based on the returns on underlying items which are required to be disclosed (see 16.1.5 below) should not include any implicit adjustments for non-financial risk. [IFRS 17.B90].
In April 2019, the IASB staff responded to a submission to the TRG which asked whether the risk adjustment for non-financial risk takes into account uncertainty related to how management will apply discretion. The IASB staff observed that the risk adjustment for non-financial risk does not reflect risks that do not arise from insurance contracts such as general operational risk. Uncertainty related to how management applies discretion for a group of insurance contracts, if not considered a general operational risk, should be captured in the risk adjustment for non-financial risk (e.g. to the extent management discretion reduces the amount it would charge for uncertainty, the discretion would reduce the risk adjustment for non-financial risk). The risk adjustment for non-financial risk should reflect favourable and unfavourable outcomes in a way that reflects the entity's degree of risk aversion.41
IFRS 17 does not specify the estimation technique(s) used to determine the risk adjustment for non-financial risk. This is because the Board decided that a principle-based approach, rather than identifying specific techniques, would be consistent with the Board's approach on how to determine a similar risk adjustment for non-financial risk in IFRS 13. Furthermore, the Board concluded that limiting the number of risk-adjustment techniques would conflict with the Board's desire to set principle-based IFRSs and, given that the objective of the risk adjustment is to reflect an entity-specific perception of non-financial risk, specifying a level of aggregation that was inconsistent with the entity's view would also conflict with that requirement. [IFRS 17.BC213].
Therefore, the risk adjustment under IFRS 17 should be determined based on the principle of the compensation that an entity requires for bearing the uncertainty arising from non-financial risk inherent in the cash flows arising from the fulfilment of the group of insurance contracts. According to this principle, the risk adjustment for non-financial risk reflects any diversification benefit the entity considers when determining the amount of compensation it requires for bearing that uncertainty. [IFRS 17.BC214].
Different entities may determine different risk adjustments for similar groups of insurance contracts because the risk adjustment for non-financial risk is an entity specific perception, rather than a market participant's perception, based on the compensation that a particular entity requires for bearing the uncertainty about the amount and timing of the cash flows that arise from the non-financial risks. Accordingly, to allow users of financial statements to understand how entity-specific assessments of risk aversion might differ from entity to entity, disclosure is required of the confidence level used to determine the risk adjustment for non-financial risk or, if a technique other than confidence level is used, the technique used and the confidence level corresponding to the technique (see 16.2 below).
IFRS 17 states that risk adjustment for non-financial risk should have the following characteristics: [IFRS 17.B91]
An entity should apply judgement when determining an appropriate estimation technique for the risk adjustment for non-financial risk. When applying that judgement, an entity should also consider whether the technique provides concise and informative disclosure so that users of financial statements can benchmark the entity's performance against the performance of other entities. [IFRS 17.B92].
It is likely that some entities will want to apply a cost of capital approach technique to estimate the risk adjustment for non-financial risk because this will be the basis of local regulatory capital requirements. It is observed in the Basis for Conclusions that although the usefulness of a confidence level technique diminishes when the probability distribution is not statistically normal, as is often the case for insurance contracts, that the cost of capital approach would be more complicated to calculate than a confidence level disclosure. However, the Board expects that many entities will have the information necessary to apply the cost of capital technique. [IFRS 17.BC217]. This implies that the Board is anticipating some, or perhaps many, entities will use a cost of capital technique to measure the risk adjustment for non-financial risk.
IFRS 17 does not specify the level within an insurance group at which to determine the risk adjustment for non-financial risk. Therefore, the question arises as to whether, in the individual financial statements of a subsidiary, the risk adjustment for non-financial risk should reflect the degree of risk diversification available to the entity or to the consolidated group as a whole and whether, in the consolidated financial statements of a group of entities, the risk adjustment for non-financial risk issued by entities in the group should reflect the degree of risk diversification available only to the consolidated group as a whole. This issue was discussed by the TRG in May 2018 and the results of the discussion were as follows:
Subsequently, the IASB declined to amend IFRS 17 on the grounds that it was considered that the risk adjustment was likely to be the same at both consolidated and individual financial statements in the vast majority of situations.
In September 2018, the TRG members also discussed an IASB staff paper which addressed a submission about the level at which the risk adjustment for non-financial risk should be determined for insurance contracts that are within industry pools managed by an association (i.e. at the association level or the individual member level). In the fact pattern an association manages two industry pools:
The IASB staff considered that there should be only one risk adjustment for each insurance contract and that the risk adjustment is at either at an individual member or an association level depending on who has issued the contract. Consistent with the discussion at the May 2018 TRG meeting above, some TRG members disagreed with the IASB staff's view that there is one single risk adjustment for a group of insurance contracts that reflects the degree of diversification that the issuer of the contract considers in determining the compensation required for bearing non-financial risk. Those TRG members expressed the view that each entity would consider the compensation it would require for non-financial risk, rather than the compensation required by the association. This would mean that the risk adjustment would not necessarily be determined by the entity that issued the contract (e.g. the pool or individual member of the association that priced the risk). As noted above, the IASB does not propose to amend or clarify IFRS 17 on this matter.43
In addition, since IFRS 17 does not specify the level of aggregation at which to determine the risk adjustment for non-financial risk, the question arises as to whether the risk adjustment for non-financial risk could be negative for a group of insurance contracts. This situation could, in theory, arise where a diversification benefit is allocated between two or more groups of insurance contracts and the additional diversification risk for one group may be negative as the insurer would accept a lower price for taking on these liabilities given that it reduces the risk for the entity in total. IFRS 17 is silent as to whether a risk adjustment could be negative.
In April 2019, the IAS staff responded to a TRG submission which questions whether the effect of reinsurance should be considered in calculating the risk adjustment for non-financial risk for contracts that have been reinsured. The IASB staff observed that the risk adjustment for non-financial risk reflects the degree of diversification benefit the entity includes when determining the compensation it requires for bearing that risk. Therefore, if an entity considers reinsurance when determining the compensation it requires for bearing non-financial risk related to underlying insurance contracts, the effect of reinsurance (both cost and benefit) would be reflected in the risk adjustment for non-financial risk of the underlying insurance contracts. The IASB staff further observed that IFRS 17 requires that the risk adjustment for non-financial risk for reinsurance contracts held represents the amount of risk being transferred by the holder of the group of reinsurance contracts to the issuer of those contracts. Therefore, the risk adjustment for non-financial risk of the reinsurance contract held could not be nil, unless:
The TRG members agreed with the IASB staff observations that if an entity considers reinsurance when determining the compensation it requires for non-financial risk, the effect of the reinsurance would be included in the risk adjustment and that the measurement of the risk adjustment for non-financial risk of a reinsurance contract held is the amount of risk transferred to the reinsurer.45
The change in risk adjustment for non-financial risk is not required to be disaggregated between the insurance service result and the insurance finance income or expense. When an entity decides not to disaggregate the change in risk adjustment for non-financial risk, the entire change should be included as part of the insurance service result. [IFRS 17.81].
The fourth element of the building blocks in the general model discussed at 8 above is the contractual service margin. The contractual service margin is a new concept to IFRS, introduced in IFRS 17 to identify the expected profitability of a group of contracts and recognise this profitability over time in an explicit manner, based on the pattern of services provided under the contract.
The contractual service margin is a component of the asset or liability for the group of insurance contracts that represents the unearned profit the entity will recognise as it provides insurance contract services in the future (words in italics proposed by ED). Hence, the contractual service margin would usually be calculated at the level of a group of insurance contracts rather than at an individual insurance contract level.
An entity should measure the contractual service margin on initial recognition of a group of insurance contracts at an amount that, unless the group of contracts is onerous (see 8.8 below), results in no income or expenses arising from: [IFRS 17.38]
Therefore, the contractual service margin on initial recognition, assuming a contract is not onerous, is no more than the balancing number needed to eliminate any day 1 differences and thereby avoiding a day 1 profit being recognised. The contractual service margin cannot depict unearned losses. Instead, IFRS 17 requires an entity to recognise a loss in profit or loss for any excess of the expected present value of the future cash flows above the expected future value of the premium inflows adjusted for risk – see 8.7 below.
The approach above on initial recognition applies to contracts with and without participation features including investment contracts with discretionary features.
For groups of reinsurance contracts held, the calculation of the contractual service margin at initial recognition is modified to take into account the fact that such groups are usually assets rather than liabilities and that a margin payable to the reinsurer rather than making profits is an implicit part of the premium – see 10 below.
A contractual margin is not specifically identified for contracts subject to the premium allocation approach although the same principle of profit recognition (i.e. no day 1 profits) applies – see 9 below.
For insurance contracts acquired in a business combination or transfer the contractual service margin at initial recognition is calculated in the same way except that initial recognition is the date of the business combination or transfer – see 13 below.
The carrying amount of a group of insurance contracts at the end of each reporting period should be the sum of: [IFRS 17.40]
Hence, after initial recognition, the fulfilment cash flows comprise two components:
In some circumstances an incurred claim can create insurance risk for an entity that would not exist if no claim was made. Two examples cited of this situation are:
The question therefore arises whether the entity's obligation to pay these amounts, that are subject to insurance risk, should be treated as a liability for incurred claims or a liability for remaining coverage. One view is that the liability for incurred claims is the entity's obligation to pay for a policyholder's claim (on becoming disabled or upon a fire occurring). The alternative view is that the liability for incurred claims is the policyholder's obligation to settle a claim that has already been made by a policyholder (for a period of disability or to pay for the cost of the house damaged by fire) and the liability for remaining coverage is the obligation to pay claims relating to future events that have not yet occurred (such as future periods of disability or claims relating to fire events that have not occurred). In September 2018, the TRG members discussed an IASB staff paper which argued that both approaches represent valid interpretations of IFRS 17 and are a matter of judgement for the entity as to which interpretation provides the most useful information about the service provided to the policyholder. The TRG members observed that:
Although leaving the decision open to the entity allows preparers to determine which approach provides more useful information given the facts and circumstances around their products, the accounting policy choice may result in identical contracts being accounted for differently in the financial statements of different insurers.
IFRS 17, as issued in 2017, states that the liability for remaining coverage is an entity's obligation to investigate and pay valid claims for insured events that have not yet occurred (i.e. the obligation that relates to the unexpired portion of the coverage period). [IFRS 17 Appendix A].
The ED proposes to amend this definition to state that the liability for remaining coverage is an entity's obligation to
At initial recognition the liability for remaining coverage should include all future cash inflows and outflows under an insurance contract. Subsequently, at each reporting date, the liability for remaining coverage, excluding the contractual service margin, is re-measured using the fulfilment cash flow requirements discussed at 8.2 above. That is, it comprises the present value of the best estimate of the cash flows required to settle the obligation together with an adjustment for non-financial risk. The fulfilment cash flows for the liability for remaining coverage for contracts without direct participation features are discounted at the date of initial recognition of the group (under both the general model and the premium allocation approach where applicable) – see 8.3 above.
Usually, the fulfilment cash flows should reduce over the contract period as the number of future insured events that have not occurred decline. When future insured events can no longer occur then the fulfilment cash flows of the liability for remaining coverage should be nil.
An entity should recognise income and expenses for the following changes in the carrying amount of the liability for remaining coverage: [IFRS 17.41]
When finance income or expense is disaggregated (see 15.3.1 below), the amount of finance income and expense included in profit or loss is:
IFRS 17, as issued in 2017, states that the liability for incurred claims is an entity's obligation to investigate and pay valid claims for insured events that have already occurred, including events that have occurred but for which claims have not been reported, and other incurred insurance expenses. [IFRS 17 Appendix A].
The ED proposes to amend this definition by stating that the liability for incurred claims is an entity's obligation to:
At initial recognition of a group of contracts, the liability for incurred claims is usually nil as no insured events have occurred. Subsequently, at each reporting date, the liability for incurred claims is measured using the fulfilment cash flow requirements discussed at 8.1 above. That is, it comprises the present value of the expected cash flows required to settle the obligation together with an adjustment for non-financial risk.
The liability for incurred claims under the general model, including claims arising from contracts with direct participation features, is discounted at a current rate (i.e. the rate applying as at the reporting date).
When finance income or expense is disaggregated (see 15.3.1 below), the amount of finance income and expense included in profit or loss is:
There is no direct relationship between the liability for incurred claims and the liability for remaining coverage. That is, the creation of a liability for incurred claims (or a reduction in the value of incurred claims) does not necessarily result in an equal and opposite reduction to the liability for remaining coverage. There is no contractual service margin attributable to the liability for incurred claims as the contractual service margin relates to future service and incurred claims relate to past service.
Consequently, the establishment of a liability for incurred claims should give rise to the following accounting entry:
DR | CR | |
Insurance service expense – profit or loss | X | |
Liability for incurred claims | X |
Subsequent to initial recognition, an entity should recognise income and expenses for the following changes in the carrying amount of the liability for incurred claims: [IFRS 17.42]
IFRS 17 does not distinguish between or require separate disclosure of the components of the liability for incurred claims which represent claims notified to the insurer (sometimes described as ‘outstanding claims’) and claims incurred but not reported (sometimes described as ‘IBNR claims’).
Disclosure of the liability for incurred claims is required showing the development of actual claims compared with previous estimates of the liability for incurred claims, except for those claims for which uncertainty about the amount and timing of payments is typically resolved within one year (see 16.3.3 below).
The contractual service margin at the end of the reporting period represents the profit in the group of insurance contracts that has not yet been recognised in profit or loss because it relates to the future service to be provided under the contracts in the group. [IFRS 17.43].
At the end of each reporting period, the carrying amount of the contractual service margin of a group of insurance contracts without direct participation features comprises the carrying amount at the start of the reporting period adjusted for: [IFRS 17.44]
The changes in future cash flows that relate to future events which adjust the contractual service margin for a group of insurance contracts without direct participation features are as follows: [IFRS 17.B96]
The proposed ED amendments were made in order to correct inadvertent omissions from IFRS 17, as issued in May 2017, which:
In February 2018, the IASB staff responded to a submission made to the TRG asking whether the adjustment of the contractual service margin for a difference in the investment component as a result of the acceleration or delay of repayment was appropriate since the contractual service margin is adjusted for changes solely in timing of payments which appears to conflict with the principle underlying insurance revenue recognition by referring to the Board's reasons for this treatment in the Basis for Conclusions.48 It is stated in the Basis for Conclusions that the Board did not regard as useful information, for example, the recognition of a gain for a delay in repaying an investment component accompanied by a loss that adjusts the contractual service margin for the expected later repayment. Acceleration or delay in repayments of investment components only gives rise to a gain or loss for the entity to the extent that the amount of the repayment is affected by its timing. As IFRS 17 does not require an entity to determine the amount of an investment component until a claim is incurred, accordingly, when a claim is incurred, IFRS 17 requires an entity to determine how much of that claim is an investment component, and whether it was expected to become payable in that period. IFRS 17 requires any unexpected repayment of an investment component to adjust the contractual service margin. The contractual service margin will also be adjusted for changes in future estimates of cash flows which will include (but not separately identify) the reduction in future repayments of investment components. This achieves the desired result of the net effect on the contractual service margin being the effect of the change in timing of the repayment of the investment component. [IFRS 17.BC235].
In September 2018, the IASB staff responded to a submission to the TRG as to whether a difference between the expected and actual crediting rate applied to a policyholder's account balance is included in insurance finance income or expenses or adjusts the contractual service margin as above. The question related to an insurance contract without direct participation features for which the account balance is expected to become payable in the future and ignores the effect of any discretion. The IASB staff observed that paragraph 96 of IFRS 17 is applicable for differences between any investment component expected to become payable in the period and the actual investment component that becomes payable in the period. However, in the fact pattern provided, the account balance is not expected to become payable in the period and does not become payable in the period and therefore the requirement to adjust the contractual service margin does not apply in that period.49
The contractual service margin for contracts without direct participation features should not be adjusted for the following changes in fulfilment cash flows because they do not relate to future service: [IFRS 17.B97]
In September 2018, the TRG members discussed an IASB staff paper in respect of a submission which asked how differences between expected premiums and actual premiums (i.e. premium experience adjustments) which relate to current or past service should be accounted for (i.e. should these adjust the contractual service margin or be recognised in the statement of profit or loss immediately as part of either insurance revenue or insurance service expenses). The TRG members agreed with the analysis in the IASB staff paper and observed that:
The TRG members also observed that:
IFRS 17 notes that some changes in the contractual service margin offset changes in the fulfilment cash flows for the liability for remaining coverage, resulting in no change in the total carrying amount of the liability for remaining coverage. To the extent that changes in the contractual service margin do not offset changes in the fulfilment cash flows for the liability for remaining coverage, an entity should recognise income and expenses for the changes, applying the requirements at 8.6.1 above. [IFRS 17.46].
The terms of some insurance contracts without direct participation features give an entity discretion over the cash flows to be paid to policyholders. A change in the discretionary cash flows is regarded as relating to future service, and accordingly adjusts the contractual service margin. To determine how to identify a change in discretionary cash flows, an entity should specify at inception of the contract the basis on which it expects to determine its commitment under the contract; for example, based on a fixed interest rate, or on returns that vary based on specified asset returns. [IFRS 17.B98].
An entity should use that specification to distinguish between the effect of changes in assumptions that relate to financial risk on that commitment (which do not adjust the contractual service margin) and the effect of discretionary changes to that commitment (which adjust the contractual service margin). [IFRS 17.B99].
If an entity cannot specify at inception of the contract what it regards as its commitment under the contract and what it regards as discretionary, it should regard its commitment to be the return implicit in the estimate of the fulfilment cash flows at inception of the contract, updated to reflect current assumptions that relate to financial risk. [IFRS 17.B100].
Determining how to release the contractual service to profit or loss is a key aspect of IFRS 17 and one of the key challenges implementing the standard. Guidance in this area is still developing as at the date of writing this chapter.
The basic principle is that an amount of the contractual service margin for a group of insurance contracts is recognised in profit or loss in each period to reflect the insurance contract services provided under the group of insurance contracts in that period.
The amount recognised in profit or loss is determined by: [IFRS 17.B119]
In February 2018, responding to a submission to the TRG as to how to allocate contractual service margin to coverage units, the IASB staff observed that the contractual service margin is allocated equally to each coverage unit provided in the current period and expected to be provided in the future. Therefore, the allocation is performed at the end of the period, identifying coverage units that were actually provided in the current period and coverage units that are expected at this date to be provided in the future.51
It is observed in the Basis for Conclusions that the Board views the contractual service margin as depicting the unearned profit for coverage and other services provided over the coverage period. Insurance coverage is the defining service provided by insurance contracts and an entity provides this service over the whole of the coverage period, and not just when it incurs a claim. Consequently, the contractual service margin should be recognised over the coverage period in a pattern that reflects the provision of coverage as required by the contract. To achieve this, the contractual service margin for a group of insurance contracts remaining (before any allocation) at the end of the reporting period is allocated over the coverage provided in the current period and expected remaining future coverage, on the basis of coverage units, reflecting the expected duration and quantity of benefits provided by contracts in the group. The Board considered whether: [IFRS 17.BC279]
The Board also considered whether the allocation of the contractual service margin based on coverage units would result in profit being recognised too early for insurance contracts with fees determined based on the returns on underlying items. For such contracts, IFRS 17 requires the contractual service margin to be determined based on the total expected fee over the duration of the contracts, including expectations of an increase in the fee because of an increase in underlying items arising from investment returns and additional policyholder contributions over time. The Board rejected the view that the allocation based on coverage units results in premature profit recognition. The Board noted that the investment component of such contracts is accounted for as part of the insurance contract only when the cash flows from the investment component and from insurance and other services are highly interrelated and hence cannot be accounted for as distinct components. In such circumstances, the entity provides multiple services in return for an expected fee based on the expected duration of contracts, and the Board concluded the entity should recognise that fee over the coverage period as the insurance services are provided, not when the returns on the underlying items occur. [IFRS 17.BC280].
IFRS 17 requires the contractual service margin remaining at the end of the reporting period to be allocated equally to the coverage units provided in the period and the expected remaining coverage units. IFRS 17 does not specify whether an entity should consider the time value of money in determining that equal allocation and consequently does not specify whether that equal allocation should reflect the timing of the expected provision of the coverage units. The Board concluded that should be a matter of judgement by an entity. [IFRS 17.BC282].
Consistent with the requirements in IFRS 15, the settlement of a liability is not considered to be a service provided by the entity. Thus, the recognition period for the contractual service margin is the coverage period over which the entity provides the coverage promised in the insurance contract, rather than the period over which the liability is expected to be settled. The margin the entity recognises for bearing risk is recognised in profit or loss as the entity is released from risk in both the coverage period and the settlement period. For contracts with a coverage period of one year, this means that the contractual service margin will be released over that one‑year period (possibly, a single reporting period). [IFRS 17.BC283]. For longer-term contracts, with a coverage period lasting many years, an entity will have to use judgement in order to determine an appropriate allocation of the contractual service margin to each reporting period.
The question of how to determine the quantity of benefits for coverage units was discussed by the TRG in both February 2018 and May 2018. In May 2018, the TRG analysed an IASB staff paper that contained the IASB staff's views on sixteen examples of different types of insurance contracts. The TRG members observed that:
The TRG members considered that the following methods might achieve the objective if they are reasonable proxies for the services provided under the groups of insurance contracts in each period:
The following examples apply the principles above to specific fact patterns for insurance contracts issued without direct participation features. Examples for reinsurance contracts issued and insurance contracts with direct participation features are discussed at 8.9.4 and 11.2.3 below respectively.53
In May 2018, the TRG analysed an IASB staff paper that contained the IASB staff's views on whether the coverage period for insurance contracts with and without direct participation features should include the period in which investment-related services are provided. The TRG members agreed with the IASB staff view that, as IFRS 17 is drafted, contracts under the general model (see 11.2.3 for the variable fee approach) only include the period in which insurance services are provided (i.e. not any additional period in which investment-related services are provided). However, most TRG members disagreed that insurance contracts under the general model should be treated as providing only insurance services.54 Some TRG members had significant concerns about the ‘cliff effect’ caused by the difference in contractual service margin allocation for contracts eligible for the variable fee approach (where it was agreed that contracts should include the period of investment-related services) and other contracts that the TRG members feel provide a similar mix of investment-related and insurance services, if allocation of the contractual service margin under the general model can only reflect the provision of insurance coverage. There were also concerns expressed by stakeholders that contracts which provide insurance coverage that ends significantly before the investment-related services would result in ‘front-end’ revenue recognition and deferred annuity contracts with an account balance accumulating in the period before the annuity payments start could result in ‘back-end’ revenue recognition if insurance coverage is provided only during the annuity periods.
