2.1 The objective of IFRS 17

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].

2.2 Definitions

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.

2.3 Scope

An entity should apply IFRS 17 to: [IFRS 17.3]

• insurance contracts, including reinsurance contracts, it issues;
• reinsurance contracts it holds; and
• investment contracts with discretionary participation features it issues, provided the entity also issues insurance contracts.

IFRS 17 is clear that all references to insurance contracts throughout the standard also apply to: [IFRS 17.4]

• reinsurance contracts held, except:
  • for references to insurance contracts issued; and
  • the specific requirements for reinsurance contracts held discussed at 10 below;
• investment contracts with a discretionary participation feature (DPF) as set out above except for the reference to insurance contracts and as described at 11.3 below.

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]

• a robust definition of an insurer that could be applied consistently from country to country would be difficult to create;
• entities that might meet the definition frequently have major activities in other areas as well as in insurance, and would need to determine how and to what extent these non-insurance activities would be accounted for in a manner similar to insurance activities or in a manner similar to how other entities account for their non-insurance activities; and
• if an entity that issues insurance contracts accounted for a transaction in one way and an entity that does not issue insurance contracts accounted for the same transaction in a different way, comparability across entities would be reduced.

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):

• IFRS 7 – Financial Instruments: Disclosures;
• IFRS 9 – Financial Instruments;
• IFRS 15 – Revenue from Contracts with Customers;
• IAS 32 – Financial Instruments: Presentation;
• IAS 36 – Impairment of Assets;
• IAS 37 – Provisions, Contingent Liabilities and Contingent Assets; and
• IAS 38 – Intangible Assets.

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).

3.1 The definition

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]

• an insurer should consider the time value of money in assessing whether the additional benefits payable in any scenario are significant (see 3.2 below); and
• a contract does not transfer significant insurance risk if there is no scenario with commercial substance in which the insurer can suffer a loss on a present value basis (see 3.2 below).

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:

• • significant insurance risk (see 3.2 below);
  • changes in the level of insurance risk (see 3.3 below);
  • uncertain future events (see 3.4 below);
  • payments in kind (see 3.5 below);
  • the distinction between insurance risk and other risks (see 3.6 below); and
  • examples of insurance and non-insurance contracts (see 3.7 below).

3.2 Significant insurance risk

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.

3.3 Changes in the level of insurance risk

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].

3.4 Uncertain future events

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]

1. the probability of an insured event occurring;
2. when the insured event will occur; or
3. how much the entity will need to pay if the insured event occurs.

An insured event will be one of the following:

• the discovery of a loss during the term of the contract, even if the loss arises from an event that occurred before the inception of the contract;
• a loss that occurs during the term of the contract, even if the resulting loss is discovered after the end of the contract term; [IFRS 17.B4] or
• the determination of the ultimate cost of a claim which has already occurred but whose financial effect is uncertain. [IFRS 17.B5].

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.

3.5 Payments in kind

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.

3.6 The distinction between insurance risk and financial risk

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].

3.7 Examples of insurance and non-insurance contracts

This section contains examples given in IFRS 17 of insurance and non-insurance contracts.

4.1 Separating embedded derivatives from an insurance contract

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:

• its economic characteristics and risks are not closely related to the economic characteristics and risks of the host contract;
• a separate instrument with the same terms would meet the definition of a derivative; and
• the hybrid contract is not measured at fair value with changes in fair value recognised in profit or loss (i.e. a derivative that is embedded in a financial liability at fair value through profit or loss is not separated). [IFRS 9.4.3.3].

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]

• ensures that contractual rights and obligations that create similar risk exposures are treated alike whether or not they are embedded in a non-derivative host contract; and
• counters the possibility that entities might seek to avoid the requirement to measure derivatives at fair value by embedding a derivative in a non-derivative host contract.

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:

• its value changes in response to a change in 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 the underlying of the contract; and
• it requires no initial net investment or an initial net investment that would be smaller than would be required for other types of contracts that would be expected to have a similar response to changes in market factors; and
• it is settled at a future date. [IFRS 9 Appendix A].