Consequently, as a result of the TRG and stakeholder concerns, the issue was redeliberated by the IASB. The Board observed that an investment-return service could be identified in some insurance contracts without direct participation features that include an investment component. In addition, the Board concluded that an investment-return service could be identified in some insurance contracts without an investment component, but that require the entity to pay amounts to the policyholder, other than claims for insured events. In the Board's view, an investment-return service might be provided during a period when a policyholder has a right to withdraw an amount from an entity.
Therefore, the ED proposes the following amendments to IFRS 17:
As a result of the proposed amendments, insurance coverage, investment-return service, (for insurance contracts without direct participation features), and investment-related service (for insurance contracts with direct participation features) are all included in ‘insurance contract services’. There are also consequential amendments to the definitions of ‘contractual service margin’, ‘coverage period’, liability for remaining coverage (see 8.6.1 above) and liability for incurred claims (see 8.6.2 above), and to the eligibility for the premium allocation approach to reflect the amendments relating to insurance contract services provided by groups of insurance contracts in the period.55
An investment-return service is provided if, and only if:
The following example illustrates the impact of the change proposed in the ED on the contractual service margin.
The impact on profit in Example 56.37 of the proposed amendment can be illustrated graphically below.
As discussed above, the proposed definition of an investment-return service does not make the investment component a necessary requirement for the presence of investment-return service in all cases. This is because the Board believe that an investment-return service might be provided in some insurance contracts during the period in which a policyholder has the right to withdraw amounts from the entity. A right to withdraw amounts would include policyholders' rights to a surrender value or premium refund cancelling the policy and rights to transfer an amount to another service provider. A policyholder might have such a right without the insurance contract including an investment component. This is illustrated by the following example based on an example in an IASB staff paper:57
In contrast, a right to receive back a pro-rata portion of a premium paid on policy cancellation (i.e. a premium refund) does not appear to satisfy the condition of an investment-return service as this is unlikely to include a positive investment return and no investment activity is being performed for the policyholder. However, as discussed at 16.1.1 below, the ED proposes an amendment to the disclosure requirements of IFRS 17 so that an entity need not disclose investment components and refunds of premiums separately.
As discussed at 8 above, a loss must be recognised on initial recognition of a group of insurance contracts if that group is onerous.
An insurance contract is onerous at the date of initial recognition if the fulfilment cash flows allocated to the contract, any previously recognised insurance acquisition cash flows and any cash flows arising from the contract at the date of initial recognition in total are a net outflow. As discussed at 5 above, an entity should group such contracts in a portfolio separately from contracts that are not onerous. To the extent that an entity has reasonable and supportable information to conclude that all contracts in a set of contracts will be in the same group, an entity may identify the group of onerous contracts by measuring a set of contracts rather than individual contracts.
When a group of insurance contracts are onerous, an entity should recognise a loss component and book the corresponding loss in profit or loss for the net outflow for the group of onerous contracts, resulting in the carrying amount of the liability for remaining coverage of the group being equal to the fulfilment cash flows and the contractual service margin of the group being zero. [IFRS 17.47].
Subsequent to initial recognition, a group of insurance contracts becomes onerous (or more onerous) if the following amounts exceed the carrying amount of the contractual service margin:
An entity should recognise a loss in profit or loss to the extent of that excess. [IFRS 17.48].
The wording changes proposed above by the ED correct an inadvertent error in IFRS 17, as issued in May 2017, which incorrectly excluded the risk adjustment for non-financial risk from the determination of the loss component and to clarify that changes in estimates need to be adjusted to the loss component in full.58
For losses under onerous groups of insurance contracts recognised either on initial recognition or subsequently, an entity should establish (or increase) a loss component of the liability for remaining coverage for an onerous group depicting the losses recognised. A ‘loss component’ means a notional record of the losses attributable to each group of onerous insurance contracts. The liability for the expected loss is contained within the liability for remaining coverage for the onerous group (as it is within the fulfilment cash flows). Keeping a record of the loss component of the liability for remaining coverage is necessary in order to account for subsequent reversals, if any, of the onerous group and any loss component is required to be separately disclosed (see 16.1.1 below). The loss component determines the amounts that are presented in profit or loss as reversals of losses on onerous groups and are consequently excluded from the determination of insurance revenue and, instead, credited to insurance service expenses. [IFRS 17.49].
After an entity has recognised a loss on an onerous group of insurance contracts, it should allocate: [IFRS 17.50]
An entity should adjust the contractual service margin only for the excess of the decrease over the amount allocated to the loss component.
The words in italics above are proposed by the ED for same reason as the proposed amendments in paragraph 48 above (i.e. to correct the inadvertent exclusion of the risk adjustment for non-financial risk from the determination of the loss component).
The subsequent changes in the fulfilment cash flows of the liability for remaining coverage to be allocated are: [IFRS 17.51]
The systematic allocation required above should result in the total amounts allocated to the loss component being equal to zero by the end of the coverage period of a group of contracts (since the loss component will have been realised in the form of incurred claims). [IFRS 17.52].
IFRS 17 does not prescribe specific methods to track the loss component. The IASB considered whether to require specific methods but concluded that any such methods would be inherently arbitrary. The IASB therefore decided to require an entity to make a systematic allocation of changes in the fulfilment cash flows for the liability for remaining coverage that could be regarded as affecting either the loss component or the rest of the liability. [IFRS 17.BC287].
Tracking the loss component of the liability for remaining coverage for each group of onerous contracts will be a new and complex task, particularly for many life insurers. Most non-life insurers will be familiar with the concept of running off provisions for unearned premiums and unexpired risks, and we expect that tracking a loss component should be easier for short duration contracts. Maintaining the loss component is not equivalent to maintaining a negative contractual service margin.
Changes in the liability for remaining coverage due to insurance finance income or expenses, release from risk, and incurred claims and other insurance service expenses, need to be allocated between the loss component and the remainder of the liability for remaining coverage on a systematic basis. An entity could allocate the effect of these changes to the loss component in proportion to the total liability, although other bases could be appropriate. Whichever approach is adopted, it should be applied consistently.
Changes in the liability for incurred claims are not allocated to the liability for remaining coverage.
The treatment of onerous contracts can be illustrated in the following example.
A reinsurance contract is a contract issued by one entity (the reinsurer) to compensate another entity for claims arising from one or more insurance contracts issued by that other entity (underlying contracts). [IFRS 17 Appendix A].
The requirements for recognition and measurement of reinsurance contracts issued are the same as for insurance contracts. This means that the issuer should make an estimate of the fulfilment cash flows including estimates of expected future cash flows. At initial recognition (and at each reporting date) this will include estimates of future cash flows arising from underlying insurance contracts expected to be issued by the reinsured entity (and covered by the issued reinsurance contract) that are within the contract boundary of the reinsurance contract. This is because the issuer of the reinsurance contract has a substantive obligation to provide insurance cover (i.e. services) for those unissued policies. However, the unit of account for measurement is the reinsurance contract rather than the underlying individual direct contracts.
Some reinsurance contracts issued may contain break clauses which allow either party to cancel the contract at any time following a specified notice period. In February 2018, the TRG members observed that, in an example of a reinsurance contract where the reinsurer can terminate coverage at any time with a three month notice period, the initial contract boundary for the issuer of the contract would exclude cash flows related to underlying insurance premiums outside of that three month notice period.59
In September 2018, the IASB staff clarified to the TRG members that if, after three months, neither the entity nor the reinsurer had given notice to terminate the reinsurance contract with respect to new business ceded, this would not cause a reassessment of the contract boundary. The cash flows related to underlying contracts that are expected to be issued and ceded in the next three‑month period are cash flows outside the existing contract boundary. In response to a concern that this may result in daily reinsurance contracts being issued, the IASB staff observed that reinsurance contracts held are recognised only when the recognition criteria for reinsurance contracts are met. The contract boundary is determined at initial recognition and in this example that will result in a new reinsurance contract held being recognised after the end of the first three-month period with a contract boundary of cash flows arising from contracts expected to be issued in the following three months. See also 10.2 below.
The submission to the IASB staff in September 2018 included an additional fact pattern in which there is (or there is not) a unilateral right for the reinsurer to amend the rate of the ceding commission it pays, in addition to unilateral termination rights. The IASB staff observed that in this fact pattern, the existence of the right to terminate the contract with a three month notice period determines the cash flows within the contract boundary regardless of the existence of a right to amend the rate of the ceding commission if the contract is not terminated. Therefore, the same accounting would apply to the additional fact pattern provided.60
For reinsurance contracts which cover events that have already occurred, but for which the financial effect is uncertain, IFRS 17 states that the insured event is the determination of the ultimate costs of the claim. [IFRS 17.B5]. As the claim has occurred already, the question arises as to how insurance revenue and insurance service expense should be presented for these insurance contracts when they are acquired in a business combination or similar acquisition in their settlement period. More specifically, whether insurance revenue should reflect the entire expected claims or not. This issue is not specific to reinsurance contracts issued; it is also relevant to direct adverse development covers issued. In February 2018, this question was submitted to the TRG and the IASB staff stated that for insurance contracts that cover events that have already occurred but the financial effects of which is uncertain the claims are incurred when the financial effect is certain. This is not when 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 settlement. Accordingly, insurance revenue would reflect the entire expected claims as the liability for remaining coverage reduces because of services provided. If some cash flows meet the definition of an investment component, those cash flows will not be reflected in insurance revenue or insurance service expenses.61
This results in entities accounting differently for similar contracts, depending on whether those contracts are issued originally by the entity or whether the entity acquired those contracts in their settlement period. The most notable outcomes of this distinction include:
The TRG members observed that, although the requirements in IFRS 17 are clear, applying the requirements reflects a significant change from existing practice and this change results in implementation complexities and costs. In May 2018, the IASB staff prepared an outreach report which included implementation concerns regarding the subsequent treatment of insurance contracts issued and acquired in their settlement period.62 Subsequently, the IASB decided not to amend IFRS 17 but have proposed some transitional relief for these contracts in the ED (see 17.2.1 below).
In September 2018, a question as to how to account for ceding commissions and reinstatement premiums was discussed by the TRG. The question asked how the following should be accounted for in the financial statements of the reinsurer:
The TRG members discussed the analysis in an IASB staff paper and observed that:
The TRG members observed that applying the requirements in IFRS 17 for amounts exchanged between a reinsurer and a cedant has practical implications because the requirements are different from existing practice. The TRG members also observed that applying the requirements of IFRS 17 may affect key performance measures currently used to assess the performance of reinsurers.63
Applying the guidance above in practice to the reinsurer:
The following flowchart may assist in the assessment of how to account for exchanges between a reinsurer and a cedant.
As discussed at 8.7.1 above, the question of how to determine the quantity of benefits for coverage units was discussed by the TRG in both February 2018 and May 2018. In May 2018, the TRG analysed an IASB staff paper that contained the IASB staff's views on sixteen examples of different types of insurance contracts.
The following examples apply the principles discussed at 8.7.1 above to specific fact patterns for reinsurance contracts issued.65
As discussed at 8.1.4 above, the ED proposes to amend IFRS 17 so that an entity can recognise an asset for insurance acquisition cash flows paid before the related group of insurance contracts is recognised as an asset, whether such an asset arises from an existing or future group of insurance contracts to which insurance acquisition cash flows are allocated.
IFRS 17, as issued in May 2017, does not require an entity to assess the recoverability of assets recognised in respect of insurance acquisition cash flows. This is because the asset is typically of relatively short duration and any lack of recoverability will be reflected on a timely basis when those assets are derecognised and the insurance acquisition cash flows are included in the measurement of a group of contracts. However, the proposed amendments could extend the period for which an asset exists and could increase the amount of the asset. The period for which the asset is recognised would also rely on an assessment of expected renewals of contracts, beyond those considered applying the existing requirements of IFRS 17. Accordingly, the Board concluded that it would be appropriate to require an entity to assess the recoverability of the asset at each reporting period, if facts and circumstances indicate that the asset may be impaired.66
As a result, the ED proposes that at the end of each reporting period, an entity should assess the recoverability of an asset recognised for insurance acquisition cash flows paid before the related group of insurance contracts is recognised as an asset if facts and circumstances indicate that the asset is impaired. An entity should perform a recoverability test and when necessary adjust the carrying amount of the asset and recognise any such loss through profit or loss.67
An entity should:
An entity shall recognise in profit or loss a reversal of some or all of an impairment loss previously recognised and increase the carrying amount of the asset, to the extent that the impairment conditions no longer exist or have improved.69
A mutual entity accepts risks from each policyholder and pools that risk. However, a defining feature of a mutual entity is that the most residual interest of the entity is due to a policyholder and not to a shareholder. Thus, the fulfilment cash flows of an insurer that is a mutual entity generally include the rights of policyholders to the whole of any surplus of assets over liabilities. This means that, for an insurer that is a mutual entity, there should, in principle, normally be no equity remaining and no net comprehensive income reported in any accounting period. [IFRS 17.BC265].
Payments to policyholders with a residual interest in a mutual entity vary depending on the returns on underlying items – the net asset of the mutual entity. These cash flows (i.e. the payments that vary with the underlying items) are within the boundary of an insurance contract. [IFRS 17.B65(c)]. Although policyholders with a residual interest in the entity bear the pooled risk collectively, the mutual, as a separate entity has accepted risk from each individual policyholder and therefore the risk adjustment for non-financial risk for these contracts reflects the compensation the mutual entity requires for bearing the uncertainty from non-financial risk in those contracts. However, because the net cash flows of the mutual entity are returned to policyholders, applying IFRS 17 to contracts with policyholders with a residual interest in the mutual entity will result in no contractual service margin for those contracts.70
Mutual entities may also issue insurance contracts that do not provide the policyholder with a residual interest in the mutual entity. Consequently, groups of such contracts are expected to have a contractual service margin. Determining whether a contract provides the policyholder with a residual interest in the mutual entity requires consideration of all substantive rights and obligations.
The IASB also suggested that to provide useful information about its financial position a mutual can distinguish between:
The statement of financial performance could include a line item ‘income or expenses attributable to policyholders in their capacity as policyholders before determination of the amounts attributable to policyholders with the most residual interest in the entity’.71
Some stakeholders expressed concern that the explanations in the Basis for Conclusions to IFRS 17, do not adequately reflect the nature of some mutual entities and the terminology used may have different interpretations in practice. In response the ED proposes to add a footnote to the Basis for Conclusions clarifying that ‘not all entities that may be described as mutual entities have the feature that the most residual interest of the entity is due to a policyholder’. The IASB decided not to develop specific guidance for, or defining mutual entities because:
IFRS 17 does not refer to impairment of insurance receivables (e.g. amounts due from policyholders or agents in respect of insurance premiums).
A premium receivable (including premium adjustments and instalment premiums) is a right arising from an insurance (or reinsurance) contract. Rights and obligations under contracts within the scope of IFRS 17 are excluded from the scope of IFRS 9 (see 2.3 above). As a premium receivable is a cash flow it is measured on an expected present value basis (see 8.2 above) which should include an assessment of credit risk. This cash flow is remeasured at each reporting date. Receivables from insurance contracts are not required to be disclosed separately on the statement of financial position but are subsumed within the overall insurance contract balances (see 14 below).
Receivables not arising from insurance contracts (such as those arising from a contractual relationship with an agent) would be within the scope of IFRS 9. When an insurer uses an agent, judgement may be required to determine whether insurance receivables from an agent on behalf of a policyholder are within the scope of IFRS 17 or IFRS 9. Such receivables may include certain balances with intermediaries and loans to intermediaries.
Some insurance contracts permit the policyholder to obtain a loan from the insurer with the insurance contract acting as collateral for the loan. Under IFRS 4 policyholder loans may have been separated from insurance contract balances and shown as separate assets. IFRS 17 regards a policyholder loan as an example of an investment component with interrelated cash flows which is not separated from the host insurance contract. [IFRS 17.BC114]. Consequently, a policyholder loan is included within the overall insurance contract balance and is part of the fulfilment cash flows (and is not within the scope of IFRS 9).
The repayment or receipt of amounts lent to and repaid by policyholders does not give rise to insurance revenue. IFRS 17, as issued in May 2017, omits the exclusion of changes resulting from cash flows from loans to policyholders from the changes in the liability for remaining coverage that give rise to insurance revenue. The ED proposes to amend paragraph B123(a) of IFRS 17 to add this exclusion and clarify that these amounts are excluded from insurance revenue. Any waiver of a loan to a policyholder would be treated the same way as any other claim.73
There may be situations when an insurance policy is collateral for a stand-alone loan, not stemming from the contractual terms of an insurance contract and not highly interrelated with an insurance contract. Such a loan would be within the scope of IFRS 9.
The premium allocation approach is a simplified form of measurement of insurance contracts. The premium allocation approach is intended to produce an accounting outcome similar to that which resulted from the unearned premium approach used by many non-life or short-duration insurers under previous local GAAP and, hence, continued under IFRS 4. The Board considers that it is similar to the customer consideration approach in IFRS 15. However, as shown at 9.1 below, the criteria required for use of the premium allocation approach means that not all contracts regulated as ‘non-life’ or ‘short-duration’ by local regulators will qualify.
Use of the premium allocation approach is optional for each group of insurance contracts that meets the eligibility criteria (see 9.1 below). The criteria are assessed for each group and the election is made for each group meeting the criteria at inception. In April 2019, the IASB staff responded to a submission to the TRG which questioned whether an entity is required, or permitted, to reassess a group's eligibility for the premium allocation approach and, as a result, to revoke its election to apply the approach. The IASB staff observed that given the eligibility criteria are assessed at inception, IFRS 17 does not require or permit reassessment of the eligibility criteria or the election to apply the approach.74
The main advantage of the simplified method, in accounting terms, is that the premium allocation approach does not require separate identification of the components (i.e. the building blocks) of the general model until a claim is incurred. Only a total amount for a liability for remaining coverage on initial recognition is determined, rather than a separate calculation of the components of the fulfilment cash flows performed with the contractual service margin as a balancing item which eliminates any expected profit. Therefore, compared to the general model, using the premium allocation approach results in a simpler accounting method. Further, as discussed at 9.2 below, an entity also has the option not to adjust liabilities for incurred claims for the effect of time value of money and financial risk in certain circumstances. Consequently, the premium allocation approach produces results which are generally more similar to current accounting practices applied under IFRS 4 than the general model, and therefore likely to be more readily understood.
The premium allocation approach can also be used for reinsurance contracts held. However, the ability to use the premium allocation approach for reinsurance contracts held must be assessed separately from the use of the premium allocation approach for the related underlying insurance contracts covered by reinsurance. See 10.7 below for discussion of the application of the premium allocation approach to reinsurance contracts held.
Although the accounting model for the premium allocation approach is broadly similar to the accounting model used by most non-life or short-duration insurers under IFRS 4 there are some important differences as follows:
A comparison of the general model with the premium allocation approach on initial recognition is shown below.
In February 2018, the TRG members agreed with the IASB staff view that the words ‘premiums, if any, received’ in paragraphs 55(a) and 55(b)(i) of IFRS 17 means premiums actually received at the reporting date. It does not include premiums due or premiums expected. However, the TRG members noted that applying these requirements reflects a significant change from existing practice and this change will result in implementation complexities and costs.75 Subsequently, the IASB staff included this matter in an implementation challenges outreach report (issued in May 2018) which was provided to the IASB within the papers for the May 2018 IASB Board meeting. However, the IASB tentatively decided not to amend the standard.
The premium allocation approach is permitted if, and only if, at the inception of the group of contracts: [IFRS 17.53]
The second criterion means that all contracts with a one‑year coverage period or less should qualify for the premium allocation approach regardless as to whether the first criterion is met. However, for insurance contracts with a coverage period greater than one year (e.g. long term construction insurance contracts or extended warranty-type contracts) entities will need to meet the first criterion in order to be eligible for the premium allocation approach.
IFRS 17 states that the first criterion is not met if, at the inception of the group of contracts, an entity expects significant variability in the fulfilment cash flows that would affect the measurement of the liability for the remaining coverage during the period before a claim is incurred. Variability in the fulfilment cash flows increases with, for example: [IFRS 17.54]
A discussion identifying the main sources of variability between the premium allocation approach and the general model is included at 9.1.1 below. A discussion of the meaning of ‘differ materially in these circumstances’ is included at 9.1.2 below.
Once an entity decides to use the premium allocation approach for a group of insurance contracts, the following choices are available separately in certain circumstances:
These choices can be shown graphically as follows:
A further choice available when applying the PAA to the liability for remaining coverage is not to adjust the liability for incurred claims for the time value of money and the effect of financial risk if those cash flows are expected to be paid or received within one year or less from the date that the claims are incurred (see 9.4 below).
The first criterion for use of the premium allocation approach discussed at 9.1 above involves a comparison of the liability for remaining coverage under the general model and the premium allocation approach over the expected period of the liability for remaining coverage. This assessment is made at inception and is not reassessed subsequently.
Under all situations the liability for incurred claims is the same between the premium allocation approach and general model. This means that after the coverage period has expired there will be no difference between the two approaches. However, a number of situations exist under which the premium allocation approach and the general model could produce different measurements for the liability for remaining coverage during the coverage period, and therefore could impact the eligibility of the premium allocation approach. These should be considered when designing the approach used for assessing the applicability of the premium allocation approach. Three examples of potential sources of differences are as follows:
When the expectation of the remaining profitability changes during the coverage period of a group of insurance contacts, so that it is still profitable, the results can differ under the premium allocation approach and general model. In this situation, the premium allocation approach will not recognise this improvement or deterioration in profitability in an explicit way until the exposure is earned, whereas the general model will recognise a portion of this change in expectations now through the unwinding of the contractual service margin even though the exposure has not yet been earned.
The significance of this difference will vary depending on how likely it is that the expected profitability of the remaining coverage might change and how much it may vary by. However, if the change in expectation of future profitability is to such an extent that the contract becomes onerous under the general model, then both approaches will give the same results.
Under the premium allocation approach an amount can be included for accretion of interest if necessary but this is based on the interest rate at the date of initial recognition of the contract (see 8.3 above). As a result, in these situations, the premium allocation approach never considers the current interest rates for the liability for remaining coverage, unlike the general model. So, if the discount rate changes significantly from the initial recognition of the contract this will result in a difference in the liability for remaining coverage between the premium allocation approach and the general model. The impact of this difference and its significance will depend on various factors including how large the discounting impact was originally, how large a change might reasonably be expected in the currency of the liabilities during the coverage period and the length of term of the liabilities, as longer-tailed contracts are more likely to be affected by discounting than shorter-tailed contracts.
An entity can elect not to adjust the liability for remaining coverage to reflect the time value of money (see 9.1 above) in which case the difference between the two approaches will be driven by the effect of discounting under the general model, which will be more significant.
Under the premium allocation approach revenue is based on the passage of time or expected pattern of release of risk (see 9.3 below). However, under the general model, the contractual service margin is allocated based on coverage units reflecting the expected quantity of benefits and duration of each group of insurance contracts (see 8.7 above).
One example of where differences in revenue recognition between the two approaches could occur is contracts where the timing of when claims occur is not evenly spread over the passage of time due to the seasonality of claims. This could arise if the release of risk is ‘significantly different from the passage of time’. For example, property insurance contracts exposed to catastrophes tend to have uneven earnings patterns.
In order to qualify for the premium allocation approach under the first criteria at 9.1 above, the measurement for the liability for remaining coverage should not ‘differ materially’ from that produced applying the general model. Materiality in this context should be as defined by IAS 1 (see Chapter 3 at 4.1.5.A). In these circumstances there are two assessments of materiality:
An entity should measure the liability for remaining coverage on initial recognition as follows: [IFRS 17.55]
As discussed at 9 above, premiums received means ‘received’ rather than receivable or due.
If the entity is not able to or chooses not to use the policy choice not to adjust the liability for remaining coverage to reflect the time value of money and the effect of financial risk (see 9.1 above), the carrying amount of the liability for remaining coverage must be adjusted to reflect the time value of money and the effect of financial risk using the discount rate as determined at initial recognition of the group. The discount rate is the rate at the date of initial recognition of the group determined using the requirements discussed at 8.3 above.
If the entity is not able to or chooses not to use the policy choice to recognise insurance acquisition cash flows as an expense then the acquisition cash flows are included within the liability for remaining coverage. The effect of recognising insurance acquisition cash flows as an expense on initial recognition is to increase the liability for remaining coverage on initial recognition and hence reduce the likelihood of any subsequent onerous contract loss. There would be an increased profit or loss charge on initial recognition offset by an increase in profit released over the twelve‑month contract period.
An entity applying the premium allocation approach should assume that no contracts in the portfolio are onerous at initial recognition unless facts and circumstances indicate otherwise. An entity should assess whether contracts that are not onerous at initial recognition have no significant possibility of becoming onerous subsequently by assessing the likelihood of changes in applicable facts and circumstances. [IFRS 17.18].
If at any time during the coverage period, including at initial recognition, facts and circumstances indicate that a group of insurance contracts is onerous, an entity should calculate the difference between: [IFRS 17.57]
Any difference arising is recognised as a loss in profit or loss and increases the liability for remaining coverage. [IFRS 17.58]. In performing the fulfilment cash flows calculation, above, if an entity does not adjust the liability for incurred claims to reflect the time value of money and the effect of financial risk, it should also not include any such adjustment in the fulfilment cash flows. [IFRS 17.57].
The following diagram provides an overview of the premium allocation approach on initial recognition.
The following example, based on an example accompanying IFRS 17, illustrates the measurement at initial recognition of a group of insurance contracts measured using the premium allocation approach.
At the end of each reporting period subsequent to initial recognition, assuming the group of insurance contracts is not onerous, the carrying amount of the liability for remaining coverage is the carrying amount at the start of the reporting period: [IFRS 17.55(b)]
This can be illustrated by the following diagram:
If a group of insurance contracts was onerous at initial recognition, then an entity would continue to compare the carrying amount of the liability for remaining coverage as calculated above with the fulfilment cash flows and recognise any further deficits or surpluses (to the extent that the fulfilment cash flows still exceed the liability for remaining coverage on a cumulative basis) in profit or loss.
Insurance revenue for the period is the amount of expected premium receipts (excluding any investment component and after adjustment to reflect the time value of money and the effect of financial risk, if applicable) allocated to the period for services provided. An entity should allocate the expected premium receipts to each period of service coverage (addition in italics and deletion proposed by ED): [IFRS 17.B126]
The liability for remaining coverage may be an asset if premiums are received after the recognition of revenue as revenue is recognised independent of the receipt of cash but is determined by the provision of coverage services.
An entity should change the basis of allocation between the two methods (passage of time and incurred insurance service expenses) as necessary if facts and circumstances change. [IFRS 17.B127]. This change results from new information and accordingly is not a correction of an error and will be accounted for prospectively as a change in accounting estimate. Judgement will be required in interpreting ‘differs significantly from the passage of time’.
The following example illustrates the subsequent measurement of a group of insurance contracts using the premium allocation approach assuming the same fact pattern as Example 56.43 above.
The liability for incurred claims for a group of insurance contracts subject to the premium allocation approach (which should usually be nil on initial recognition) is measured in the same way as the liability for incurred claims using the general model (i.e. a discounted estimate of future cash flows with a risk adjustment for non-financial risk). See 8.6.2 above.
When the entire finance income or expense is included in profit or loss, incurred claims are discounted at current rates (i.e. the rate at the reporting date). When finance income or expense is disaggregated between profit or loss and other comprehensive income (see 15.3.2 below) the amount of finance income or expense included in profit or loss is determined using the discount rate at the date of the incurred claim. See 8.3 above.
However, when applying the premium allocation method to the liability for remaining coverage, an entity is, for the liability for incurred claims, not required to adjust future cash flows for the time value of money and the effect of financial risk if those cash flows (for that group of insurance contracts) are expected to be paid or received in one year or less from the date the claims are incurred. [IFRS 17.59(b)]. This is a separate election from the election not to adjust the carrying amount of the liability for remaining coverage to reflect the time value of money and the effect of financial risk at initial recognition (see 9.2 above). It is possible that a group of insurance contracts would be eligible to avoid adjusting the liability for remaining coverage for time value of money (because the coverage period and the premium due date are within one year) but have to discount the liability for incurred claims (because the claims are not expected to settle within one year or less from the date in which they are incurred). This would probably be the case for liability claims such as disability, employer's liability or product liability.
IFRS 17 does not state whether the discounting election above is irrevocable. There may be circumstances in which groups of claims that were expected originally to be settled within one year (and hence not discounted) subsequently turn out to take much longer to settle. In those circumstances, we believe that an entity should start discounting the claims in the period in which it identifies such change and account for it prospectively (as this is a change in estimate).
A reinsurance contract is an insurance contract issued by one entity (the reinsurer) to compensate another entity for claims arising from one or more insurance contracts issued by that other entity (underlying contracts). [IFRS 17 Appendix A].
IFRS 17 requires a reinsurance contract held to be accounted for separately from the underlying insurance contracts to which it relates. This is because an entity that holds a reinsurance contract does not normally have a right to reduce the amounts it owes to the underlying policyholder by amounts it expects to receive from the reinsurer. It is acknowledged in the Basis for Conclusions that separate accounting for the reinsurance contracts and their underlying insurance contracts might create mismatches that some regard as purely accounting, for example; on the timing of recognition, the measurement of the reinsurance contracts and the recognition of profit. However, the Board concluded that accounting for a reinsurance contract held separately from the underlying insurance contracts gives a faithful representation of the entity's rights and obligations and the related income and expenses from both contracts. [IFRS 17.BC298]. Examples of potential accounting mismatches are:
A modified version of the general model is applied by cedants for reinsurance contracts held. This is to reflect that: [IFRS 17.BC302]
A further consideration in requiring modification to the general model is that most reinsurance contracts held will be ‘loss making’ if the underlying insurance contracts to which they relate are profitable. Given that IFRS 17 does not permit gains on initial recognition of insurance contracts issued, it would seem inappropriate to require anticipated losses on related reinsurance contracts held to be expensed on initial recognition. This would create an accounting mismatch.
Consequently, the overall result of the modifications of the general model for reinsurance contracts held are that:
A key consideration arising for insurers will be the extent of any accounting mismatches arising from the different treatment of reinsurance contracts held with underlying insurance contracts and whether the model used by the underlying insurance contracts can be used by the related reinsurance contracts held (see 10.5 and 10.6 below).
An entity should divide portfolios of reinsurance contracts held by applying the same criteria as the general model (see 8 above) except that references to onerous contracts (see 8.8 above) should be replaced with a reference to contracts on which there is a net gain on initial recognition. [IFRS 17.61]. This appears to mean that a portfolio of reinsurance contracts held should be divided into a minimum of:
An entity is not allowed to group contracts purchased more than a year apart. A group of contracts is not reassessed after initial recognition. It is acknowledged by IFRS 17 that for some reinsurance contracts held, applying the general model, as modified, will result in a group that comprises a single contract. [IFRS 17.61].
A reinsurance contract held cannot be onerous. Therefore, the requirements for onerous contracts in the general model (see 8.8 above) do not apply. [IFRS 17.68].
The contract boundary requirements of IFRS 17 (see 8.1 above) apply also to reinsurance contracts held. Many aspects below apply also to reinsurance contracts issued (see 8.9 above).
In some cases, reinsurance contracts held will offer protection for underlying contracts that an entity has not yet issued. The question therefore arises as to whether the boundary of a reinsurance contract held should include those anticipated cash flows from unissued underlying contracts (which will not have been recognised as underlying insurance contracts by the entity). In February 2018, this issue was discussed by the TRG who agreed with the IASB staff's conclusion that the application of the contract boundary requirements to reinsurance contracts held means that cash flows within the boundary of a reinsurance contract held arise from substantive rights and obligations of the entity, i.e. the holder of the contract. Therefore:
This means that an entity will need to estimate the fulfilment cash flows of contracts it expects to issue that will give rise to cash flows within the boundary of the reinsurance contracts that it holds. Potentially, this will result in a measurement mismatch between the direct insurance contracts issued and the reinsurance contracts held. The TRG members observed that applying this requirement is likely to result in operational complexity because it is a change from existing practice under IFRS 4.
Additionally, some reinsurance contracts issued may contain break clauses which allow either party to cancel the contract at any time following a specified notice period. In February 2018, the TRG members observed that, in an example of a reinsurance contract which:
the initial contract boundary would exclude cash flows related to premiums outside of that three month notice period.77
In September 2018, the IASB staff clarified to TRG members that, if as at 31 March (i.e. after three months) neither the entity nor the reinsurer had given notice to terminate the reinsurance contract with respect to new business ceded, this would not cause a reassessment of the contract boundary. This is because the contract boundary determination at initial recognition (i.e. three months) was not based on an assessment of the practical ability to set a price that fully reflected the risk in the contract. The cash flows related to underlying contracts that are expected to be issued and ceded in the next three-month period are cash flows outside the existing contract boundary. In response to a concern that this may result in daily reinsurance contracts being issued, the IASB staff observed that reinsurance contracts held are recognised only when the recognition criteria are met. In the fact pattern provided, this is likely to be 1 April or later. The contract boundary is determined at initial recognition and, in this example, that will result in a new reinsurance contract held being recognised after the end of the first three-month period with a contract boundary of cash flows arising from contracts expected to be issued in the following three months. Both of these contracts held could belong to an annual group of contracts applying the level of aggregation criteria.
The submission to the IASB staff in September 2018 included an additional fact pattern in which there is a unilateral right for the reinsurer to amend the rate of the ceding commission it pays, in addition to unilateral termination rights. The IASB staff observe that in this fact pattern, the existence of the right to terminate the contract with a three-month notice period determines the cash flows within the contract boundary regardless of the existence of a right to amend the rate of the ceding commission if the contract is not terminated. Therefore, the same accounting would apply to the additional fact pattern provided.78
In May 2018, the TRG discussed an IASB staff paper concerning the determination of the boundary of a reinsurance contract held when the reinsurer has the right to reprice remaining coverage prospectively. In the fact pattern provided, the reinsurer can adjust premium rates at any time, subject to a minimum three month notice period and could choose either (i) not to exercise the right to reprice, in which case the holder of the reinsurance contract is committed to continue paying premiums to the reinsurer, or (ii) to exercise the right to reprice in which case the holder has the right to terminate coverage. The TRG members observed that:
The TRG members also observed that although the fact pattern in this example was limited in scope, it demonstrates the principle that both rights and obligations need to be considered when assessing the boundary of a contract.79
Instead of applying the recognition requirements for an insurance contract (discussed at 6 above), an entity should recognise a group of reinsurance contracts held: [IFRS 17.62]
The Basis for Conclusions explains that the first category above is meant to include reinsurance contracts held to cover the losses of separate contracts on a proportionate basis. [IFRS 17.BC304]. IFRS 17, as issued in 2017, did not elaborate further on the meaning of ‘proportionate reinsurance’.
The ED proposes to add the following definition of reinsurance held which provides proportionate coverage:
‘A reinsurance contract held that provides an entity with the right to recover from the issuer a percentage of all claims incurred on groups of underlying insurance contracts. The percentage the entity has a right to recover is fixed for all contracts in a single group of underlying insurance contracts, but can vary between groups of underlying insurance contracts’.80
The proposed amendments in the ED further state that proportional ‘reinsurance contracts provide the entity with the right to recover from the issuer a fixed percentage of all claims incurred on a group of underlying insurance contracts. Such reinsurance contracts can also include cash flows, other than claims, that are not proportionate to cash flows of the underlying groups of insurance contracts issued. For example, in such reinsurance contracts, the premiums due to the reinsurer might not be proportionate to premiums due from the policyholders of the groups of underlying insurance contracts’.81
The proposed definition appears to be more restrictive than the way it was previously interpreted as it appears to exclude many reinsurance contracts that provide protection on a proportionate basis but where either the claims recovery amount is not fixed for all contracts in a group (e.g. surplus reinsurance polices where the reinsurer accepts risk above a pre-determined amount but the amount ceded can vary per underlying assured) or where the reinsurance policy does not reinsure each contract within a group. This appears to be confirmed by a proposed amendment to the Basis for Conclusions which states that ‘the Board observed that if a reinsurance contract held covers claims in excess of a specified amount on an individual insurance contract that reinsurance contract does not provide proportionate coverage’.
The Basis for Conclusions to IFRS 17, as issued in May 2017, states that the ‘other cases’ (i.e. reinsurance contracts that do not provide proportionate cover) are intended to include contracts that cover aggregate losses from a group of underlying contracts that exceed a specified amount. [IFRS 17.BC304]. In the Board's view, the coverage benefits the entity from the beginning of the coverage period of the group of reinsurance contracts held because such losses accumulate throughout the coverage period. [IFRS 17.BC305(b)]. An example of such a contract is one which provides cover for losses in the aggregate from a single event excess of a predetermined limit and with a fixed premium payable.
When a reinsurance contract held provides proportionate coverage, the initial recognition of the (group of) reinsurance contract(s) will, as a simplification, be later than the beginning of the coverage period if no underlying contracts have been recognised as at that date. [IFRS 17.BC305(a)].
The following examples illustrate application of the recognition criteria for reinsurance contracts when the general model is used.
Contracts that do not provide proportionate coverage (often referred to as non-proportional or excess of loss) usually provide insurance for claim events exceeding a certain underlying limit. A non-proportional contract is illustrated in the following example.
A reinsurance contract held should be measured using the same criteria for fulfilment cash flows and contractual service margin as an insurance contract issued to the extent that the underlying contracts are also measured using this approach. However, the entity should use consistent assumptions to measure the estimates of the present value of future cash flows for the group of reinsurance contracts held and the estimates of the present value of the underlying insurance contracts. [IFRS 17.63].
In February 2018, in answer to a TRG submission, the IASB staff stated that ‘consistent’ in this context does not necessarily mean ‘identical’ (i.e. the use of an identical discount rate for measurement of the group of underlying insurance contracts and the related group of reinsurance contracts held was not mandated). The extent of dependency between the cash flows of the reinsurance contract held and the underlying cash flows should be evaluated in applying the requirements of paragraph 63 of IFRS 17.82 In May 2018, in answer to a TRG submission, the IASB staff further noted that consistency is required to the extent that the same assumptions apply to both the underlying contracts and the reinsurance contracts held. In the IASB staff's view, this requirement does not require or permit the entity to use the same assumptions used (e.g. the same discount rates) for measuring the underlying contracts when measuring the reinsurance contracts held if those assumptions are not valid for the term of the reinsurance contracts held. If different assumptions apply for reinsurance contracts held, the entity uses those different assumptions when measuring the contract. The TRG members did not disagree with either of the IASB staff statements.83
In addition to using consistent assumptions, an entity should make the following modifications in calculating the fulfilment cash flows:
In April 2019, the IASB staff discussed a TRG submission which explained that the non-performance risk of a reinsurer may incorporate different risks such as insolvency risk and the risk related to disputes and further negotiations. The submission questioned whether these risks are identified as financial or non-financial risks and the impact this determination has on the measurement of reinsurance contracts held when determining the risk being transferred from the holder of the reinsurance contract to the issuer of the reinsurance contract. The IASB staff observed that paragraph 63 of IFRS 17 specifically requires that estimates of the present value of future cash flows should include the effect of the risk of any non-performance by the issuer including the effects of collateral and losses from disputes. Thus, the risk adjustment for non-financial risk of a reinsurance contract held reflects only the risks that the cedant transfers to the reinsurer. The risk of non-performance by the reinsurer is not a risk transferred to the reinsurer nor does it reduce the risk transferred to the reinsurer. Hence, the risk of non-performance is only reflected in the present value of the future cash flows of the reinsurance contracts held, similar to the treatment of financial risks. The IASB staff further observed that IFRS 17 does not provide specific requirements on how to determine the risk of any non-performance.85
IFRS 17 prohibits changes in fulfilment cash flows that relate to the risk of non-performance adjusting the contractual service margin. In the Board's view, differences in expected credit losses do not relate to future service. [IFRS 17.67]. Accordingly, any changes in expected credit losses are economic events that the Board decided should be reflected as gains and losses in profit or loss when they occur. This would result in consistent accounting for expected credit losses between reinsurance contracts held and purchased, and originated credit-impaired financial assets accounted for in accordance with IFRS 9 (which does not apply to rights and obligations arising under a contract within the scope of IFRS 17 such as a receivable due under a reinsurance contract held – see 2.3 above). [IFRS 17.BC309].
In determining the contractual service margin on initial recognition, the requirements of the general model are modified to reflect the fact that there is no unearned profit but instead a net gain or net cost on purchasing the reinsurance. Hence, on initial recognition the entity should recognise any net cost or net gain on purchasing the group of reinsurance contracts held as a contractual service margin measured at an amount equal to the sum of: [IFRS 17.65]
If the net cost of purchasing reinsurance coverage relates to events that occurred before the purchase of the group of reinsurance contracts, an entity should recognise such a cost immediately in profit or loss as an expense. [IFRS 17.65A].
It is stated in the Basis for Conclusions that the IASB decided that the net expense of purchasing reinsurance should be recognised over the coverage period as services are received unless the reinsurance covers events that have already occurred. For such reinsurance contracts held, the Board concluded that entities should recognise the whole of the net expense at initial recognition, to be consistent with the treatment of the net expense of purchasing reinsurance before an insured event has occurred. The Board acknowledged that this approach does not treat the coverage period of the reinsurance contract consistently with the view that for some insurance contracts the insured event is the discovery of a loss during the term of the contract, if that loss arises from an event that had occurred before the inception of the contract. However, the Board concluded that consistency of the treatment of the net expense across all reinsurance contracts held would result in more relevant information. [IFRS 17.BC312].
IFRS 17 provides no guidance as to how a cedant should account for the net cost of a reinsurance contract held which provides both prospective and retrospective coverage.
Measurement of a reinsurance contract held on initial recognition is illustrated by the following example, based on Example 11 in IFRS 17. [IFRS 17.IE124‑129)]. Section 10.4.1 below discusses the initial recognition of reinsurance contracts in situations where a group of underlying insurance contracts is onerous at initial recognition.
In IFRS 17 as issued in May 2017, a measurement inconsistency arises when an underlying group of insurance contracts is onerous at initial recognition since the resulting onerous loss at inception must be recognised immediately (see 8.8 above) whereas any net gain on purchasing the related reinsurance held is deferred and released to profit or loss as services are received over the coverage period (see 10.4 above). Although the IASB was aware of this mismatch, it considered that this circumstance would be rare. However, since IFRS 17 was issued some stakeholders have commented that there may be significant mismatches in profit or loss.
Consequently, the IASB agreed to address these concerns and the ED proposes to amend IFRS 17 to:
An entity should also establish (or adjust) a loss-recovery component of the asset for remaining coverage for a group of reinsurance contracts held depicting the recovery of losses recognised applying the requirements above. The loss recovery component determines the amounts that are presented in profit or loss as reversals of recoveries of losses from reinsurance contracts held and are consequently excluded from the allocation of premiums paid to the reinsurer. After an entity has established a loss-recovery component, it should:
See 10.3 above for the definition of proportionate reinsurance as proposed in the ED.
The following examples, based on an IASB staff paper, illustrate the proposed effect of the proposed amendment.89
Instead of applying the subsequent measurement requirements for the general model, an entity should measure the contractual service margin at the end of the reporting period for a group of reinsurance contracts held as the carrying amount determined at the start of the reporting period, adjusted for: [IFRS 17.66]
Changes in the fulfilment cash flows that result from changes in the risk of non-performance by the issuer of a reinsurance contract held do not relate to future service and should not adjust the contractual service margin. [IFRS 17.67].