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:

• benefits, such as death benefits, linked to equity prices or an equity index;
• options to take life-contingent annuities at guaranteed rates;
• guarantees of minimum interest rates in determining surrender or maturity values;
• guarantees of minimum annuity payments where the annuity payments are linked to investment returns or asset prices;
• a put option for the policyholder to surrender a contract. These can be specified in a schedule, based on the fair value of a pool of interest-bearing securities or based on an equity or commodity price index;
• an option to receive a persistency bonus (an enhancement to policyholder benefits for policies that remain in-force for a certain period);
• an industry loss warranty where the loss trigger is an industry loss as opposed to an entity specific loss;
• a catastrophe trigger where a trigger is defined as a financial variable such as a drop in a designated stock market;
• an inflation index affecting policy deductibles;
• contracts where the currency of claims settlement differs from the currency of loss; and
• contracts with fixed foreign currency rates.

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.

4.2 Separating investment components from an insurance contract

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].

4.3 Separating a promise to provide distinct goods and non-insurance services from insurance contracts

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]

• apply IFRS 15 to attribute the cash inflows between the insurance component and any promises to provide distinct goods or non-insurance or services other than insurance contract services; and
• attribute the cash outflows between the insurance component and any promised goods or non-insurance services other than insurance contract services (amendments in italics proposed by the ED) accounted for by applying IFRS 15 so that:
  • cash outflows that relate directly to each component are attributed to that component; and
  • any remaining cash outflows are attributed on a systematic and rational basis, reflecting the cash outflows the entity would expect to arise if that component were a separate contract.

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 cash flows and the risks associated with the good or service are highly interrelated with the cash flows and risks associated with the insurance components in the contract; and
• the entity provides a significant service in integrating the good or non-insurance service with the insurance components.

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].

5.1 Identifying portfolios

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.

5.2 Identifying groups according to expected profitability

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]

• based on the likelihood of changes in assumptions which, if they occurred, would result in the contract becoming onerous; and
• using information about estimates prepared by the entity's internal reporting. Hence, in assessing whether contracts that are not onerous at initial recognition have no significant possibility of becoming onerous:
  • an entity should not disregard information provided by its internal reporting about the effect of changes in assumptions on different contracts on the possibility of their becoming onerous; but
  • an entity is not required to gather additional information beyond that provided by the entity's internal reporting about the effect of changes in assumptions on different contracts.

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).

5.2.1 ‘Cohorts’

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].

5.3 Identifying groups for contracts applying the premium allocation approach

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.

6.1 Initial recognition of insurance acquisition cash flows as assets

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:

• those it expects to pay after the related group of insurance contracts is recognised as part of the fulfilment cash flows of the group of insurance contracts (see 8.2 to 8.4 below);
• those cash flows paid before the related group of insurance contracts is recognised as an asset. An entity should recognise such an asset for each existing or future group of insurance contracts to which insurance acquisition cash flows are allocated.

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).

7.1 Overview of the general model

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]

• fulfilment cash flows, which comprise:
  • estimates of expected future cash flows over the life of the contract;
  • an adjustment to reflect the time value of money and the financial risks related to the future cash flows to the extent that the financial risks are not included in the estimates of the future cash flows; and
  • a risk adjustment for non-financial risk;
• a contractual service margin (CSM), representing the unearned profit on the group of contracts.

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 liability for remaining coverage, comprising:
  • the fulfilment cash flows related to future service allocated to

    the group at that date; and

  • the CSM of the group at that date; and
• the liability for incurred claims comprising the fulfilment cash flows related to past service allocated to the group at that date.

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.