The contractual service margin of a group of insurance contracts issued can never be negative. In contrast, IFRS 17 does not include a limit on the amount by which the contractual service margin of a group of reinsurance contracts held could be adjusted as a result of changes in estimates of cash flows. In the Board's view, the contractual service margin for a group of reinsurance contracts held is different from that for a group of insurance contracts issued – the contractual service margin for the group of reinsurance contracts held depicts the expense the entity incurs when purchasing reinsurance coverage rather than the profit it will make by providing services under the insurance contract. Accordingly, the Board placed no limit on the amount of the adjustment to the contractual service margin for the group of reinsurance contracts held, subject to the amount of premium paid to the reinsurer. [IFRS 17.BC314].
It is stated in the Basis for Conclusions in IFRS 17, as issued in 2017, that the Board considered the situation that arises when the underlying group of insurance contracts becomes onerous after initial recognition because of adverse changes in estimates of fulfilment cash flows relating to future service. In such a situation, the entity recognises a loss on the group of underlying insurance contracts (this situation would also apply to the subsequent accounting of underlying direct contracts that were already onerous at their initial recognition). The Board concluded that corresponding changes in cash inflows from a group of reinsurance contracts held should not adjust the contractual service margin of the group of reinsurance contracts held, with the result that the entity recognises no net effect of the loss and gain in the profit or loss for the period. This means that, to the extent that the change in the fulfilment cash flows of the group of underlying contracts is matched with a change in fulfilment cash flows on the group of reinsurance contracts held, there is no net effect on profit or loss. [IFRS 17.BC315].
These requirements are illustrated by the following example, based on Example 12 in IFRS 17. [IFRS 17.IE130‑138].
The principles for release of the contractual service margin for reinsurance contracts held follows the same principles as for insurance and reinsurance contracts issued, i.e. the contractual service margin is released to revenue as the reinsurer renders service. For a reinsurance contract held, the period that the reinsurer renders services is the coverage period of the reinsurance contract.
The coverage period of a reinsurance contract held ends when the coverage periods of all underlying contracts are expected to end. This could be up to two years for reinsurance contracts written on a twelve months ‘risks attaching’ basis where underlying insurance contracts incepting in a twelve month period are covered by a single reinsurance contract.
For retroactive reinsurance contracts held, the coverage period of the underlying insurance contracts may have expired prior to the inception of the reinsurance contract held. In respect of these contracts, the coverage is provided against an adverse development of an event that has already occurred. [IFRS 17.B5]. This means that the contractual service margin should be released over the expected settlement period of the claims of the underlying insurance contracts (since that is, in effect, the coverage period for the reinsurance contract).
In May 2018, the IASB staff confirmed that, applying the requirements of the general model (see 8.7 above), the coverage units in a group of reinsurance contracts held is the coverage received by the insurer from those 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, an entity may consider relevant facts and circumstances related to the underlying insurance contracts.90
An entity may use the premium allocation approach discussed at 9 above (adapted to reflect the features of reinsurance contracts held that differ from insurance contracts issued, for example the generation of expenses or reduction in expenses rather than revenue) to simplify the measurement of a group of reinsurance contracts held, if at the inception of the group: [IFRS 17.69]
Assessment of eligibility for groups of reinsurance contracts held to be able to use the premium allocation approach is independent of whether the entity applies the premium allocation approach to the underlying groups of insurance contracts issued by an entity. Therefore, for example, reinsurance contracts which are written on a twelve months risks attaching basis (i.e. the underlying insurance contracts subject to the reinsurance contract incept over a twelve month period) will have a contract boundary of up to two years if each of the underlying insurance contracts have a coverage period of one year. Our provisional view is that the two year contract boundary means that those reinsurance contracts held will not meet the twelve month criterion for use of the premium allocation approach and would have to qualify for the premium allocation approach on the basis that the resulting measurement would not differ materially from the result of applying the requirements in the general model. As a consequence, a mismatch in measurement models may arise if the underlying contracts are accounted for under the premium allocation approach.
IFRS 17 confirms that an entity cannot meet the first condition above if, at the inception of the group, an entity expects significant variability in the fulfilment cash flows that would affect the measurement of the asset for remaining coverage during the period before a claim is incurred. Variability in the fulfilment cash flows increases with, for example: [IFRS 17.70]
The ED proposes that the requirements to adjust the contractual service margin on a group of profitable proportionate reinsurance contracts when a group of underlying insurance contracts are onerous (see 10.4 above) should also apply to the premium allocation approach. For the premium allocation approach, the carrying amount of the asset for remaining coverage is adjusted instead of the contractual service margin.91
An entity is not permitted to use the variable fee approach for reinsurance contracts held. The variable fee approach also cannot be applied to reinsurance contracts issued. [IFRS 17.B109]. This will therefore cause an accounting mismatch when an entity has reinsured contracts subject to the variable fee approach discussed at 11 below. It is stated in the Basis for Conclusions that the IASB considers that the entity and the reinsurer do not share in the returns on underlying items and therefore the criteria for the variable fee approach are not met, even if the underlying insurance contracts issued are insurance contracts with direct participation features. The IASB therefore decided not to modify the scope of the variable fee approach to include reinsurance contracts held as it was considered that such an approach would be inconsistent with the Board's view that a reinsurance contract held should be accounted for separately from the underlying contracts issued. [IFRS 17.BC248].
Many entities issue participating contracts (referred to in IFRS 17 as contracts with participation features) that is, to say, contracts in which both the policyholder and the entity benefit from the financial return on the premiums paid by sharing the performance of the underlying items over the contract period. Participating contracts can include cash flows with different characteristics, for example:
Insurance companies in many countries have issued contracts with participation features. For example, in some countries, insurance companies must return to the policyholders at least a specified proportion of the investment profits on certain contracts, but may give more. In other countries, bonuses are added to the policyholder account at the discretion of the insurer. In a third example, insurance companies distribute realised investment gains to the policyholder, but the companies have discretion over the timing of realising the gains. These gains are normally based on the investment return generated by the underlying assets but sometimes include allowance for profits made on other contracts.
IFRS 17 includes:
Insurance contracts without direct participation features are not permitted to apply the variable fee approach even if such contracts contain participation features. IFRS 17 assumes that contracts with participation features ineligible for the variable fee approach will apply the general model; contracts with participating features that are not eligible for the variable fee approach are not excluded from applying the premium allocation approach but IFRS 17 appears to assume that they will not meet the eligibility criteria (as, usually, the contract boundary will be significantly in excess of one year). Consequently, there will be a difference between the recognition of insurance revenue for insurance contracts without direct participation features but that have some asset dependent cash flows and for insurance contracts with direct participation features accounted for using the variable fee approach, not least because different discount rates should be used for re-measuring the contractual service margin (see 8.3 above).
The following diagram compares accounting for direct participating contracts to other insurance contracts.
Reinsurance contracts issued and held cannot be insurance contracts with direct participation features for the purposes of IFRS 17 (see 10.6 above). [IFRS 17.B109].
Many participation contracts also contain an element of discretion which means that the entity can choose whether or not to pay additional benefits to policyholders. However, contracts without participation features may also contain discretion. As discussed at 8 above, the expected cash outflows of an insurance contract should include outflows over which the entity has discretion. IFRS 4 permitted the discretionary component of an insurance contract with participation features to be classified in its entirety as either a liability or as equity. [IFRS 4.34(b)]. As a result, under IFRS 4, many insurers classified the entire contract (including amounts potentially due to shareholders) as a liability. Under IFRS 17, entities must make a best estimate of the liability due to policyholders under the contracts.
The following are two examples of contracts with a participation feature.
Entities should consider whether the cash flows of insurance contracts in one group affect the cash flows to policyholders of contracts in another group. In practice, this effect is referred to as ‘mutualisation’. Contracts are ‘mutualised’ if they result in policyholders subordinating their claims or cash flows to those of other policyholders, thereby reducing the direct exposure of the entity to a collective risk.
Some insurance contracts affect the cash flows to policyholders of other contracts by requiring: [IFRS 17.B67]
Sometimes, such contracts will affect the cash flows to policyholders of contracts in other groups. The fulfilment cash flows of each group reflect the extent to which the contracts in the group cause the entity to be affected by expected cash flows, whether to policyholders in that group or to policyholders in another group. Hence the fulfilment cash flows for a group: [IFRS 17.B68]
It is observed in the Basis for Conclusions that the reference to future policyholders is necessary because sometimes the terms of an existing contract are such that the entity is obliged to pay to policyholders amounts based on underlying items, but with discretion over the timing of the payments. That means that some of the amounts based on underlying items may be paid to policyholders of contracts that will be issued in the future that share in the returns on the same underlying items, rather than to existing policyholders. From the entity's perspective, the terms of the existing contract require it to pay the amounts, even though it does not yet know when or to whom it will make the payments. [IFRS 17.BC172].
For example, to the extent that payments to policyholders in one group are reduced from a share in the returns on underlying items of €350 to €250 because of payments of a guaranteed amount to policyholders in another group, the fulfilment cash flows of the first group would include the payments of €100 (i.e. would be €350) and the fulfilment cash flows of the second group would exclude €100 of the guaranteed amount. [IFRS 17.B69].
Different practical approaches can be used to determine the fulfilment cash flows of groups of contracts that affect or are affected by cash flows to policyholders of contracts in other groups. In some cases, an entity might be able to identify the change in the underlying items and resulting change in the cash flows only at a higher level of aggregation than the groups. In such cases, the entity should allocate the effect of the change in the underlying items to each group on a systematic and rational basis. [IFRS 17.B70].
After all the service coverage (addition in italics and deletion proposed by ED) has been provided to the contracts in a group, the fulfilment cash flows may still include payments expected to be made to current policyholders in other groups or future policyholders. An entity is not required to continue to allocate such fulfilment cash flows to specific groups but can instead recognise and measure a liability for such fulfilment cash flows arising from all groups. [IFRS 17.B71].
It is observed in the Basis for Conclusions that the Board considered whether to provide specific guidance on amounts that have accumulated over many decades in participating funds and whose ‘ownership’ may not be attributable definitively between shareholders and policyholders. It concluded that it would not. In principle, IFRS 17 requires an entity to estimate the cash flows in each scenario. If that requires difficult judgements or involves unusual levels of uncertainty, an entity would consider those matters in deciding what disclosures it must provide to satisfy the disclosure objective in IFRS 17 (see 16.2 below). [IFRS 17.BC170].
The Board considered whether prohibiting groups from including contracts issued more than one year apart would create an artificial divide for contracts with cash flows that affect or are affected by cash flows to policyholders in another group. The Board acknowledged that, for contracts that fully share risks, the groups together will give the same results as a single combined risk-sharing portfolio and therefore considered whether IFRS 17 should give an exception to the requirement to restrict groups to include only contracts issued within one year. However, the Board concluded that setting the boundary for such an exception would add complexity to IFRS 17 and create the risk that the boundary would not be robust or appropriate in all circumstances. Nonetheless, the Board noted that the requirements specify the amounts to be reported, not the methodology to be used to arrive at those amounts. Therefore, it may not be necessary for an entity to restrict groups in this way to achieve the same accounting outcome in some circumstances. [IFRS 17.BC138].
In September 2018, the TRG members discussed an IASB staff paper which considered a submission about annual groups of contracts which all share a return on a specified pool of underlying items with some of the return contractually passing from one group of policyholders to another. The question asked in what circumstances would measuring the contractual service margin at a higher level than an annual cohort level, such as a portfolio level, achieve the same accounting outcome as measuring the contractual service margin at an annual cohort level. The TRG members observed that:
However, TRG members expressed concern that in practice cash flows would be determined at a higher-level of measurement than in the examples provided in the IASB staff paper and then the entity would have to allocate the effect of the change in the underlying items to each group on a systematic and rational basis (see above).92
IFRS 17 identifies a separate set of insurance contracts with participation features described as insurance contracts with direct participation features. These contracts apply an adapted version of the general model in which, to summarise, the changes in the contractual service margin are mostly driven by the movements in the assets ‘backing’ the contracts or other profit-sharing items (referred to as ‘underlying items’) rather than by the fulfilment cash flows of the insurance contract liability. Use of this adapted model is mandatory for those groups of insurance contracts which meet the criteria (see 11.2.1 below). Contracts with participation features are significantly different across jurisdictions. Not all groups of contracts with participation features will meet the criteria to be accounted for as direct participation contracts.
Conceptually, insurance contracts with direct participation features are contracts under which an entity's obligation to the policyholder is net of: [IFRS 17.B104]
This approach is commonly referred to as the ‘variable fee’ approach.
The Board concluded that returns to the entity from underlying items should be viewed as part of the compensation the entity charges the policyholder for service provided under the insurance contract, rather than as a share of returns from an unrelated investment, in a narrow set of circumstances in which the policyholders directly participate in a share of the returns on the underlying items. In such cases, the fact that the fee for the contract is determined by reference to a share of the returns on the underlying items is incidental to its nature as a fee. The Board concluded, therefore, that depicting the gains and losses on the entity's share of the underlying items as part of a variable fee for service faithfully represents the nature of the contractual arrangement. [IFRS 17.BC244].
IFRS 17 requires the contractual service margin for insurance contracts with direct participation features to be updated for more changes than those affecting the contractual service margin for other insurance contracts. In addition to the adjustments made for other insurance contracts, the contractual service margin for insurance contracts with direct participation features is also adjusted for the effect of changes in: [IFRS 17.BC240]
It is stated in the Basis for Conclusions that the Board decided that these differences are necessary to give a faithful representation of the different nature of the fee in these contracts. The Board concluded that for many insurance contracts it is appropriate to depict the gains and losses on any investment portfolio related to the contracts in the same way as gains and losses on an investment portfolio unrelated to insurance contracts. [IFRS 17.BC241].
An entity should assess whether the conditions for meeting the definition of an insurance contract with direct participation features are met using its expectations at inception of the contract and should not reassess the conditions afterwards, unless the contract is modified (see 12 below for modifications). [IFRS 17.B102].
Insurance contracts with direct participation features are insurance contracts that are substantially investment-related service contracts under which an entity promises an investment return based on underlying items (i.e. items that determine some of the amounts payable to a policyholder). Hence, they are defined as insurance contracts for which: [IFRS 17.B101]
When an insurance contract is acquired in a business combination or transfer, the criteria as to whether the contract applies the variable fee approach should be assessed at the business combination or transfer date (see 13 below).
Situations where cash flows of insurance contracts in a group affect the cash flows of contracts in other groups are discussed at 11.1 above.
The pool of underlying items can comprise any items, for example a reference portfolio of assets, the net assets of the entity, or a specified subset of the net assets of the entity, as long as they are clearly identified by the contract. An entity need not hold the identified pool of underlying items (although there are accounting consequences of this – see 15.3.1 below). However, a clearly identified pool of underlying items does not exist when: [IFRS 17.B106]
It is explained in the Basis for Conclusions that the Board believes that, for the variable fee approach to be applied, the contract must specify a determinable fee and because of this a clearly identified pool of underlying items must exist. Without a determinable fee, which can be expressed as a percentage of portfolio returns or portfolio asset values rather than only as a monetary amount, the share of the return on the underlying items the entity retains would be entirely at the discretion of the entity and, in the Board's view, this would not be consistent with being equivalent to a fee. [IFRS 17.BC245(a)]. However, IFRS 17 does not mention a stated minimum determinable fee.
In April 2019, the IASB staff considered a submission to the TRG which provided an example of a contract for which an entity charges an asset management fee determined as a percentage of the fair value of the underlying items plus a premium for mortality cover which reduces the underlying items at the beginning of each period. The submission asked how to determine the share of the fair value of the underlying items ignoring the mortality cover. The IASB staff clarified that, in this example, the fixed annual charge for mortality cover reduces the underlying items at the start of the year and hence is included in the portion of the fair value shared with the policyholder as opposed to the asset management fee which is considered to be a charge that is not shared with the policyholder. The TRG members observed that a distinguishing feature in this example is that the premium for mortality is fixed rather than varying with the fair value of the underlying items. The IASB staff confirmed that the analysis might differ had the charge varied with the fair value of the underlying items. The TRG members also observed that when determining whether an insurance contract is in the scope of the variable fee approach, in some circumstances it may be necessary to consider the way a charge is determined, rather than the way it is labelled in the contract, to identify what the charge represents. The IASB staff also noted that one of the other conditions of assessing eligibility for the variable fee approach is that a substantial proportion of the changes in amounts paid to policyholders should vary with the changes in the fair value of the underlying items, regardless of whether they have been paid from the underlying items or not.93
The word ‘share’ referred to above does not preclude the existence of the entity's discretion to vary amounts paid to the policyholder. However, the link to the underlying items must be enforceable. [IFRS 17.B105].
An entity should interpret the word ‘substantial’ (as in both ‘substantial share’ and ‘substantial proportion’): [IFRS 17.B107]
IFRS 17 provides no quantitative threshold for ‘substantial’.
The Basis for Conclusions observes that the entity should expect to pay to the policyholder an amount equal to a substantial share of the fair value returns on the underlying items and that a substantial proportion of the amounts paid to the policyholder should also vary with a change in the fair value of the underlying items and it would not be a faithful representation if this did not occur. [IFRS 17.BC245(b)]. This raises the question as to whether the variable fee approach can be applied to contracts where the return to policyholders is determined on a basis other than fair value (e.g. at amortised cost). In February 2018, in response to a submission to the TRG, the IASB staff observed that contracts which provide a return that is based on an amortised cost measurement of the underlying items would not automatically fail the definition of an insurance contract with direct participation features. Entities expectations of returns would be assessed over the duration of the contract and therefore returns based on an amortised cost measurement might equal returns based on the fair value of the underlying items over the contract duration. The TRG members noted the IASB's staff conclusion that the variable fee approach could be met when the return is based on amortised cost measurement of the underlying items.94
IFRS 17 further explains that if, for example, the entity expects to pay a substantial share of the fair value returns on underlying items, subject to a guarantee of a minimum return, there will be scenarios in which: [IFRS 17.B108]
The entity's assessment of the variability will reflect a present value probability-weighted average of all these scenarios.
In reality, as many participation contracts contain guarantees, the question as to whether a contract is one with direct participation features or not depends on the effect of the guarantee on the expected value of the cash flows being insignificant at inception. It does not mean that there can be no scenarios in which the guarantee ‘kicks in’. Instead, it does mean that the effect of those scenarios on a probability-weighted basis should be such that a substantial share of the expected returns payable to the policyholder are still based on the fair value of the underlying items. Considering the impact of options and guarantees on the eligibility criteria will have to be based on the specific facts and circumstances and requires the use of judgement.
When the cash flows of insurance contracts in a group affect the cash flows to policyholders of contracts in other groups (see 11.1 above), an entity should assess whether the conditions for meeting the classification of the group of contracts as insurance contracts with direct participation features are met by considering the cash flows that the entity expects to pay to the policyholders. [IFRS 17.B103].
At initial recognition, the contractual service margin for a group of insurance contracts with direct participation features is measured in the same way as a group of insurance contracts without direct participation features (i.e. as a balancing figure intended to eliminate any day 1 profits unless the contract is onerous – see 8.5 above).
At the end of a reporting period, for insurance contracts with direct participation features, the carrying amount of a group of contracts equals the carrying amount at the beginning of the reporting period adjusted for the following amounts (words added in italics and deletions proposed by ED): [IFRS 17.45]
IFRS 17 further states that:
Changes in fulfilment cash flows that do not vary based on returns on underlying items comprise: [IFRS 17.B113]
An entity is not required to identify the separate components of the adjustments to the contractual service margin resulting from changes in the entity's share of the fair value of underlying items that relate to future service and changes in the fulfilment cash flows relating to future service. Instead, a combined amount may be determined for some or all of the adjustments. [IFRS 17.B114].
Except in situations when a group of contracts is onerous, or to the extent the entity applies the risk mitigation exception (see 11.2.4 below), the effect of the general model and the variable fee approach may be compared, as follows:
Comparison of | General model | Variable fee approach |
Insurance finance income or expenses (total) recognised in statement of financial performance |
|
|
Changes in the carrying amount of fulfilment cash flows arising from the time value of money and financial risk | Recognised immediately in the statement of financial performance | Adjusts the contractual service margin unless risk mitigation applied (in which case it adjusts profit or loss or other comprehensive income) |
Discount rates for accretion of, and adjustment to, the contractual service margin | Rates determined at initial recognition | Rate included in the balance sheet measurement (i.e. current rates) |
In April 2019, the IASB staff responded to a TRG submission which described a specific fact pattern for a contract applying the variable fee approach where the entity shares returns with policyholders by paying dividends. The dividends scale varies based on the market value returns with respect to economic experience of the investments and a statutory basis for the non-economic experience (such as expenses and reinsurance contracts held). The questions asked were whether the measurement of the change in non-economic experience for the purpose of the variable fee approach is determined on an IFRS, statutory or fair value basis and whether the option to disaggregate insurance finance income or expenses between profit or loss and other comprehensive income is limited to financial income or expense on underlying items held or any income or expense arising from underlying items.
The IASB staff observed that under the variable fee approach an entity adjusts the contractual service margin of a group of contracts based on changes in the fair value of underlying items. Therefore, a statutory basis or an IFRS measure which are not fair value measurements cannot be used to determine the adjustment to the contractual service margin. The IASB staff also observed that, when disaggregation is applied, the amount of income or expense included in profit or loss should exactly match the income or expense included in profit or loss for the underlying items, resulting in the net of the two separately presented items being nil. Therefore, income or expense on underlying items is not limited to financial income or expense.95
Based on IFRS 17, as issued in May 2017, the recognition of the contractual service margin in profit or loss for insurance contracts with direct participation features follows the same principle for contracts without direct participation features discussed at 8.7 above. That is, the contractual service margin is recognised in profit or loss to reflect the services provided in the period.
In May 2018, the TRG discussed an IASB staff paper which considered whether services provided by an insurance contract include investment-related services and observed that:
The TRG members expressed different views on whether it was necessary to clarify that the definition of coverage period for variable fee approach contracts includes the period in which investment services are provided.96 In June 2018, the IASB tentatively decided to propose to clarify the definition of the coverage period for insurance contracts with direct participation features and this amendment has been incorporated into the ED by creating a new definition of ‘insurance contract services’ which states that, for insurance contracts with direct participation features, these represent both:
The ED also clarifies that the period of investment-related services ends at or before the date that all amounts due to current policyholders relating to those services have been paid, without considering payments to future policyholders.98
The effect of the proposed amendment can be illustrated by the following example.
Based on IFRS 17, as issued in May 2017, the contractual service margin would be released over the insurance coverage period in years 1‑5. Based on the proposed amendment in the ED, the contract provides insurance and investment‑related services and the coverage period for total services is ten years. The coverage units should be determined reflecting the benefits to the policyholder of the insurance service and the investment-related services. See also 8.7.2 above for a discussion on a similar proposed amendment for insurance contracts without direct participation features.
Amounts payable to policyholders create risks for an entity, particularly if the amounts payable are independent of the amounts that the entity receives from investments; for example, if the insurance contract includes guarantees. An entity is also at risk from possible changes in its share of the fair value returns on underlying items. An entity may purchase derivatives to mitigate such risks. When applying IFRS 9, such derivatives are measured at fair value through profit or loss. [IFRS 17.BC250].
For contracts with direct participation features the contractual service margin is adjusted for the changes in the fulfilment cash flows, including changes that the derivatives are intended to mitigate (unlike for contracts without direct participation features where the contractual service margin is not adjusted for such changes). Consequently, the change in the value of the derivative would be recognised in profit or loss, but, unless the group of insurance contracts was onerous, there would be no equivalent change in the carrying amount of the insurance liability to recognise, creating an accounting mismatch. A similar accounting mismatch arises if the entity uses derivatives to mitigate risk arising from its share of the fair value return on underlying items. [IFRS 17.BC251‑253].
Therefore, the Board concluded that, to avoid such accounting mismatches, an entity should be permitted to not recognise a change in the contractual service margin to reflect some or all of the changes in the effect of financial risk on the amount of the entity's share of underlying items or the fulfilment cash flows that do not vary based on the returns of underlying items. [IFRS 17.B115]. An entity that elects to use this approach should determine the eligible fulfilment cash flows in a group of contracts in a consistent manner in each reporting period. [IFRS 17.B117].
IFRS 17, as issued in May 2017, permits the risk mitigation exception to apply only to derivatives. In addition, reinsurance contracts issued and held cannot use the variable fee approach. Since the issuance of IFRS 17 some stakeholders have expressed concerns that measuring a reinsurance contract held applying the general model when the underlying insurance contracts are measured using the variable fee approach may give rise to accounting mismatches. In the view of these stakeholders, the resulting accounting fails to reflect the economics of the arrangement mitigating the entity's risk exposure. For example, some reinsurance contracts are designed to share the entity's share of the return on underlying items between the entity and the reinsurer.
As a result of these concerns, the IASB has agreed to amend IFRS 17 and the ED proposes to expand the scope of the risk mitigation exception to also apply if an entity uses a reinsurance contract held to mitigate financial risk as well as applying if a derivative is used. The same risk management conditions must be met for a reinsurance contract or a derivative to be used for risk mitigation. The Board rejected the suggestion that reinsurance contracts held themselves could be accounted for using the variable fee approach because a reinsurance contract held allows an entity to receive insurance coverage rather than provide asset management services. The Board also rejected suggestions that the risk mitigation option should apply to financial instruments other than derivatives on the grounds that the risk mitigation option was designed to address a specific accounting mismatch between insurance contracts with direct participation features and derivatives rather than deal with broader risk mitigation activities. The Board also noted that both IAS 39 and IFRS 9 include general hedge accounting requirements and IAS 39 includes specific ‘macro hedge accounting’ requirements (fair value hedge accounting for portfolios of interest rate risk) that may enable entities to address some of the accounting mismatches.99
This relief, as amended by the proposed ED (proposed changes in italics below), is conditional on the entity having a previously documented risk management objective and strategy for managing financial risk arising from the insurance contracts using derivatives or reinsurance contracts held to mitigate financial risk arising from insurance contracts and, in applying that objective and strategy: [IFRS 17.B116]
If, and only if, any of the conditions above ceases to be met, an entity should cease to apply the risk mitigation accounting from that date. An entity shall not make any adjustment for changes previously recognised in profit or loss (words in italics proposed by the ED). [IFRS 17.B118].
The amendments proposed above by the ED to paragraph B118 are intended to clarify that an entity can discontinue the use of the risk mitigation option to a group of insurance contracts only if the eligibility criteria for the group cease to apply. The application of risk mitigation is intended to be aligned with the hedge accounting requirements in IFRS 9 and IFRS 9 does not allow an entity to discontinue hedge accounting unless the hedging relationship ceases to meet the qualifying criteria.100
IFRS 17 is silent as to where this effect should be presented in the statement of comprehensive income (i.e. in insurance service result or in insurance finance income and expense).
As discussed at 15.3 below, entities have an accounting policy choice, per portfolio of insurance contracts, between:
For insurance contracts with direct participation features the allocation of the insurance finance income or expense is different depending on whether or not the underlying items are held.
If the underlying items are not held, then the insurance finance income or expense included in profit or loss is an amount determined by a systematic allocation of the expected total finance income or expense over the duration of the group of contracts (see 15.3.1 below).
If the underlying items are held, then the insurance finance income or expense included in profit or loss is an amount that eliminates accounting mismatches with income and expenses on the underlying items held. This means that the expenses or income from the movement of the insurance liability should exactly match the income or expenses included in profit or loss for the underlying items, resulting in the net of the two separately presented items being nil (see 15.3.3 below). This approach is sometimes referred to as the ‘current period book yield approach’.
An investment contract with discretionary participation features does not include a transfer of insurance risk and therefore is a financial instrument. Nevertheless, these contracts are within the scope of IFRS 17 provided the entity also issues insurance contracts. [IFRS 17.3(c)].
There is no de minimis limit on the number of insurance contracts that an entity must issue in order to ensure that its investment contracts with discretionary participation features are within the scope of IFRS 17. In theory, an entity need only issue one insurance contract.
An investment contract with discretionary participation features is a financial instrument that provides a particular investor with the contractual right to receive, as a supplement to an amount not subject to the discretion of the issuer, additional amounts: [IFRS 17 Appendix A]
The Basis for Conclusions observes that although investment contracts with discretionary participation features do not meet the definition of insurance contracts, the advantages of treating them the same as insurance contracts rather than as financial instruments when they are issued by entities that issue insurance contracts are that: [IFRS 17.BC83]
Investment contracts with discretionary participation features are accounted for in the same way as other insurance contracts. That is to say, the general model is applied (as discussed at 8 above) and, at initial recognition, an entity should assess whether the contracts contain direct participation features and hence should apply the variable fee approach (discussed at 11.2 above).
However, as investment contracts without discretionary participation features do not transfer insurance risk, IFRS 17 requires certain modifications as follows: [IFRS 17.71]
In April 2019, the IASB staff considered a submission to the TRG which described an investment contract in a specific jurisdiction that is linked to a crediting rate and asked whether the product meets the third criteria of the definition of an investment contract with discretionary participation features (see above). The crediting rate in the example was based on returns of assets held and weighted average rates on local treasury bonds and can be adjusted by the entity to some extent, based on future expected revenue and returns (the discretionary feature). The IASB staff observed that the definition of an investment contract with discretionary participation features requires that the additional discretionary amounts are contractually based on specified pools of contracts, specified pools of assets or the profit or loss of the entity or fund that issues the contract and that the discretionary features in each investment contract need to be assessed against these criteria considering all relevant facts and circumstances101 (i.e. the IASB staff was sceptical that the investment contract in the example met the criteria of an investment contract with discretionary participation features).
Some contracts may contain options for the policyholder to switch between funds over the lifetime of the contract and therefore change from holding an investment contract measured under IFRS 9 to holding an investment contract with discretionary participation features measured under IFRS 17 (or vice versa) provided the entity also issues insurance contracts. Where the assessment at contract inception has concluded that the contract is not an investment contract with discretionary participation features the question arises as to whether the existence of the option means that the contract is accounted for under IFRS 17 (as an investment contract with discretionary participation features) or under IFRS 9. If the option contains features (for example in terms of pricing) that require it to be considered within the boundary of the contract (see 8.1 above) the option may already scope the contract within IFRS 17 from inception as an investment contract with discretionary participation features.
IFRS 17 states that once a contract is within its scope then it is not subsequently reassessed even if, at a later date, it is no longer a contract within its scope. Therefore, investment contracts with discretionary participation features, issued by an entity that also issues insurance contracts, that subsequently lose their ‘discretionary feature’ as the result of the exercise of a policyholder option will remain within the scope of IFRS 17.
IFRS 17 states that a contract which qualifies as an insurance contract remains an insurance contract until all rights and obligations are extinguished (i.e. discharged, cancelled or expired) unless the contract is derecognised because of a contract modification. [IFRS 17.B25].
IFRS 4 contained no guidance on when or whether a modification of an insurance contract might cause derecognition of that contract. Therefore, prior to IFRS 17, most insurers would have applied the requirements, if any, contained in local GAAP.
An insurance contract can be modified either by agreement between the parties or as result of regulation. If the terms of an insurance contract are modified, an entity should derecognise the original insurance contract and recognise the modified contract as a new contract, if and only if, any of the conditions listed below are satisfied. The conditions are that: [IFRS 17.72]
In summary, any contract modification which changes the accounting model or the accounting standards measuring the components of the insurance contract is likely to result in derecognition. This is probably a different treatment compared to current practices applied under IFRS 4.
However, the exercise of a right included in the terms of a contract is not a modification. [IFRS 17.72].
If a contract modification meets none of the conditions above for derecognition, the entity should treat any changes in cash flows caused by the modification as changes in the estimates of the fulfilment cash flows. [IFRS 17.73]. See 8.6 and 11.2.3 above for the accounting for changes in the fulfilment cash flows.
Accounting for derecognition of a modified contract is discussed at 12.3 below.
An insurance contract is derecognised when, and only when [IFRS 17.74]
The treatment of contract derecognition differs depending on which of the two scenarios above applies. See 12.3 below.
When an insurance contract is extinguished, the entity is no longer at risk and is therefore no longer required to transfer any economic resources to satisfy the insurance contract. Therefore, the settlement of the last claim outstanding on a contract does not necessarily result in derecognition of the contract per se although it may result in the remaining fulfilment cash flows under a contract being immaterial. For derecognition to occur all obligations must be discharged or cancelled. When an entity purchases reinsurance, it should derecognise the underlying insurance contracts only when those underlying insurance contracts are extinguished. [IFRS 17.75].
There are three different ways to treat the derecognition of a contract, depending on the circumstances discussed at 12.3.1 to 12.3.3 below.
An entity derecognises an insurance contract from within a group of insurance contracts by applying the following requirements: [IFRS 17.76]
In practice, derecognition as a result of extinguishment will occur mostly on contracts where a contractual service margin (or liability for remaining coverage) no longer exists. In these circumstances, extinguishment will result in the elimination of any fulfilment cash flows for the liability for incurred claims with a corresponding adjustment to profit or loss. The Board observes in the Basis for Conclusions that an entity might not know whether a liability has been extinguished because claims are sometimes reported years after the end of the coverage period. It also considered concerns that an entity might be unable to derecognise those liabilities. In the Board's view, ignoring contractual obligations that remain in existence and can generate valid claims would not give a faithful representation of an entity's financial position. However, it is expected that when the entity has no information to suggest there are unasserted claims on a contract with an expired coverage period, the entity would measure the insurance contract liability at a very low amount. Accordingly, there may be little practical difference between recognising an insurance liability measured at a very low amount and derecognising the liability. [IFRS 17.BC322].
When an entity transfers a group of insurance contracts or derecognises an insurance contract because it either transfers that contract to a third party or derecognises the insurance contract and recognises a new insurance contract (see 12.3.2 and 12.3.3 below) it should: [IFRS 17.91]
In April 2019, responding to a submission to the TRG, the IASB staff clarified that when, as a result of a modification that results in a derecognition of an existing contract, an entity recognises new contracts that are in their settlement period, and therefore cover events that have already occurred but the financial effect of which is uncertain, the insured event is the determination of the ultimate cost of the claims.102 See 8.9.2 above.
When an entity derecognises an insurance contract because it transfers the contract to a third party the entity should: [IFRS 17.77]
If there is no contractual service margin to be adjusted then the difference between the fulfilment cash flows derecognised and the premium charged by the third party are recognised in profit or loss.
When an entity derecognises an insurance contract and recognises a new insurance contract as a result of a modification described at 12.1 above the entity should: [IFRS 17.77]
This can be illustrated by the following example.
Determining any hypothetical premium will require the exercise of judgement by the reporting entity.
IFRS 17 does not contain guidance on how contracts accounted for under the premium allocation approach (see 9 above) should apply the requirements at 12.3.1 to 12.3.3 above in circumstances in which the derecognised contracts are part of a group which has a liability for remaining coverage but no separate contractual service margin (as a contractual service margin is not recognised separately under the premium allocation approach).
Insurance contracts may be acquired in a transfer (often referred to as a portfolio transfer) or in a business combination as defined in IFRS 3.
In summary, insurance contracts acquired in a transfer or a business combination are measured in the same way as insurance contracts issued by the entity except that the fulfilment cash flows are recognised at date of the combination or transfer. IFRS 3 requires a group of insurance contracts acquired in a business combination to be measured at the acquisition date under IFRS 17 rather than at fair value. [IFRS 3.31A].
This results in the following key differences for insurance contracts acquired in a business combination compared with the accounting used previously under IFRS 4:
IFRS 17 does not explicitly state that contracts acquired in a business combination should be classified based on the contractual terms and conditions as they exist at the acquisition date. However, neither do other standards in similar circumstances. The amendments to IFRS 3 are clear that, in a business combination, an entity is required to classify contracts (i.e. assess whether a contract transfers significant insurance risk or contains a discretionary participation feature) based on the contractual terms and other factors at the date of acquisition rather than the original inception date of the contract.104
As IFRS 3 also refers to ‘groupings’ and ‘operating and accounting policies’, this implies that other assessments like the eligibility for the variable fee approach for direct participation contracts or the premium allocation approach (see 9.1 and 11.2 above) should be based on the contractual terms and conditions at the date of acquisition rather than at the date of the original inception of the contract. This approach may result in, for example, contracts that are insurance contracts of the acquiree being investment contracts of the acquirer and consequently there will be a different accounting treatment between the consolidated financial statements that include the acquiree and the separate financial statements of the acquiree. However, this would reflect the substance that the acquirer has purchased investment contracts rather than insurance contracts.
When insurance contracts or reinsurance contracts held are acquired in a transfer that is not a business combination, an entity should apply the aggregation requirements for the identification of portfolios of insurance contracts and divide those into groupings as explained at 5 above as if it had entered into the contracts on the date of acquisition. [IFRS 17.B93]. In our view, this also implies that these contracts should be classified (i.e. assessed for significant insurance risk and eligibility for the variable fee approach and the premium allocation approach) based on the terms and conditions at the transfer date. This is consistent with the requirements in IFRS 3 for the allocation of the cost of a group of asset acquired to individual identifiable assets and liabilities based on their relative fair values at the date of purchase. [IFRS 3.2(b)].
IFRS 17 requires an entity to treat the consideration received or paid for insurance contracts acquired in a transfer of business or a business combination, including contracts in their settlement period, as a proxy for the premiums received. This means that the entity determines the contractual service margin in accordance with all other requirements of IFRS 17 in a way that reflects the premium paid for the contracts. In a business combination the consideration received or paid is the fair value of the contracts at that date but IFRS 17 states that the entity does not apply the requirement in IFRS 13 and that the fair value of a financial liability with a demand feature cannot be less than the amount payable on demand, discounted from the first date that the amount could be required to be paid. [IFRS 17.B94].
The consideration received or paid for the contracts excludes the consideration received or paid for any other assets or liabilities acquired in the same transaction. Therefore, an acquirer will have to allocate the consideration received or paid between contracts within the scope of IFRS 17, other assets and liabilities outside the scope of IFRS 17 and goodwill, if any. [IFRS 17.B94].
For insurance contracts measured using the general model, on initial recognition (i.e. acquisition) the contractual service margin is calculated: [IFRS 17.B95]
If the acquired insurance contracts issued are onerous:
If the premium allocation approach applies to insurance contracts acquired in a transfer or business combination then the premium received is the initial carrying amount of the liability for remaining coverage and the liability for incurred claims. If facts and circumstances indicate that the contract is onerous, the difference between the carrying amount of the liability for remaining coverage and the fulfilment cash flows that relate to the remaining coverage should be treated the same way as a contract under the general model (i.e. recognised within goodwill or the gain on bargain purchase in a business combination or recognised as a loss in profit or loss on a transfer).
Investment contracts within the scope of IFRS 9 are required to be measured at fair value when acquired in a business combination.
The following two examples, based on Illustrative Examples 13 and 14 of IFRS 17 demonstrate the measurement on initial recognition for insurance contracts acquired. [IFRS 17.IE139‑151].
The ED proposes changes to the business combination requirements to reflect the new requirements for reinsurance of underlying onerous contracts as discussed at 10.4.1 above. These changes require an entity to establish a loss-recovery component of the asset for remaining coverage on a group of proportionate reinsurance contracts held depicting the recovery of losses recognised when an entity recognises a loss on initial recognition of a group of onerous underlying insurance contracts. The proposed changes are that:
For retroactive insurance contracts which cover events that have already occurred, but for which the financial effect is uncertain, IFRS 17 states that the insured event is the determination of the ultimate costs of the claim. [IFRS 17.B5]. As the claim has occurred already, the question arises as to how insurance revenue and insurance service expense should be presented for these insurance contracts when they are acquired in a business combination or similar acquisition in their settlement period. More specifically, whether insurance revenue should reflect the entire expected claims or not. In February 2018, this question was submitted to the TRG and the IASB staff stated that acquiring contracts in their settlement period is essentially providing coverage for the adverse development of claims. Therefore, the settlement period for the entity that issued the original contract becomes the coverage period for the entity that acquires the contracts. Therefore, contracts acquired in their settlement period will be considered part of the liability for remaining coverage for the entity that acquired the contract and not part of the liability for incurred claims. Accordingly, insurance revenue would reflect the entire expected claims as the liability for remaining coverage reduces because of services provided. If some cash flows meet the definition of an investment component, those cash flows will not be reflected in insurance revenue or insurance service expenses.106
This results in entities accounting differently for similar contracts, depending on whether those contracts are issued by the entity or whether the entity acquired those contracts in their settlement period. The most notable outcomes of this distinction include:
In May 2018, in response to a TRG submission, the IASB staff further clarified that, for contracts acquired in their settlement period, claims are incurred (and, hence, the liability for remaining coverage is reduced) when the financial effect becomes certain. This is not when the 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. Additionally, for contracts acquired in their settlement period where the liability for remaining coverage is determined to have nil contractual service margin at initial recognition (i.e. insurance contracts are measured at zero with nil contractual service margin) and estimates of future cash flows decrease subsequently (i.e. positive fulfilment cash flows), the IASB staff stated that a contractual service margin larger than zero may be recognised post acquisition.107
The TRG members had no specific comments on the IASB staff observations although the TRG members had previously observed that the requirements reflect a significant change from existing practice and this change results in implementation complexities and costs. In May 2018, the IASB staff prepared an outreach report which included implementation concerns regarding the subsequent treatment of insurance contracts acquired in their settlement period.108 Subsequently, the IASB agreed to provide transitional relief for the settlement of claims incurred before an insurance contract is acquired when the modified retrospective approach or fair value approach is used (see 17.2.1 below).
IFRS 3 does not apply to a combination of entities or businesses under common control (i.e. a common control business combination). [IFRS 3.2(c)]. This raises the question as to whether insurance contracts acquired in a common control business combination should be recognised and measured by the acquirer based on the terms and conditions at the date of acquisition (as for a business combination within the scope of IFRS 3 discussed at 13 above) or whether some form of predecessor accounting (also referred to as pooling of interests or merger accounting) can be used. IFRS 17, as issued in 2017, does not mention common control business combinations as such but the requirements for accounting for business combinations (see 13 above) are stated to apply to a ‘business combination’ without any qualification.
The ED proposes an amendment to IFRS 17 to limit the accounting requirements in paragraphs B93 to B95 of IFRS 17 to a ‘business combination in the scope of IFRS 3’ (proposed new words in italics). This amendment is intended to exclude business combinations outside the scope of IFRS 3, such as business combinations under common control, from the specific requirements of IFRS 17 for determining the contractual service margin for insurance contracts acquired in a transfer of insurance contracts or a business combination.109
The impact of the proposed amendment is that there will not be any requirements in IFRS 17 for accounting for insurance contracts acquired in a business combination under common control. Consequently, an entity will need to develop an appropriate accounting policy for business combinations under common control. Accounting for business combinations under common control is discussed in Chapter 10 at 3 and the application and use of the pooling of interests method is discussed in Chapter 10 at 3.3.1.
When an entity acquires a portfolio of insurance contracts the main accounting consideration is to determine whether that acquisition meets the definition of a business. IFRS 3 defines a business as ‘an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing goods or services to customers, generating investment income (such as dividends or interest) or generating other income from ordinary activities’. [IFRS 3 Appendix A]. The application guidance to IFRS 3 notes that a business consists of inputs and processes applied to those inputs that have the ability to contribute to the creation of outputs. Although businesses usually have outputs they are not required for an integrated set of assets and activities to be a business. [IFRS 3.B7‑8]. Where it is considered that a business is acquired, goodwill may need to be recognised, as may deferred tax liabilities, in respect of any acquired intangibles. For an isolated transfer, neither goodwill nor deferred tax should be recognised.
The determination of whether a portfolio of contracts or a business has been acquired will be a matter of judgement based on the facts and circumstances. Acquisitions of contracts that also include the acquisition of underwriting systems and/or the related organised workforce are more likely to meet the definition of a business than merely the acquisition of individual or multiple contracts.
Rights to issue or renew contracts in the future (as opposed to existing insurance contracts) are separate intangible assets and the accounting for the acquisition of such rights is discussed at 13.3.3 below.