7.2 Modifications to the general model

An entity should apply the general model to all groups of insurance contracts except as follows: [IFRS 17.29]

• a simplified or premium allocation approach may be applied for groups of insurance contracts meeting either of the specified criteria for that approach – see 9 below;
• for groups of reinsurance contracts held, an entity should apply either the general model or the premium allocation model as modified by separate measurement requirements – see 10 below;
• an adaptation of the general model, the ‘variable fee approach’ is applied to insurance contracts with direct participation features (see 11.2 below); and
• for groups of investment contracts with discretionary participation features, an entity applies the general model (as modified) because of the lack of insurance risk in the contracts (see 11.3 below).

7.3 Insurance contracts in a foreign currency

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.

8.1 The contract boundary

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]

1. the entity has the practical ability to reassess the risks of the particular policyholder and, as a result, can set a price or level of benefits that fully reflects those risks; or
2. both of the following criteria are satisfied:
   1. the entity has the practical ability to reassess the risks of the portfolio of insurance contracts that contains the contract and, as a result, can set a price or level of benefits that fully reflects the risk of that portfolio; and
   2. the pricing of the premiums for coverage (deletion proposed by ED) up to the date when the risks are reassessed does not take into account the risks that relate to periods after the reassessment date.

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]

• An entity may price a contract so that the premiums charged in early periods subsidise the premiums charged in later periods, even if the contract states that each premium relates to an equivalent period of coverage. This would be the case if the contract charges level premiums and the risks covered by the contract increase with time. The Board concluded that the premiums charged in later periods would be within the boundary of the contract because, after the first period of coverage, the policyholder has obtained something of value, namely the ability to continue coverage at a level price despite increasing risk.
• An insurance contract might bind the entity, but not the policyholder, by requiring the entity to continue to accept premiums and provide coverage (without the ability to reprice the contract) but permitting the policyholder to stop paying premiums, although possibly incurring a penalty. In the Board's view, the premiums the entity is required to accept and the resulting coverage it is required to provide fall within the boundary of the contract.
• An insurance contract may permit an entity to reprice the contract on the basis of general market experience (for example, mortality experience), without permitting the entity to reassess the individual policyholder's risk profile (for example, the policyholder's health). In this case, the insurance contract binds the entity by requiring it to provide the policyholder with something of value: continuing insurance coverage without the need to undergo underwriting again. Although the terms of the contract are such that the policyholder has a benefit in renewing the contract, and thus the entity expects that renewals will occur, the contract does not require the policyholder to renew the contract. As a result, the repriced cash flows are outside the contract boundary provided both the criteria in (b) above are met.

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 requirements in the two paragraphs are different because they address two different circumstances;
• when paragraph 35 of IFRS 17 applies, additional cash flows will be recognised as a new contract when the recognition criteria of a new group of contracts are met;
• paragraph B64 of IFRS 17 discusses the assessment of the practical ability of an entity to reprice a contract considering constraints that might limit that ability and, therefore, applies to the reassessment of the contract boundary in this context. For example, a contract boundary reassessment may occur when, in one reporting period, repricing restrictions that have no commercial substance but in the next reporting period facts and circumstances come to light that would have led to a different conclusion at inception (if known then). When paragraph B64 applies, the fulfilment cash flows are updated to reflect changes in cash flows that are within the (revised) contract boundary. When such changes relate to future service they are recognised by adjusting the carrying amount of the contractual service margin of the group of contracts to which the contract belongs.

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

8.2 Estimates of expected future cash flows

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]

• incorporate, in an unbiased way, all reasonable and supportable information available without undue cost or effort about the amount, timing and uncertainty of those future cash flows. To do this, an entity should estimate the expected value (i.e. the probability-weighted mean) of the full range of possible outcomes;
• reflect the perspective of the entity, provided that the estimates of any relevant market variables are consistent with observable market prices for those variables (see 8.2.3 below);
• be current – the estimates should reflect conditions existing at the measurement date, including assumptions at that date about the future (see 8.2.4 below); and
• be explicit – the entity should estimate the adjustment for non-financial risk separately from the other estimates. The entity also should estimate the cash flows separately from the adjustment for the time value of money and financial risk, unless the most appropriate measurement technique combines these estimates (see 8.4 below).