IAS 12 requires deferred tax to be recognised in respect of temporary differences arising in business combinations, for example if the tax base of the asset or liability remains at cost when the carrying amount is fair value. IFRS 17 contains no exemption from these requirements. Therefore, deferred tax will often arise on temporary differences created by the recognition of insurance contracts at a value different from that applied previously by the acquiree (e.g. because the fulfilment cash flows at the date of acquisition for the insurance contracts acquired, calculated on the basis of the contractual terms at the date of the acquisition, is different from the carrying value of the fulfilment cash flows calculated by the acquiree on the basis of contractual terms on initial recognition of the insurance contract). The deferred tax adjusts the amount of goodwill recognised as discussed in Chapter 33 at 12.
The requirements discussed at 13 above apply only to recognised insurance contracts that exist at the date of a business combination or transfer.
Therefore, they do not apply to customer lists and customer relationships reflecting the expectation of future contracts that do not meet the IFRS 17 recognition criteria. IAS 36 and IAS 38 apply to such transactions just as they apply to other intangible assets.
The following example deals with customer relationships acquired together with a portfolio of one-year motor insurance contracts.
IFRS 17 specifies minimum amounts of information that need to be presented on the face of the statement of financial position. This minimum information is supplemented by disclosures to explain the amounts recognised on the face of the primary financial statements (see 16 below).
For presentation in the statement of financial position, IFRS 17 as issued in May 2017 requires insurance contracts to be aggregated by groups and presented separately as follows: [IFRS 17.78]
This presentation is also required by IAS 1. [IAS 1.54(da), (ma)].
The groups referred to above are those established at initial recognition when a portfolio of insurance contracts is divided into groups (see 5 above).
In February 2018, the TRG members observed that applying the presentation requirements reflects a significant change from existing practice and this change results in information complexities and costs. In May 2018, the IASB staff prepared an outreach report which included implementation concerns regarding the presentation of groups of insurance contracts in the statement of financial position. In particular, the TRG members expressed concern that information disaggregated in a manner consistent with the way entities manage their operations and systems, for example separate identification of insurance receivables, reserves that relate to future coverage, the liability for incurred claims and deferred acquisition costs, would be lost in applying IFRS 17.110
Subsequently, the IASB decided that there was merit in providing a practical relief for entities by requiring entities to present insurance contracts at a higher level of aggregation than the group level. Consequently, the ED proposes that an entity shall present separately in the statement of financial position the carrying amount of portfolios (emphasis added) of:
The IASB considers that:
Any assets or liabilities for insurance acquisition cash flows are subsumed in the carrying amount of the related portfolios groups of insurance contracts issued, and any assets or liabilities for cash flows related to portfolios groups of reinsurance contracts held are subsumed in the carrying amount of the portfolios groups of reinsurance contracts held (words in italics and deletions proposed by ED). [IFRS 17.79].
The presentation requirements are significantly different to that required by IFRS 9 in respect of financial instruments. They are also likely to differ significantly from any presentation applied previously by an insurer under IFRS 4. For example:
Under IFRS 4, many entities account for premiums receivable as financial assets and claims payable as a liability, separate from the rest of the insurance contract liability. Some stakeholders believe that the nature of premiums receivable and claims payable would be better reflected if these were measured and presented separately on the statement of financial position. However, the IASB considers that measuring premiums receivable and claims payable separately from insurance contracts would result in internal inconsistencies within IFRS 17 since the principle of IFRS 17 is that a contract creates a single bundle of rights and obligations. For example, premiums receivable for future coverage is not a gross asset separable from the related liability for future coverage.113 The IASB note that IAS 1 permits the presentation of additional line items including by disaggregation of required line items, headings and subtotals in the statement of financial position when such presentation is relevant to an understanding of the entity's financial position. [IAS 1.55]. Applying that requirement, an entity may be able to present a disaggregation which shows the components of each of those line items (for example, to present the amounts of premiums receivable and claims payable included in the carrying amount of the insurance contract liability). However, the requirement does not permit an entity to present premiums receivable or claims payable as separate line items, it only permits for the required line items to be disaggregated when such presentation is relevant to an understanding of the entity's financial position.114
There is no requirement for disclosure of balances in respect of the general model, the premium allocation model or the variable fee approach to be shown separately on the face of the statement of financial position. Nor is there a requirement for the components of the contract balances (for example, the contractual risk margin) to be presented on the face of the statement of financial position.
However, an entity should disclose reconciliations in the notes to the financial statements that show how the amounts disclosed on the face of the statement of financial position (i.e. the net carrying amount of contracts within the scope of IFRS 17) changed during the reporting period because of cash flows and income and expenses recognised in the statement of financial performance. Separate reconciliations are required for insurance contracts issued and reinsurance contracts held. [IFRS 17.98]. The detailed requirements of these reconciliations are discussed at 16.1 below. In summary, separate reconciliations are required for contracts subject to the general model and the premium allocation approach together with reconciliations for the individual components of the contract balances. An entity is required to consider the level of aggregation of these reconciliations necessary to meet the overall disclosure objectives of the disclosure requirements of IFRS 17. [IFRS 17.95].
An entity is required to disaggregate the amounts recognised in the statement of profit and loss and the statement of other comprehensive income (collectively, the statement of financial performance) into: [IFRS 17.80]
In addition, income or expenses from reinsurance contracts held should be presented separately from the expenses or income from insurance contracts issued. [IFRS 17.82]. An entity may present the income or expense from a group of reinsurance contracts held, other than finance income and expense, as either: [IFRS 17.86]
This presentation is also required by IAS 1 which, additionally, requires insurance finance income and expense to be split between contracts issued within the scope of IFRS 17 and reinsurance contracts held on the face of the statement of profit or loss. [IAS 1.82(a)(ii), (ab), (ac)]. IAS 1 also requires this split in other comprehensive income when insurance finance income is disaggregated. [IAS 1.7(i), (j)].
The change in risk adjustment for non-financial risk is not required to be disaggregated between the insurance service result and the insurance finance income or expense. When an entity decides not to disaggregate the change in risk adjustment for non-financial risk, the entire change should be included as part of the insurance service result. [IFRS 17.81].
The following table illustrates a summary statement of financial performance under IFRS 17.
Statement of profit or loss and other comprehensive income | 2021 | 2020 | |
£'m | £'m | ||
Insurance revenue | 10,304 | 8,894 | |
Insurance service expenses | (9,069) | (8,489) | |
Incurred claims and insurance contracts expenses | (7,362) | (7,012) | |
Insurance contract acquisition cash flows | (1,259) | (1,150) | |
Insurance service result before reinsurance contracts held | 1,235 | 405 | |
Income (expenses) from reinsurance contracts held | (448) | (327) | |
Insurance service result | 787 | 78 | |
Finance income and expense from contracts issued within the scope of IFRS 17 | 394 | 353 | |
Finance income and expense from reinsurance contracts held | 200 | 300 | |
Net financial result | 594 | 653 | |
Profit before tax | 1,381 | 731 | |
Other comprehensive income | |||
Items that may be reclassified subsequently to profit or loss | |||
Finance income and expense from contracts issued within the scope of IFRS 17 | 50 | (25) | |
Finance income and expense from reinsurance contracts held | (25) | 50 | |
Other comprehensive income for the year net of tax | 25 | 25 | |
Total comprehensive income for the year | 1,406 | 756 |
There is nothing to prevent an entity from providing further sub-analysis of the components of the insurance service result (which may make the relationship of the reconciliations discussed at 16 below to the face of the statement of financial performance more understandable). Indeed, IAS 1 states that an entity should present additional line items (including by disaggregating the line items specified by the standard), headings and subtotals in the statement(s) presenting profit or loss and other comprehensive income when such presentation is relevant to an understanding of the entity's financial performance. [IAS 1.85].
Each of the amounts required to be reported in the statement of financial performance are discussed at 15.1 to 15.3 below.
Insurance revenue should depict the provision of insurance contract services coverage and other services (amendments proposed by ED) arising from the group of insurance contracts at an amount that reflects the consideration to which the entity expects to be entitled in exchange for those services. [IFRS 17.83].
Insurance revenue from a group of insurance contracts is therefore the consideration for the contracts, i.e. the amount of premiums paid to the entity: [IFRS 17.B120]
Investment components are accounted for separately and are not part of the insurance service result.
The amount of insurance revenue recognised in a period depicts the transfer of promised services at an amount that reflects the consideration to which the entity expects to be entitled in exchange for those services. The total consideration for a group of contracts covers the following amounts: [IFRS 17.B121]
The words in italics above are proposed in the ED to avoid potential double-counting of the risk adjustment for non-financial risk in the revenue analysis.
When an entity provides services in a period, it reduces the liability for remaining coverage for the services provided and recognises insurance revenue. This is consistent with IFRS 15 in which revenue is recognised when an entity derecognises the performance obligation for services that it provides. [IFRS 17.B123].
The reduction in the liability for remaining coverage that gives rise to insurance revenue excludes changes in the liability that do not relate to services expected to be covered by the consideration received by the entity. Those changes are: [IFRS 17.B123]
Additionally, any insurance revenue present in profit or loss should exclude any investment components. [IFRS 17.85].
After having explained what insurance revenue is not, IFRS 17 then explains which changes in the liability for remaining coverage in the period relates to services for which the entity expects to receive compensation. Those changes are: [IFRS 17.B124]
The words in italics are proposed in the ED in order to avoid potential double-counting of the risk adjustment for non-financial risk and to deal with premium receipts.
Insurance revenue related to insurance acquisition cash flows should be determined by allocating the portion of the premiums that relate to recovering those cash flows to each reporting period on a systematic way on the basis of passage of time. An entity should recognise the same amount as insurance service expenses. [IFRS 17.B125]. The following example illustrates how insurance acquisition cash flows are allocated to revenue.
In September 2018, the TRG members discussed an IASB staff paper which considered a submission about accounting for changes in insurance acquisition cash flows. The IASB staff paper noted that insurance acquisition cash flows are included in the determination of the contractual service margin or loss component for a group of insurance contracts on initial recognition. They are treated the same way as other cash flows incurred in fulfilling insurance contracts and an entity is therefore not required to identify whether it will recover the acquisition cash flows at each reporting date since the measurement model captures any lack of recoverability automatically. It does this by limiting the contractual service margin from becoming negative. When expected cash inflows are less than the total of expected cash outflows (including acquisition cash flows) and the risk adjustment for non-financial risk, a loss component is recognised along with a charge to profit or loss. The TRG members observed that:
The TRG members also noted that experience adjustments arising from premiums received in the period that relate to future service, and the related cash flows such as insurance acquisition cash flows, adjust the contractual service margin.115
This means that, for example, if initial estimates of acquisition cash flows, payable at the end of a one-year coverage period, were $100 and at six months into the coverage period the entity now expects to pay $120 for acquisition cash flows at the end of the coverage period compared to the initial expectation of $100 then the amount of insurance service expenses related to the amortisation of acquisition cash flows (and insurance revenue recognised) at six months is $60.
In April 2019, the IASB staff discussed a TRG submission which asked whether IFRS 17 requires or permits an entity to accrete interest on the amount of acquisition cash flows paid for determining insurance revenue and insurance services expenses. The IASB staff observed that an entity is required to determine insurance revenue related to insurance acquisition cash flows by allocating the portion of premiums that relate to recovering those cash flows to each reporting period on a systematic way on the basis of passage of time and such a systematic way does not preclude a way that considers interest accretion.116
When an entity applies the premium allocation approach, insurance revenue for the period is the amount of expected premium receipts (excluding any investment component and adjusted to reflect the time value of money and the effect of financial risk, if applicable) allocated to the period. The entity should allocate the expected premium receipts to each period of service coverage (change in italics and deletion proposed by ED): [IFRS 17.B126]
An entity should change the basis of allocation between the two methods above as necessary if facts and circumstances change. [IFRS 17.B127]. As discussed at 9.3 above, any change in the basis of allocation is a change in accounting estimate and applied prospectively.
IFRS 17 permits an entity to present income or expenses from a group of reinsurance contracts held, other than insurance finance income or expense, either:
Consistent with this, IAS 1 requires only a net figure of income or expenses from reinsurance contracts held to be presented separately from insurance revenue and insurance service expenses in profit or loss. [IAS 1.82(ac)].
If an entity presents separately the amounts recovered from the reinsurer and an allocation of the premiums paid, it should: [IFRS 17.86]
Insurance service expenses comprise the following: [IFRS 17.84]
As discussed at 15 above, an entity should disaggregate this information (for example to show insurance acquisition cash flows separately from other insurance service expenses) when such presentation is relevant to an understanding of the entity's financial performance.
Insurance finance income or expenses comprises the change in the carrying amount of the group of insurance contracts arising from: [IFRS 17.87]
Insurance finance income or expenses do not include income or expenses related to financial assets or liabilities within the scope of IFRS 9 such as investment finance income on underlying items. This is disclosed separately under IAS 1 (see Chapter 3 at 3.2.2).
An entity is required to include in insurance finance income or expenses the effect of the time value of money and financial risk and changes therein assumptions that relate to financial risk. For this purpose: [IFRS 17.B128]
The words in italics above are proposed amendments in the ED and are intended to clarify the IASB's intention that changes in the measurement of insurance contracts arising from changes in underlying items should be treated as insurance finance income or expenses because the underlying items are regarded as investments that determine the amount of some payments to policyholders. This would include changes in the value of underlying items not caused by the time value of money or the effect of financial risks, for example where the underlying items include non-financial assets.117
In April 2019, the IASB staff considered a submission to the TRG which questioned whether changes in fulfilment cash flows as a result of changes in inflation assumptions are treated as changes in non-financial risk (and adjust the contractual service margin) or changes in financial risk for contracts measured under the general approach. The submission provided examples of cash flows such as claims contractually linked to a specified consumer price inflation index and cash flows that are not contractually linked to an index but which are expected to increase with inflation. The IASB staff observed that cash flows that an entity expects to increase with an index are considered to be an assumption that relates to financial risks, even if the cash flows are not contractually linked to a specific index. The TRG members did not disagree with the IASB staff's observation.118
Exchange differences on changes in the carrying amount of groups of insurance contracts, including the contractual service margin, are included in the statement of profit or loss, unless they relate to changes in the carrying amount of groups of insurance contracts in other comprehensive income, in which case they should be included in other comprehensive income. [IFRS 17.92]. Neither IAS 21 nor IFRS 17 specify where, in profit or loss, exchange differences should be presented – see 7.3 above.
Entities have an accounting policy choice between presenting insurance finance income or expenses in profit or loss or disaggregated between profit or loss and other comprehensive income. [IFRS 17.88]. An entity shall apply its choice of accounting policy to portfolios of insurance contracts. The choice is then applied to all groups of contracts within that portfolio. In assessing the appropriate accounting policy for a portfolio of insurance contracts, applying the requirements of IAS 8 (see Chapter 3 at 4.3) the entity shall consider for each portfolio the assets that the entity holds and how it accounts for those assets. [IFRS 17.B129]. In April 2019, the IASB staff responded to a question submitted to the TRG about a situation in which portfolios of insurance contracts change due to the manner in which an entity manages its contracts and questioned the impact of such a change on the application of the option to disaggregate insurance finance income or expenses. The IASB staff observed that applying the requirements of IAS 8, an entity should select and apply an accounting policy consistently for similar portfolios of insurance contracts. This implies that when an entity decides to choose a policy of disaggregation (or decides to cease a policy of disaggregation) that policy change or choice should be applied to all similar portfolios.119
An entity should consider, for each portfolio, the assets that it holds and how it accounts for them. Entities will seek to minimise accounting mismatches between assets and liabilities. We expect that entities with a tradition of recording the effect of market fluctuations in other comprehensive income will choose the same approach for insurance contract liabilities, if unavoidable mismatches in profit or loss are at a level that is acceptable to them. Entities that have classified equities as available-for-sale under IAS 39 may be reluctant to classify equities at fair value through other comprehensive income. This is because under IFRS 9 fair value gains and losses on fair value through other comprehensive income equities are not recycled to income on disposal. An entity might choose a fair value through profit or loss (FVPL) approach to assets and liabilities for portfolios of insurance contracts where assets backing liabilities include substantial amounts of equity instruments. Entities that have traditionally measured assets at FVPL and used current discount rates to measure insurance contract liabilities might elect not to disaggregate insurance finance expense and to invoke the fair value option for financial assets that otherwise would be measured in accordance with IFRS 9 at amortised cost or fair value through other comprehensive income.
The disaggregation approaches for each type of insurance contract are discussed at 15.3.1 to 15.3.3 below. In summary, the approaches are as follows:
For insurance contracts without direct participation features and contracts with direct participation features where the entity does not hold the underlying items (i.e. all insurance contracts except those with direct participation features for which the entity holds the underlying items), an entity should make an accounting policy choice between: [IFRS 17.88]
This approach applies to both the liability for remaining coverage and the liability for incurred claims under the general model. Under the premium allocation model, it applies only to the liability for incurred claims. Disaggregating discount rates for the liability for incurred claims under the premium allocation approach is discussed at 15.3.2 below.
When an entity chooses the disaggregation policy set out above, it should include in other comprehensive income the difference between the insurance finance income or expenses measured on a systematic allocation basis (as explained below) and the total finance income or expenses in the period. [IFRS 17.90].
A systematic allocation means an allocation of the total expected finance income or expenses of a group of insurance contracts over the duration of the group that: [IFRS 17.B130]
For groups of insurance contracts for which changes in assumptions that relate to financial risk do not have a substantial effect on the amounts paid to the policyholder, the systematic allocation (i.e. the amount presented in profit or loss) is determined using the discount rates determined at the date of initial recognition of the group of contracts. [IFRS 17.B131].
For groups of insurance contracts for which changes in assumptions that relate to financial risk have a substantial effect on the amounts paid to the policyholders: [IFRS 17.B132]
When an entity that has disaggregated the finance income or expenses of a group of insurance contracts transfers that group of insurance contracts or derecognises an insurance contract (see 12.3.1 to 12.3.3 above) it should reclassify to profit or loss as a reclassification adjustment any remaining amounts for the group (or contract) that were previously recognised in other comprehensive income as a result of its accounting policy choice. [IFRS 17.91(a)].
In April 2019, the IASB staff responded to a submission to the TRG which asked whether accumulated other comprehensive income on insurance contracts measured applying the general model should be reclassified to profit or loss when experience does not unfold as expected, and if so, how. The IASB staff observed that the cumulative amount recognised in other comprehensive income at any date is the difference between the carrying amount of the group of contracts and the amount that the group would be measured at when applying the systematic allocation of the expected total finance or expenses over the duration of the group.120 In other words, when the insurance liability is increased or decreased as a result of experience adjustments, the discount rate used for the systematic allocation of the expected total finance or expenses continues to be calculated as before (e.g. based on the discount rates determined at initial recognition for a group of insurance contracts for which changes in assumptions that relate to financial risk do not have a substantial effect on the amounts paid to the policyholder) and a reclassification adjustment occurs only on derecognition.
When the premium allocation approach is applied (see 9 above), an entity may be required, or may choose to discount the liability for incurred claims (see 9.4 above). In such cases, it may also choose to disaggregate the insurance finance income or expenses as discussed at 15.3.1 above. If the entity makes this choice, it should determine the insurance finance income or expenses in profit or loss using the discount rate determined at the date of the incurred claim. [IFRS 17.B133].
For insurance contracts with direct participation features, for which the entity holds the underlying items, an entity should make an accounting policy choice between: [IFRS 17.89]
This means that, when disaggregation is applied, the amount included in profit or loss finance income or expenses in respect of the insurance contracts with direct participation features exactly matches the finance income or expenses included in profit or loss for the underlying items, resulting in the net of the two separately presented items being nil. [IFRS 17.B134]. This is sometimes described as the current period book yield approach.
An entity may qualify for the accounting policy choice above in some periods but not in others because of a change in whether it holds the underlying items. If such a change occurs, the accounting policy choice available to the entity changes from that set out in above to that set out at 15.3.1 above or vice versa. Hence, an entity might change its accounting policy between that set out above and that set out at 15.3.1 above. In making such a change an entity should: [IFRS 17.B135]
An entity should not recalculate the accumulated amount previously included in other comprehensive income as if the new disaggregation had always applied; and the assumptions used for the reclassification in future periods should not be updated after the date of the change. [IFRS 17.B136].
When an entity which has disaggregated the finance income or expenses of a group of insurance contracts with direct participation features, transfers that group of insurance contracts or derecognises an insurance contract (see 12.3.2 and 12.3.3 above) it should not reclassify to profit or loss as a reclassification adjustment any remaining amounts for the group (or contract) that were previously recognised in other comprehensive income as a result of its accounting policy choice. [IFRS 17.91(b)]. This is a different accounting treatment than for contracts which do not have direct participation features for which the entity holds the underlying items (see 15.3.1 above).
It is observed in the Basis for Conclusions that requiring the contractual service margin to be adjusted for changes in estimates of the fulfilment cash flows but not for experience adjustments has the consequence that the accounting depends on the timing of a reporting date. [IFRS 17.BC236]. Therefore, to avoid IAS 34 – Interim Financial Reporting – being interpreted as requiring the recalculation of previously reported amounts, an entity should not change the treatment of accounting estimates made in previous interim financial statements when applying IFRS 17 in subsequent interim financial statements or in the annual reporting period. [IFRS 17.B137].
In September 2018, an IASB staff paper submitted to the TRG in response to a submission confirmed that the exception in paragraph B137 of IFRS 17 described above applies only to interim reports prepared applying IAS 34. If a subsidiary does not prepare interim reports applying IAS 34 (e.g. it prepares interim internal management reports that do not comply with IAS 34) then this exception is not applicable to the subsidiary.121 The TRG members agreed with the IASB staff's interpretation but highlighted the significant operational challenges of applying it in practice.122 For example:
The effect of this requirement on profit or loss is illustrated in the following example:
Example 56.60 above focusses on the impact of the release of the contractual service margin on insurance revenue and not on the impact on profit or loss of other components of an insurance contract liability. The example also assumes there are no other changes in expectations and ignores accretion of interest for simplicity.
IFRS 17 has no specific requirements in respect of changes in accounting policies and changes in accounting estimates except those for insurance contracts with direct participation features which are required to change the way they account for disaggregated finance and income when the underlying items are no longer held by those contracts – see 15.3.3 above.