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]

• information about claims already reported by policyholders;
• other information about the known or estimated characteristics of the insurance contracts;
• historical data about the entity's own experience, supplemented when necessary with historical data from other sources. Historical data is adjusted to reflect current conditions, for example, if:
  • the characteristics of the insured population differ (or will differ, for example, because of adverse selection) from those of the population that has been used as a basis for the historical data;
  • there are indications that historical trends will not continue, that new trends will emerge or that economic, demographic and other changes may affect the cash flows that arise from the existing insurance contracts; or
  • there have been changes in items such as underwriting procedures and claims management procedures that may affect the relevance of historical data to the insurance contracts;
• current price information, if available, for reinsurance contracts and other financial instruments (if any) covering similar risks, such as catastrophe bonds and weather derivatives, and recent market prices for transfers of insurance contracts. This information should be adjusted to reflect the differences between the cash flows that arise from those reinsurance contracts or other financial instruments, and the cash flows that would arise as the entity fulfils the underlying contracts with the policyholder.

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]

• surrender their contracts, if there is some probability that some of the policyholders will not; or
• continue their contracts, if there is some probability that some of the policyholders will not.

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 (i.e. variables that can be observed in, or derived directly from markets (for example, prices of publicly traded securities and interest rates)); and
• non-market variables (i.e. all other variables, such as the frequency and severity of insurance claims and mortality).

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.

8.3 Discount rates

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]

• reflect the time value of money, the characteristics of the cash flows and the liquidity characteristics of the insurance contracts;
• be consistent with observable current market prices (if any) for financial instruments with cash flows whose characteristics are consistent with those of the insurance contracts, in terms of, for example, timing, currency and liquidity; and
• exclude the effect of factors that influence such observable market prices but do not affect the future cash flows of the insurance contracts.

The discount rates calculated according to the requirements above should be determined as follows: [IFRS 17.B72]

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 current discount rate used to measure the fulfilment cash flows of each contract when it joins a group of insurance contracts; and
• the weighted average discount rates used at initial recognition of a group of insurance contracts.

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]

• cash flows that do not vary based on the returns on any underlying items should be discounted at rates that do not reflect any such variability;
• cash flows that vary based on the returns on any financial underlying items should be:
  • discounted using rates that reflect that variability; or
  • adjusted for the effect of that variability and discounted at a rate that reflects the adjustment made;
• nominal cash flows (i.e. those that include the effect of inflation) should be discounted at rates that include the effect of inflation; and
• real cash flows (i.e. those that exclude the effect of inflation) should be discounted at rates that exclude the effect of inflation.

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]

• maximise the use of observable inputs and reflect all reasonable and supportable information on non-market variables available without undue cost or effort, both external and internal. In particular, the discount rates used should not contradict any available and relevant market data, and any non-market variables used should not contradict observable market variables;
• reflect current market conditions from the perspective of a market participant; and
• exercise judgement to assess the degree of similarity between the features of the insurance contracts being measured and the features of the instrument for which observable market prices are available and adjust those prices to reflect the differences between them.

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:

• a ‘bottom-up’ approach; and
• a ‘top-down’ approach.

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]

• if there are observable market prices in active markets for assets in the reference portfolio, an entity should use those prices;
• if a market is not active, an entity should adjust observable market prices for similar assets to make them comparable to market prices for the assets being measured;
• if there is no market for assets in the reference portfolio, an entity should apply an estimation technique. For such assets an entity should:
  • develop unobservable inputs using the best information available in the circumstances. Such inputs might include the entity's own data and, in the context of IFRS 17, the entity might place more weight on long-term estimates than on short-term fluctuations; and
  • adjust the data to reflect all information about market participant assumptions that is reasonably available.

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]

• adjusting for differences between the amount, timing and uncertainty of the cash flows of the assets in the portfolio and the amount, timing and uncertainty of the cash flows of the insurance contracts; and
• excluding market risk premiums for credit risk, which are relevant only to the assets included in the reference portfolio.