Consequently, any changes in accounting policies and changes in accounting estimates should be accounted for in accordance with IAS 8. The requirements of IAS 8 in respect of changes in accounting policies and accounting estimates are discussed in Chapter 3 at 4.4 and 4.5 respectively.
One of the main objectives of IFRS 17 is to establish principles for the disclosure of insurance contracts which gives a basis for users of the financial statements to assess the effect that insurance contracts have on an entity's financial position, financial performance and cash flows. [IFRS 17.1].
Hence, the objective of the disclosure requirements is for an entity to disclose information in the notes that, together with the information provided in the statement of financial position, statement(s) of financial performance and statement of cash flows, gives a basis for users of financial statements to assess the effect of contracts within the scope of IFRS 17. To achieve that objective, an entity should disclose qualitative and quantitative information about: [IFRS 17.93]
The disclosure objective is supplemented with some specific disclosure requirements designed to help the entity satisfy this objective. By specifying the objective of the disclosures, the Board aims to ensure that entities provide the information that is most relevant for their circumstances and to emphasise the importance of communication to users of financial statements rather than compliance with detailed and prescriptive disclosure requirements. In situations in which the information provided to meet the specific disclosure requirements is not sufficient to meet the disclosure objective, the entity is required to disclose additional information necessary to achieve that objective. [IFRS 17.BC347].
The Board used the disclosure requirements in IFRS 4, including the disclosure requirements in IFRS 7 that are incorporated in IFRS 4 by cross-reference, as a basis for the requirements in IFRS 17. This is because stakeholders have indicated that such disclosures provide useful information to users of financial statements for understanding the amount, timing and uncertainty of future cash flows from insurance contracts. The disclosure requirements brought forward from IFRS 4 include information about significant judgements in applying the standard as well as most of the disclosures about the nature and extent of risks that arise from insurance contracts. [IFRS 17.BC348]. In addition, when developing IFRS 17, the Board identified key items it views as critical to understanding the financial statements of entities issuing insurance contracts, in the light of the requirement to update the measurement of insurance contracts at each reporting date. Consequently, additional disclosures have been added requiring: [IFRS 17.BC349]
The result of this is that the disclosure requirements of IFRS 17 are likely to be more extensive compared to the requirements of IFRS 4. They comprise forty paragraphs of the standard and many of these disclosures will not have previously been applied by insurance entities. In summary, complying with the disclosure requirements will be challenging.
IFRS 17 requires a reporting entity to consider the level of detail necessary to satisfy the disclosure objective and how much emphasis to place on each of the various requirements. Preparers are informed that if the mandatory disclosures required are not enough to meet the disclosure objective, additional information should be disclosed as necessary to meet that objective. [IFRS 17.94].
An entity should aggregate or disaggregate information so that useful information is not obscured either by the inclusion of a large amount of insignificant detail or by the aggregation of items that have different characteristics. [IFRS 17.95].
Preparers are also reminded of the requirements in IAS 1 relating to materiality and aggregation of information (see Chapter 3 at 4.1.5.A). IFRS 17 states that examples of aggregation bases that might be appropriate for information disclosed about insurance contracts are: [IFRS 17.96]
The first part of the disclosure objective established by the standard is that an entity should disclose qualitative and quantitative information about the amounts recognised in its financial statements for contracts within its scope. [IFRS 17.93].
The principal method by which the disclosure objective is achieved is by the disclosure of reconciliations that show how the net carrying amounts of contracts within the scope of IFRS 17 changed during the period because of cash flows and income and expenses recognised in the statement(s) of financial performance. Separate reconciliations should be disclosed for insurance contracts issued and reinsurance contracts held. An entity should adapt the requirements of the reconciliations described below to reflect the features of reinsurance contracts held that differ from insurance contracts issued; for example, the generation of expenses or reduction in expenses rather than revenue. [IFRS 17.98].
Enough information should be provided in the reconciliations to enable users of financial statements to identify changes from cash flows and amounts that are recognised in the statement(s) of financial performance. To comply with this requirement, an entity should: [IFRS 17.99]
The objective of the reconciliations detailed in 16.1.1 to 16.1.2 below is to provide different types of information about the insurance service result. [IFRS 17.102].
These reconciliations are required for all contracts other than those to which the premium allocation approach is applied including contracts with direct participation features.
Firstly, an entity must provide overall reconciliations from the opening to the closing balances separately for each of: [IFRS 17.100]
Within the overall reconciliations above, an entity should separately disclose each of the following amounts related to insurance services, if applicable: [IFRS 17.103]
The words above in italics are proposed by the ED.
Below is an example of this overall reconciliation, based on an illustrative disclosure in the IASB's IFRS 17 Effects Analysis.
Liability for remaining coverage | |||||
Excluding onerous contracts component | Onerous contracts component | Liabilities for incurred claims | Total | ||
Insurance contract liabilities 2020 | 161,938 | 15,859 | 1,021 | 178,818 | |
Insurance revenue | (9,856) | – | – | (9,856) | |
Insurance services expenses | 1,259 | (623) | 7,985 | 8,621 | |
Incurred claims and other expenses | (840) | 7,945 | 7,105 | ||
Acquisition expenses | 1,259 | – | 1,259 | ||
Changes that relate to future service: loss on onerous contracts and reversals of those losses | – | 217 | – | 217 | |
Changes that relate to past service: changes to liability for incurred claims | – | – | 40 | 40 | |
Investment components | (6,465) | – | 6,465 | – | |
Insurance service result | (15,062) | (623) | 14,450 | (1,235) | |
Insurance finance expenses | 8,393 | 860 | 55 | 9,308 | |
Total changes in the statement of comprehensive income | (6,669) | 237 | 14,505 | 8,073 | |
Cash flows | |||||
Premiums received | 33,570 | – | – | 33,570 | |
Claims, benefits and other expenses paid | (14,336) | (14,336) | |||
Acquisition cash flows paid | (401) | – | – | (401) | |
Total cash flows | 33,169 | – | (14,336) | 18,833 | |
Insurance contract liabilities 2021 | 188,438 | 16,096 | 1,190 | 205,724 | |
Figure 56.2: Movements in insurance contract liabilities analysed between the liability for remaining coverage and the liabilities for incurred claims.
Secondly, an entity should also disclose reconciliations from the opening to the closing balances separately for each of: [IFRS 17.101]
Within these reconciliations, an entity should disclosure the following amounts related to insurance contract services, if applicable: [IFRS 17.104]
The words in italics are proposed by the ED in order to avoid potential double-counting of the risk adjustment for non-financial risk in the reconciliation disclosure.
In April 2019, the IASB staff considered a submission to the TRG which asked whether a gross disclosure should be made of the component parts which make up the changes that relate to future service. In the example submitted there was a premium experience adjustment related to future service that would increase a loss component and a change in fulfilment cash flows related to future service that would decrease a loss component. The IASB staff observed that IFRS 17 requires an entity to provide disclosure of changes that relate to future service separately from those related to current or past service and in the example submitted all changes relate to future service. In other words, no sub-analysis of the changes that relate to future service was required for the example included in the submission.123
Below is an example of these reconciliations, based on an illustrative disclosure in the IASB's IFRS 17 Effects Analysis.
Estimates of the present value of future cash flows | Risk adjustment | Contractual service margin | Total | |
Insurance contract liabilities 2020 | 163,962 | 5,998 | 8,858 | 178,818 |
Changes that relate to current service | 35 | (604) | (923) | (1,492) |
Contractual service margin recognised for service period | – | – | (923) | (923) |
Risk adjustment recognised for the risk expired | – | (604) | – | (604) |
Experience adjustments | 35 | – | – | 35 |
Changes that relate to future service | (784) | 1,117 | (116) | 217 |
Contracts initially recognised in the period | (2,329) | 1,077 | 1,375 | 123 |
Changes in estimates reflected in the contractual service margin | 1,452 | 39 | (1,491) | – |
Changes in estimates that result in onerous contract losses | 93 | 1 | – | 94 |
Changes that relate to past service | 47 | (7) | – | 40 |
Adjustments to liabilities for incurred claims | 47 | (7) | – | 40 |
Insurance service result | (702) | 506 | (1,039) | (1,235) |
Insurance finance expenses | 9,087 | – | 221 | 9,308 |
Total changes in the statement of comprehensive income | 8,385 | 506 | (818) | 8,073 |
Cash flows | 18,833 | – | – | 18,833 |
Insurance contract liabilities 2021 | 191,180 | 6,504 | 8,040 | 205,724 |
Figure 56.3: Movements in insurance contract liabilities analysed by components.
In April 2019, the IASB staff responded to a TRG submission which asked whether changes disclosed as relating to past service in an interim reporting period should be disclosed in the reconciliations above as changes relating to current service in the annual reporting. The IASB staff stated 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 reporting period. The amounts disclosed in the reconciliations above reflected the amounts included in the measurement of insurance contracts and that the description of the amount as relating to past or current service does not affect the measurement.124
In addition, to complete the reconciliations above, an entity should also disclose separately each of the following amounts not related to insurance contract services provided in the period, if applicable: [IFRS 17.105]
The ED proposes the following additional disclosures for acquisition cash flows as a result of the proposed accounting changes discussed at 8.1.4 and 8.10 above:125
In respect of insurance revenue recognised in the period, entities need to provide the following analysis: [IFRS 17.106]
The words in italics above are proposed by the ED (see 8.6.2 above).
Below is an example of this insurance revenue analysis, based on an illustrative disclosure in the IASB's IFRS 17 Effects Analysis.
2021 | ||
Amounts related to liabilities for remaining coverage | 8,597 | |
Expected incurred claims and other expenses | 7,070 | |
Contractual service margin for the service provided | 923 | |
Risk adjustment for the risk expired | 604 | |
Recovery of acquisition cash flows | 1,259 | |
Insurance revenue | 9,856 |
The effect on the statement of financial position for insurance contracts issued and reinsurance contracts held that are initially recognised in the period should be shown separately, disclosing the effect at initial recognition on: [IFRS 17.107]
In the reconciliation showing the effect of insurance contracts issued and reinsurance contracts held, there should be separate disclosure of: [IFRS 17.108]
Below is an example of this analysis, based on an illustrative disclosure in the IASB's IFRS 17 Effects Analysis. The example shows insurance contracts issued only for an entity which has not acquired contracts in the period via transfers or business combinations.
Contracts initially recognised in 2021 | Of which contracts acquired | Of which onerous contracts | ||
Estimates of the present value of futures cash inflows | (33,570) | (19,155) | (1,716) | |
Estimates of the present value of future cash outflows | ||||
Insurance acquisition cash flows | 401 | 122 | 27 | |
Claims payable and other expenses | 30,840 | 17,501 | 1,704 | |
Risk adjustment | 1,077 | 658 | 108 | |
Contractual service margin | 1,375 | 896 | – | |
Total | 123 | 22 | 123 |
Figure 56.5: Analysis of contracts initially recognised in the period.
Additionally, an entity should disclose an explanation of when it expects to recognise the contractual service margin remaining at the end of the reporting period in profit or loss, either quantitatively in appropriate time bands or by providing qualitative information. Such information should be provided separately for insurance contracts issued and reinsurance contracts held (deletions to remove qualitative option as proposed by the ED). [IFRS 17.109].
The reconciliations described below apply to contracts using the premium allocation approach (most also apply for contracts using the general model – see 16.1.1 above). The changes proposed by the ED are in italics and are the same changes as shown at 16.1.1 above.
Overall reconciliations from the opening to the closing balances separately for each of: [IFRS 17.100]
Within the overall reconciliations above, separate disclosure of each of the following amounts related to insurance contract services, if applicable: [IFRS 17.103]
Disclosure of each of the following amounts that are not related to insurance contract services provided in the period, if applicable: [IFRS 17.105]
The additional disclosures proposed by the ED for insurance acquisition cash flow assets also apply to the premium allocation approach (see 16.1.1 above).
Unlike IFRS 4, IFRS 17 does not contain an explicit requirement for an insurer's accounting policies for insurance contracts and related liabilities, income and expense to be disclosed. However, IAS 1 requires an entity to disclose its significant accounting policies comprising: [IAS 1.117]
When an entity uses the premium allocation approach it must disclose the following: [IFRS 17.97]
These accounting policy choices are discussed at 9.1 and 9.4 above.
The total amount of insurance finance income or expenses in the reporting period should be disclosed and explained. In particular, an entity should explain the relationship between insurance finance income or expenses and the investment return on its assets, to enable users of its financial statements to evaluate the sources of finance income or expenses recognised in profit or loss and other comprehensive income. [IFRS 17.110].
Specifically, for contracts with direct participation features, an entity should:
An entity should provide disclosures that enable users of financial statements to identify the effect of groups of insurance contracts measured at the transition date applying the modified retrospective approach (see 17.3 below) or the fair value approach (see 17.4 below) on the contractual service margin and insurance revenue in subsequent periods. As a result, IFRS 17 requires various disclosures that must continue to be made each reporting period until the contracts which exist at transition have expired or been extinguished.
Hence an entity should disclose the reconciliation of the contractual service margin and the amount of insurance revenue required at 16.1.1 above separately for: [IFRS 17.114]
In addition, for all periods in which disclosures are made for contracts which, on transition, were accounted for using either the modified retrospective approach or the fair value approach, an entity should explain how it determined the measurement of insurance contracts at the transition date. The purpose of this is to enable users of financial statements to understand the nature and significance of the methods used and judgements applied in determining the transition amounts. [IFRS 17.115].
An entity that chooses to disaggregate insurance finance income or expenses between profit or loss and other comprehensive income applies the requirements discussed at 17.3 below (for the modified retrospective approach) or 17.4 below (for the fair value approach) to determine the cumulative difference between the insurance finance income or expenses that would have been recognised in profit or loss and the total insurance finance income or expenses at the transition date for the groups of insurance contracts to which the disaggregation applies. For all periods in which amounts determined by applying these transitional approaches exist, the entity should disclose a reconciliation of the opening to the closing balance of the cumulative amounts included in other comprehensive income for financial assets measured at fair value through other comprehensive income related to the groups of insurance contracts. The reconciliation should include, for example, gains or losses recognised in other comprehensive income in the period and gains or losses previously recognised in other comprehensive income in previous periods reclassified in the period to profit or loss. [IFRS 17.116].
IAS 1 requires that an entity should disclose the judgements that management has made in the process of applying the entity's accounting policies and that have the most significant effect on the amounts recognised in the financial statements. [IAS 1.122].
Consistent with IAS 1, the second part of the disclosure objective established by the IFRS 17 is that an entity should disclose the significant judgements and changes in judgements made by an entity in applying the standard. [IFRS 17.93].
Specifically, an entity should disclose the inputs, assumptions and estimation techniques used, including: [IFRS 17.117]
The words in italics above are proposed by the ED and relate to the proposed accounting changes discussed at 8.7.2 and 11.2.3 above.
If, an entity chooses to disaggregate insurance finance income or expenses into amounts presented in profit or loss and amounts presented in other comprehensive income (see 15.3.1 to 15.3.3 above), the entity should disclose an explanation of the methods used to determine the insurance finance income or expenses recognised in profit or loss. [IFRS 17.118].
An entity should also disclose the confidence level used to determine the risk adjustment for non-financial risk. If the entity uses a technique other than the confidence level technique for determining the risk adjustment for non-financial risk, it should disclose: [IFRS 17.119]
An entity should disclose the yield curve (or range of yield curves) used to discount cash flows that do not vary based on the returns on underlying items. When an entity provides this disclosure in aggregate for a number of groups of insurance contracts, it should provide such disclosures in the form of weighted averages, or relatively narrow ranges. [IFRS 17.120].
The third part of the disclosure objective established by the standard is that an entity should disclose the nature and extent of the risks from contracts within the scope of IFRS 17. [IFRS 17.93].
To comply with this objective, an entity should disclose information that enables users of its financial statements to evaluate the nature, amount, timing and uncertainty of future cash flows that arise from contracts within the scope of IFRS 17. [IFRS 17.121].
The disclosures detailed below are considered to be those that would normally be necessary to meet this requirement. These disclosures focus on the insurance and financial risks that arise from insurance contracts and how they have been managed. Financial risks typically include, but are not limited to, credit risk, liquidity risk and market risk. [IFRS 17.122]. Many similar disclosures were contained in IFRS 4, often phrased to the effect that an insurer should make disclosures about insurance contracts assuming that insurance contracts were within the scope of IFRS 7. The equivalent disclosures now required by IFRS 17 are more specific to the circumstances of the measurement of insurance contracts in the standard and do not cross-refer to IFRS 7.
For each type of risk arising from contracts within the scope of IFRS 17, an entity should disclose: [IFRS 17.124]
An entity should also disclose, for each type of risk: [IFRS 17.125]
If the information disclosed about an entity's exposure to risk at the end of the reporting period is not representative of its exposure to risk during the period, the entity should disclose that fact, the reason why the period-end exposure is not representative, and further information that is representative of its risk exposure during the period. [IFRS 17.123].
Disclosure of an entity's objectives, policies and processes for managing risks and the methods used to manage the risk provides an additional perspective that complements information about contracts outstanding at a particular time and might include information about:
Additionally, it might be useful to provide disclosures both for individual types of risks insured and overall. These disclosures might include a combination of narrative descriptions and specific quantified data, as appropriate to the nature of the contracts and their relative significance to the insurer.
Quantitative information about exposure to insurance risk might include:
An entity should disclose information about concentrations of risk arising from contracts within the scope of IFRS 17, including a description of how the entity determines the concentrations, and a description of the shared characteristic that identifies each concentration (for example, the type of insured event, industry, geographical area, or currency).
It is further explained that concentrations of financial risk might arise, for example, from interest-rate guarantees that come into effect at the same level for a large number of contracts. Concentrations of financial risk might also arise from concentrations of non-financial risk; for example, if an entity provides product liability protection to pharmaceutical companies and also holds investments in those companies (i.e. a sectoral concentration). [IFRS 17.127].
Other concentrations could arise from, for example:
Disclosure of concentrations of insurance risk might include a description of the shared characteristic that identifies each concentration and an indication of the possible exposure, both before and after reinsurance held, associated with all insurance liabilities sharing that characteristic.
Disclosure about the historical performance of low-frequency, high-severity risks might be one way to help users assess cash flow uncertainty associated with those risks. For example, an insurance contract may cover an earthquake that is expected to happen, on average, once every 50 years. If the earthquake occurs during the current reporting period the insurer will report a large loss. If the earthquake does not occur during the current reporting period the insurer will report a profit. Without adequate disclosure of long-term historical performance, it could be misleading to report 49 years of large profits, followed by one large loss, because users may misinterpret the insurer's long-term ability to generate cash flows over the complete cycle of 50 years. Therefore, describing the extent of the exposure to risks of this kind and the estimated frequency of losses might be useful. If circumstances have not changed significantly, disclosure of the insurer's experience with this exposure may be one way to convey information about estimated frequencies. However, there is no specific requirement to disclose a probable maximum loss (PML) in the event of a catastrophe.
An entity should disclose information about sensitivities to changes in risk exposures variables arising from contracts within the scope of IFRS 17. To comply with this requirement, an entity should disclose: [IFRS 17.128]
Market risk comprises three types of risk: currency risk, interest rate risk and other price risk. [IFRS 7 Appendix A].
If an entity prepares a sensitivity analysis (e.g. an embedded value analysis) that shows how amounts different from those above are affected by changes in risk exposures variables and uses that sensitivity analysis to manage risks arising from contracts within the scope of IFRS 17, it may use that sensitivity analysis in place of the analysis specified above. The entity should also disclose: [IFRS 17.129]
The words above in italics are proposed by the ED to correct the terminology in the disclosure requirements (by replacing ‘exposures’ with ‘variables’).
An entity should disclose actual claims compared with previous estimates of the undiscounted amount of the claims (i.e. claims development). The disclosure about claims development should start with the period when the earliest material claim(s) arose and for which there is still uncertainty about the amount and timing of the claims payments at the end of the reporting period; but the disclosure is not required to start more than 10 years before the end of the reporting period (although there is transitional relief for first-time adopters – see 17.2 below). An entity is not required to disclose information about the development of claims for which uncertainty about the amount and timing of the claims payments is typically resolved within one year. [IFRS 17.130].
An entity should reconcile the disclosure about claims development with the aggregate carrying amount of the groups of insurance contracts which comprise the liabilities for incurred claims (see 16.1.1 and 16.1.2 above). [IFRS 17.130]. Hence, only incurred claims are required to be compared with previous estimates and not any amounts within the liability for remaining coverage. In this context incurred claims appears to include those arising from reinsurance contracts held as well as those arising from insurance and reinsurance contracts issued. [IFRS 17.100].
These requirements apply to incurred claims arising from all models (i.e. general model, premium allocation approach and variable fee approach). However, because insurers need not disclose the information about claims for which uncertainty about the amount and timing of payments is typically resolved within a year, it is unlikely that many life insurers will need to give the disclosure.
Any discounting adjustment will be a reconciling item as the claims development table is required to be undiscounted. Given the long tail nature of many non-life insurance claims liabilities it is likely that many non-life insurers will still have claims outstanding at the reporting date that are more than ten years old and which will also need to be included in a reconciliation of the development table to the statement of financial position.
IFRS 17 does not contain an illustrative example of a claims development table (or, indeed, specifically require disclosure in a tabular format). The example below is based on an illustrative example contained in the Implementation Guidance to IFRS 4. This example, as a simplification for illustration purposes, presents five years of claims development information by underwriting year although the standard itself requires ten (subject to the transitional relief upon first-time adoption) and assumes no reinsurance held. Other formats are permitted, including for example, presenting information by accident year or reporting period rather than underwriting year.
IFRS 17 is also does not address the presentation in the claims development table of:
As IFRS 17 is silent on these matters, a variety of treatments would appear to be permissible provided they are adequately explained to the users of the financial statements and consistently applied in each reporting period.
For credit risk that arises from contracts within the scope of IFRS 17, an entity should disclose: [IFRS 17.131]
Credit risk is defined in IFRS 7 as ‘the risk that one party to a financial instrument will fail to discharge an obligation and cause the other party to incur a financial loss’. IFRS 17 provides no further detail about what is considered to be the maximum exposure to credit risk for an insurance contract or reinsurance contract held at the end of the reporting period. The equivalent IFRS 7 requirement for financial instruments requires disclosure of credit risk gross of collateral or other credit enhancements. [IFRS 7.35K(a)]. However, IFRS 17 does not specify that the maximum credit risk should be disclosed gross of collateral or other credit enhancements.
Information about the credit quality of reinsurance could be provided by an analysis based on credit risk rating grades.
For liquidity risk arising from contracts within the scope of IFRS 17, an entity should disclose: [IFRS 17.132]
The amendments in italics are proposed by the ED and reflect the proposed presentation changes which are discussed at 14 above.
There is no equivalent disclosure required for portfolios of insurance contracts and reinsurance contracts held that are in an asset position.
IFRS 7 does not contain an equivalent requirement to disclose ‘amounts that are payable on demand’ so the nature of this requirement in IFRS 17 is not entirely clear (i.e. whether it is intended to include liabilities payable at the reporting date in respect of portfolios of insurance contracts and reinsurance assets held that are assets or whether the requirement is intended to show only those net cash outflows payable at the reporting date included within the maturity analysis).
Most insurance entities are exposed to externally imposed capital requirements and therefore the IAS 1 disclosures in respect of these requirements are likely to be applicable.
Where an entity is subject to externally imposed capital requirements, disclosures are required of the nature of these requirements and how these requirements are incorporated into the management of capital. Disclosure of whether these requirements have been complied with in the reporting period is also required and, where they have not been complied with, the consequences of such non-compliance. [IAS 1.135].
Many insurance entities operate in several jurisdictions. Where an aggregate disclosure of capital requirements and how capital is managed would not provide useful information or distorts a financial statement user's understanding of an entity's capital resources, separate information should be disclosed for each capital requirement to which an entity is subject. [IAS 1.136].
In addition to the requirements of IAS 1, an entity should disclose information about the effect of the regulatory frameworks in which it operates; for example, minimum capital requirements or required interest-rate guarantees. [IFRS 17.126]. These extra disclosures do not contain an explicit requirement for an insurer to quantify its regulatory capital requirements. The IASB considered whether to add a requirement for insurers to quantify regulatory capital on the grounds that such disclosures might be useful for all entities operating in a regulated environment. However, the Board was concerned about developing such disclosures in isolation in a project on accounting for insurance contracts that would go beyond the existing requirements in IAS 1. Accordingly, the Board decided to limit the disclosures about regulation to those set out above. [IFRS 17.BC369‑371].
Additionally, if an entity includes contracts within the same group which would have been in different groups only because law or regulation specifically constrains the entity's practical ability to set a different price or level of benefits for policyholders with different characteristics (see 6 above), it should disclose that fact. [IFRS 17.126].
Contracts within the scope of IFRS 17 are not excluded from the scope of IFRS 13 and therefore any of those contracts measured at fair value are also subject to the disclosures required by IFRS 13. In practice, this is unlikely as IFRS 17 does not require contracts within its scope to be measured at fair value. In addition, all contracts within the scope of IFRS 17 are excluded from the scope of IFRS 7. [IFRS 7.3(d)]. Under IFRS 4, investment contracts with a DPF are within the scope of IFRS 7.
However, IFRS 7 applies to: [IFRS 7.3(d)]
IFRS 17 does not require disclosure of key performance indicators. However, such disclosures might be a useful way for an insurer to explain its financial performance during the period and to give an insight into the risks arising from insurance contracts.
An entity should apply IFRS 17 for annual reporting periods beginning on or after 1 January 2021 (or 1 January 2022 based on the proposal in the ED). [IFRS 17.C1]. When IFRS 17 is applied, IFRS 4 is withdrawn. [IFRS 17.C34].
If an entity applies IFRS 17 earlier than reporting periods beginning on or after 1 January 2021 (or 1 January 2022 if the proposal in the ED is finalised), it should disclose that fact. However, early application is permitted only for entities that also apply both IFRS 9 and IFRS 15 on or before the date of initial application of IFRS 17. [IFRS 17.C1].
For the purposes of the transition requirements discussed at 17.2 below: [IFRS 17.C2]
An entity should apply IFRS 17 retrospectively from the transition date unless impracticable. When applying IFRS 17 retrospectively, an entity should: [IFRS 17.C4]
The balances derecognised upon application of IFRS 17 would include balances recognised previously under IFRS 4 as well as items such as deferred acquisition costs, deferred origination costs (for investment contracts with discretionary participation features) and some intangible assets that relate solely to existing contracts. The requirement to recognise any net difference in equity means that no adjustment is made to the carrying amounts of goodwill from any previous business combination. [IFRS 17.BC374]. However, the value of contracts within the scope of IFRS 17 acquired in prior period business combinations or transfers would have to be adjusted by the acquiring entity from the date of acquisition (i.e. initial recognition) together with any intangible related to those in-force contracts. Any intangible asset derecognised would include an intangible asset that represented the difference between the fair value of insurance contracts acquired in a business combination or transfer and a liability measured in accordance with an insurer's previous accounting practices for insurance contracts where an insurer previously chose the option in IFRS 4 to use an expanded presentation that split the fair value of acquired insurance contracts into two components. [IFRS 4.31].
Applying the standard retrospectively means that comparative period (i.e. the annual reporting period immediately preceding the date of initial application) must be restated and comparative disclosures made in full in the first year of application subject to the exemptions noted below. An entity may also present adjusted comparative information applying IFRS 17 for any earlier periods presented (i.e. any periods earlier than the annual reporting period immediately preceding the date of initial application) but is not required to do so. If an entity does present adjusted comparative information for any prior periods, the reference to ‘the beginning of the annual reporting period immediately preceding the date of initial application’ (see 17 above) should be read as ‘the beginning of the earliest adjusted comparative period presented’. [IFRS 17.C25]. However, an entity is not required to provide the disclosures specified at 16 above for any period presented before the beginning of the annual accounting period immediately preceding the date of initial application. [IFRS 17.C26]. If an entity presents unadjusted comparative information and disclosures for any earlier periods, it should clearly identify the information that has not been adjusted, disclose that it has been prepared on a different basis, and explain that basis. [IFRS 17.C27].
The requirement to apply IFRS 17 retrospectively as if it has always applied seems to imply that an entity should estimate the contractual service margin for all individual interim periods previously presented to get to a number for the contractual service margin that reflects that as if IFRS 17 had always been applied. [IFRS 17.B137]. This is based on the fact that only a fully retrospective interim contractual service margin roll-forward would provide the outcome that corresponds to a situation as if IFRS 17 had always been applied. As a result, retrospective application may be different for those entities that do and those that do not issue interim financial statements (see Example 56.60 at 15.4 above). Applying the standard retrospectively by an entity that issues interim financial statements may present significant additional operational challenges for insurers upon transition. This is because the contractual service margin for each interim reporting period subsequent to initial recognition of a group of contracts would need to be tracked and estimated in accordance with the requirements in IFRS 17 to determine the contractual service margin on transition date.
In May 2018, in response to a TRG submission about whether reasonable approximations are permitted when applying IFRS 17 retrospectively, the IASB staff drew attention to the guidance in paragraph 51 of IAS 8 which states that ‘...the objective of estimates related to prior periods remains the same as estimates related to the current period, namely, for the estimates to reflect the circumstances that existed when the transaction, other event or condition occurred’.126
Notwithstanding the requirement for retrospective application, if it is impracticable (as defined in IAS 8), to apply IFRS 17 retrospectively for a group of insurance contracts, an entity should apply one of the two following approaches instead: [IFRS 17.C5]
IAS 8 states that applying a requirement is ‘impracticable’ when an entity cannot apply it after making every reasonable effort to do so. [IAS 8.5]. Guidance on what impracticable means in the context of restatement of prior periods following a change in accounting policy is discussed in Chapter 3 at 4.7.
The Board permitted these alternative options to the full retrospective approach on the grounds that measuring the remaining amount of the contractual service margin for contracts acquired in prior periods, as well as the information needed in the statement of financial performance in subsequent periods, was likely to be challenging for preparers. This is because these amounts reflect a revision of estimates for all periods after the initial recognition of a group of contracts. [IFRS 17.BC377]. In the Board's opinion, measuring the following amounts needed for retrospective application would often be impracticable: [IFRS 17.BC378]
The choice of applying either a modified retrospective approach or a fair value approach exists separately for each group of insurance contracts when it is impracticable to apply IFRS 17 retrospectively to that group. An entity is permitted to use either of these two methods although use of the modified retrospective approach is conditional on the availability of reasonable and supportable information. [IFRS 17.C6(a)].
Within the two permitted methods there are also measurement choices available depending on the level of prior year information. Consequently, there is likely to be considerable diversity of practice across entities in calculating the contractual margin at transition date. In turn, this will result in potentially different releases of the contractual service margin (i.e. different profit) for similar types of contract in subsequent accounting periods. The Board has acknowledged that the choice of transition methods results in a lack of comparability of transition amounts. [IFRS 17.BC373]. This explains why the Board included a requirement for disclosures that track the effects of the modified retrospective approach and the fair value approach on the contractual service margin and insurance revenue in future periods (see 16.1.5 above).
An overview of the transition methods is illustrated below:
As exceptions to retrospective application: [IFRS 17.C3]
Additionally, an entity need not disclose previously unpublished information about claims development that occurred earlier than five years before the end of the annual reporting period in which it first applies IFRS 17 (i.e. information about claims that occurred prior to 1 January 2018 for an entity first applying the standard with an annual reporting period ending 31 December 2022). An entity that elects to take advantage of this disclosure relief should disclose that fact. [IFRS 17.C28].
It is observed in the Basis for Conclusions that no simplification has been provided for contracts that have been derecognised before transition. This is because the Board considers that reflecting the effect of contracts derecognised before the transition date on the remaining contractual service margin was necessary to provide a faithful representation of the remaining profit of the group of insurance contracts. [IFRS 17.BC390].
In addition to the risk mitigation relief discussed above, the ED proposes the following additional transition relief:
At transition to IFRS 17, entities should provide the disclosures required by IAS 8 applicable to changes in accounting policies apart from the exemption discussed above (i.e. there is no requirement to present the amount of the adjustment resulting from applying IFRS 17 affecting each financial line item to either the current period or each prior period presented and the impact of applying IFRS 17 in those periods on earnings per share).
IAS 8 requires the following disclosures upon initial application of an IFRS: [IAS 8.28]
In addition, as discussed at 16.1.5 above, entities are required to provide disclosures to enable users of the financial statements to identify the effects of groups of insurance contracts measured at transition date applying the modified retrospective approach or the fair value approach on the contractual service margin in subsequent periods. This information is provided in the form of reconciliations. In all periods for which disclosures are made for those contracts which used the modified retrospective or fair value approach on transition, an entity should continue to explain how it determined the measurement requirements at transition date.
This approach contains a series of permitted modifications to retrospective application as follows: [IFRS 17.C7]
An entity is permitted to use each modification listed above only to the extent that it does not have reasonable and supportable information to apply the retrospective approach. [IFRS 17.C8].
The objective of the modified retrospective approach is to achieve the closest outcome to retrospective application possible using reasonable and supportable information available without undue cost or effort. Accordingly, in applying this approach, an entity should: [IFRS 17.C6]
‘Undue cost and effort’ is not defined in IFRS. However, the IFRS for Small and Medium-sized Entities states that considering whether obtaining or determining the information necessary to comply with a requirement would involve undue cost or effort depends on the entity's specific circumstances and on management's judgement of the costs and benefits from applying that requirement. This judgement requires consideration of how the economic decisions of those that are expected to use the financial statements could be affected by not having that information. Applying a requirement would involve undue cost or effort by a Small and Medium sized entity (SME) if the incremental cost (for example, valuers' fees) or additional effort (for example, endeavours by employees) substantially exceed the benefits those that are expected to use the SME's financial statements would receive from having the information. The Basis for Conclusions to the IFRS for SMEs further observes that:
The IASB's Conceptual Framework also notes that although cost is a pervasive constraint on the information provided by financial reporting and that the cost of producing information must be justified by the benefits that it provides, the cost is ultimately borne by the users (not the preparers) and implies that any cost constraint should be seen from a user's viewpoint. See Chapter 2 at 5.3.
The Basis for Conclusions to the ED observes that the IASB considered that some stakeholders believe that the inclusion of specified modifications in IFRS 17 for the modified retrospective approach implies that an entity cannot make estimates in applying IFRS 17 retrospectively. The IASB noted that paragraph 51 of IAS 8 specifically acknowledges the need for estimates in retrospective application and that this paragraph applies to entities applying IFRS 17 for the first time just as it does to entities applying other IFRS standards for the first time. The IASB also noted that it expects that estimates will often be needed when applying a specified modification in the modified retrospective approach.133
When it is impracticable for an entity to apply the retrospective approach, an entity should determine the following matters using information available at the transition date: [IFRS 17.C9]
To apply IFRS 17 retrospectively, an entity needs to determine the group of insurance contracts to which individual contracts would have belonged on initial recognition. IFRS 17 requires entities to group only contracts written within one year. [IFRS 17.BC391]. The IASB considered that it may not always be practicable for entities to group contracts written in the same one‑year period retrospectively. [IFRS 17.BC392]. Consequently, in aggregating contracts when it is impracticable to apply a retrospective approach, an entity is permitted (to the extent that reasonable and supportable information does not exist) to aggregate contracts in a portfolio issued more than one year apart into a single group. [IFRS 17.C10]. This may mean that a single group of, say, term life contracts, could span many years to the extent reasonable and supportable information would not be available to aggregate the contracts into groups that only contain contracts issued within one year.
When it is impracticable for an entity to apply the retrospective approach at initial recognition to determine the contractual service margin or the loss component of the liability for remaining coverage, an entity is permitted to determine these at transition date using a modified approach to determine the components of the liability for remaining coverage. [IFRS 17.C11].
The modified retrospective approach allows considerable judgement as it permits an entity to go back as far as it is able in order to determine reliable accounting estimates for the fulfilment cash flows. Inevitably, this will result in diversity of practice being applied by first time adopters and some lack of comparability in the release of the contractual margin in future periods between entities with longer-term contracts.
The process applied is as follows:
The estimate of future cash flows referred to above at the date of initial recognition would include an estimate of acquisition cash flows.134
If applying the modified requirements above results in a contractual service margin at initial recognition (i.e. there is a profit on initial recognition) then the entity should determine the contractual service margin at transition date as follows: [IFRS 17.C15]
If applying the modified requirements above results in a loss component of that liability for remaining coverage at the date of initial recognition, an entity should determine any amounts allocated to that loss component before the transition date applying the modified requirements above and using a systematic basis of allocation. [IFRS 17.C16].
The modified retrospective approach requires that reasonable and supportable information exists for the cash flows prior to transition up until the date of initial recognition (i.e. the date past which reasonable and supportable information is no longer available). This means all of the cash flows within the boundary of the insurance contract, as discussed at 8.2 above, including, for example, internally allocated directly attributable insurance acquisition cash flows, claims handling costs, policy maintenance and administration costs and an allocation of fixed and variable overheads.
The following example, based on Example 17 in the Illustrative Examples to IFRS 17, shows the transition requirements for a group of insurance contracts without direct participation features applying the modified retrospective approach. [IFRS 17.IE186-IE191].
When it is impracticable for an entity to apply the retrospective approach at initial recognition to determine the contractual service margin or the loss component of the liability for remaining coverage for groups of contracts with direct participation features, these should be determined as: [IFRS 17.C17]
The following example, based on Example 18 in the Illustrative Examples to IFRS 17, shows the transition requirements for a group of insurance contracts with direct participation features when applying the modified retrospective approach. [IFRS 17.IE192‑IE199].
The modified requirements for insurance finance income or expenses are different depending on whether, as a result of applying the modified retrospective approach, groups of insurance contracts include contracts issued more than one year apart (see 17.3.1 above).
When an entity has aggregated a group of insurance contracts on a basis that includes contracts issued more than one year apart in the same group: [IFRS 17.C18]
When an entity has aggregated a group of insurance contracts on a basis that does not include contracts issued more than one year apart in the same group: [IFRS 17.C19]
The fair value approach is:
To apply the fair value approach, an entity should determine the contractual service margin or loss component of the liability for remaining coverage at the transition date as the difference between the fair value of a group of insurance contracts at that date and the fulfilment cash flows measured at that date. In determining fair value, an entity must apply the requirements of IFRS 13 except for the requirement that the fair value of a financial liability with a demand feature (e.g. a demand deposit) cannot be less than the amount payable on demand, discounted from the first date that the amount could be required to be paid. [IFRS 17.C20]. This means that insurance contract liabilities can be measured at an amount lower than the discounted amount repayable on demand.
In April 2019, the IASB staff considered a TRG submission on the fair value approach and confirmed that when, in applying the fair value approach, an entity determines the contractual service margin by comparing the fulfilment cash flows and the fair value of a group of insurance contracts, the fair value measurement in this situation reflects the effect of non-performance risk as required by IFRS 17 (but not the requirements relating to demand features). However, the fulfilment cash flows of an entity do not reflect the non-performance risk of the entity and this applies also to the fulfilment cash flows of an entity using the fair value approach on transition (i.e. the fulfilment cash flows of an entity that applies the fair value approach on transition exclude non-performance risk but non-performance risk is considered when determining the fair value of a group of contracts at transition date for the purpose of the calculation of the contractual service margin as the difference between the fulfilment cash flows and fair value).135
In applying the fair value approach an entity may use reasonable and supportable information for what the entity would have determined given the terms of the contract and the market conditions at the date of inception or initial recognition, as appropriate or, alternatively, reasonable and supportable information at the transition date in determining: [IFRS 17.C21‑22]
In addition, the general requirements of IFRS 17 are modified as follows when the fair value approach is used:
Although there is the option above to set other comprehensive income at nil on transition no equivalent option exists under transition in IFRS 9 for financial assets held at fair value through other comprehensive income.
In May 2018, the TRG discussed the analysis in an IASB staff paper that considered whether, when applying the fair value approach to transition, insurance acquisition cash flows that occurred prior to the transition date are recognised as revenue and expenses for reporting periods subsequent to the transition date. The TRG members noted that:
The IASB staff noted that this analysis applies in all situations that the fair value transition approach is taken, irrespective of whether the entity can identify and measure the insurance acquisition cash flows that applied prior to the transition date.136
At the date of initial application of IFRS 17, an entity that had applied IFRS 9 to annual reporting periods before the initial application of IFRS 17: [IFRS 17.C29]
An entity should apply the above on the basis of the facts and circumstances that exist at the date of initial application of IFRS 17. An entity should apply those designations and classifications retrospectively. In doing so, the entity should apply the relevant transition requirements in IFRS 9. The date of initial application for that purpose should be deemed to be the date of initial application of IFRS 17. [IFRS 17.C30].
Any changes resulting from applying the above do not require the restatement of prior periods. The entity may restate prior periods only if it is possible without the use of hindsight. This therefore may result in a situation whereby the comparative period is restated for the effect of IFRS 17 (which may include changes that affect financial instruments within the scope of IFRS 9, for example accounting for investment components that are separated) but not for consequential changes resulting to the classification of financial assets (this situation will also potentially arise when an entity has not previously applied IFRS 9 – see 17.6 below). If an entity does restate prior periods, the restated financial statements must reflect all the requirements of IFRS 9 for those affected financial assets. If an entity does not restate prior periods, the entity should recognise, in the opening restated earnings (or other component of equity, as appropriate) at the date of initial application, any difference between:
Other disclosure requirements when redesignation of financial assets is applied are as follows:
The ED proposes additional transitional relief in IFRS 9 as a result of the proposed amendments to IFRS 17 for an entity that first applies IFRS 17 after it first applies IFRS 9. The new proposals permit an entity to revoke a prior designation of a financial liability at fair value through profit or loss if the conditions that resulted in fair value designation are no longer satisfied as a result of amendments made by the ED or designate a financial liability at fair value through profit or loss if the conditions for fair value designation were not previously satisfied but have been satisfied as a result of the amendments made by the ED. Restatement of prior periods for these amendments is not required but the entity should make disclosures detailing the impact of any reclassification including previous and new measurement categories, new and previous carrying amounts and the reason for any change in designation or de-designation. An entity may restate prior periods only if it possible to do so without the use of hindsight.137
Most entities meeting the eligibility criteria for the temporary exemption from IFRS 9 in IFRS 4 (see Chapter 55 at 10) are expected to elect to defer IFRS 9 until IFRS 17 becomes effective.
An entity that adopts IFRS 9 at the same time that it adopts IFRS 17 will be able to assess financial asset classifications, elections and designations while, at the same time, assessing the implications of the requirements of IFRS 17. An entity adopting IFRS 9 at the same time that it adopts IFRS 17 will also be able to apply the various transitional provisions of IFRS 9.
IFRS 17 requires any net differences resulting from its application to be recorded in net equity at the date of transition (i.e. 1 January 2021 for an entity applying IFRS 17 for the first time in its annual reporting period ending 31 December 2022). In contrast, IFRS 9's starting point is that the net differences resulting from its application are recorded in net equity at the date of initial application (i.e. 1 January 2022 for an entity applying IFRS 9 for the first time in its annual reporting period ending 31 December 2022). Comparative periods may only be restated if it is possible to do so without the use of hindsight. [IFRS 9.7.2.15]. Some care may therefore be needed to explain the presentation of the comparative results to users of the financial statements in the year of initial application of IFRS 17.
As discussed at 1 above, in June 2019, the IASB issued an ED proposing several amendments to IFRS 17. The Board's objective in issuing the ED was to make targeted amendments to IFRS 17 with the aim of easing implementation of the standard by reducing implementation costs and making it easier for entities to explain the results of applying IFRS 17 to investors and others. Although narrow in scope, in the IASB's opinion, the targeted amendments address many of the concerns and challenges raised by stakeholders. All amendments are intended to be effective for accounting periods beginning on or after 1 January 2022.
The principal amendments proposed in the ED by the IASB are summarised as follows:
The comment period for the ED expired on 25 September 2019. The IASB will discuss comments received on the ED with a view to issuing final amendments to IFRS 17 in mid-2020.