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:

• an entity could use the assets it holds as a reference portfolio of assets;
• an entity could ignore the liquidity characteristics of insurance contracts; and
• changes in the assets the entity holds result in changes in the discount rates used to measure insurance contracts under specific circumstances.

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:

• IFRS 17 does not specify restrictions on the reference portfolio of assets used in applying a top-down approach to determine discount rates and also does not define ‘a reference portfolio of assets’. Consequently, a portfolio of assets an entity holds can be used as a reference portfolio to determine the discount rates provided that the discount rates achieve the objectives of reflecting the characteristics of the insurance contracts and are consistent with observable current market prices.
• IFRS 17 requires that discount rates reflect, among other factors, the liquidity characteristics of the insurance contracts. However, when using the top-down approach, as a simplification, IFRS 17 permits an entity not to adjust the yield curve derived from a reference portfolio of assets for differences in liquidity characteristics of the insurance contracts and the reference portfolio. The IASB expected a reference portfolio of assets typically to have liquidity characteristics closer to the liquidity characteristics for a group of insurance contracts than would be the case for highly-liquid, high-quality bonds.
• In determining the appropriate discount rates for cash flows that do not vary based on underlying items, an entity ensures that at each reporting date those discount rates reflect the characteristics of the insurance contracts, even when the entity chooses to use a portfolio of assets that it holds to determine the discount rates.
• An entity needs to make adjustments to the yield curve of the reference portfolio of assets at each reporting date to eliminate any effect on discount rates of credit risk and differences in liquidity characteristics of the insurance contracts and the reference portfolio. However, if the entity uses the simplification related to liquidity, fluctuations in the liquidity of the reference portfolio are mirrored in the changes in discount rates used to measure the group of insurance contracts.
• The TRG members also observed that, when an entity uses simplification related to liquidity (i.e. the top-down approach discussed above), small changes in discount rates that result from changes in the composition of the reference portfolio could result in significant changes to the insurance contract liabilities measured using those rates, particularly with respect to long-term insurance contracts.

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.

8.4 The risk adjustment for non-financial risk

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]

• fulfilling a liability that has a range of possible outcomes arising from non-financial risk; and
• fulfilling a liability that will generate fixed cash flows with the same expected present value as the insurance contracts.

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]

• the compensation that a market participant would require for bearing the non-financial risk that is associated with the contract. This is because the measurement model is not intended to measure the current exit value or fair value, which reflects the transfer of the liability to a market participant. Consequently, the risk adjustment for non-financial risk should be determined as the amount of compensation that the entity, not a market participant, would require; and
• an amount that would provide a high degree of certainty that the entity would be able to fulfil the contract. Although such an amount might be appropriate for some regulatory purposes, it is not compatible with the Board's objective of providing information that will help users of financial statements make decisions about providing resources to the entity.

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 degree of diversification benefit the entity includes when determining the compensation it requires for bearing that risk; and
• both favourable and unfavourable outcomes, in a way that reflects the entity's degree of risk aversion.

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

8.5 The contractual service margin

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]

• the initial recognition of an amount for the fulfilment cash flows (see 8.2 above);
• the derecognition at the date of initial recognition of any asset or liability recognised for insurance acquisition cash flows (see 6 above); and
• any cash flows arising from the contracts in the group at that date.

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.

8.6 Subsequent measurement

The carrying amount of a group of insurance contracts at the end of each reporting period should be the sum of: [IFRS 17.40]

• the liability for remaining coverage comprising:
  • the fulfilment cash flows related to future service allocated to the group at that date, measured applying the requirements discussed at 8.2 above – see 8.6.1 below;
  • the contractual service margin of the group at that date, measured applying the requirements discussed at 8.6.3 below; and
• the liability for incurred claims, comprising the fulfilment cash flows related to past service allocated to the group at that date, measured applying the requirements discussed at 8.2 above – see 8.6.2 below.

Hence, after initial recognition, the fulfilment cash flows comprise two components:

• those relating to future service (the liability for remaining coverage); and
• those relating to past service (the liability for incurred claims).

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:

• insurance coverage for disability that provides an annuity for the period when a policyholder is disabled; and
• insurance coverage for fire that provides compensation for the cost of rebuilding a house after a fire.

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:

• the classification of an obligation as a liability for incurred claims or a liability for remaining coverage does not affect the determination of fulfilment cash flows. However, the classification does affect the determination of the coverage period. Consequently, the classification affects whether some changes in fulfilment cash flows adjust the contractual service margin and allocation of the contractual service margin;
• the definitions in IFRS 17 allow an entity to use judgement when determining whether the obligation to pay an annuity after a disability event and the obligation to pay the costs of rebuilding a house after a fire event are part of the liability for remaining coverage or liability for incurred claims;
• it is a matter of judgement for an entity to develop an accounting policy that reflects the insurance service provided by the entity to the policyholder under the contract in accordance with IFRS 17. The requirements of IAS 8 apply and hence the entity should apply an approach consistently for similar transactions and over time;
• whatever approach an entity applies, IFRS 17 requires disclosure of significant judgements made in applying the standard and requires disclosures relating to the contractual service margin, which will enable users to understand the effects of the approach required; and
• these observations are also relevant when law or regulation impose a requirement for an entity to settle a claim by life-contingent annuity.⁴⁶

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.

8.6.3 Subsequent measurement of the contractual service margin (for insurance contracts without direct participation features)

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 effect of any new contracts added to the group (see 6 above);
• interest accreted on the carrying amount of the contractual service margin during the reporting period, measured at the discount rates at initial recognition (see 8.3 above);
• the changes in fulfilment cash flows relating to future service (see below), except to the extent that:
  • such increases in the fulfilment cash flows exceed the carrying amount of the contractual service margin, giving rise to a loss (see 8.8 below); or
  • such decreases in the fulfilment cash flows are allocated to the loss component of the liability for remaining coverage (see 8.8 below);
• the effect of any currency exchange differences (see 7.3 above) on the contractual service margin; and
• the amount recognised as insurance revenue because of the transfer of insurance contract (words in italics proposed by the ED) services in the period, determined by the allocation of the contractual service margin remaining at the end of the reporting period (before any allocation) over the current and remaining coverage period (see 8.7 below)

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]

• experience adjustments arising from premiums received in the period that relate to future service, and related cash flows such as insurance acquisition cash flows and premium-based taxes, measured at the discount rates applying at the date of initial recognition;
• changes in estimates of the present value of the future cash flows in the liability for remaining coverage (except those changes described below) measured at the discount rates applying at the date of initial recognition;
• differences between any investment component expected to become payable in the period and the actual investment component that becomes payable in the period, except those described in B97(a) (i.e. the effect of the time value of money and changes in the time value of money and the effect of financial risk and changes in financial risk) measured at the discount rates applying at the date of initial recognition; and
• changes in the risk adjustment for non-financial risk that relate to future service. An entity is not required to disaggregate the change in the risk adjustment for non-financial risk between (i) a change related to non-financial risk and (ii) the effect of the time value of money and changes in the time value of money. If the entity makes such a disaggregation, it shall adjust the contractual service margin for the change related to non-financial risk, measured at the discount rates applying at the date of initial recognition (words in italics proposed by the ED).

The proposed ED amendments were made in order to correct inadvertent omissions from IFRS 17, as issued in May 2017, which:

• did not require changes in an investment component related to the time value of money and financial risk to be recognised in profit or loss (or other comprehensive income) even though doing so is a clear principle of IFRS 17; and
• did not address the treatment of changes in the risk adjustment for non-financial risk in respect of the time value of money and financial risk if they are disaggregated. IFRS 17 allows, but does not require, an entity to disaggregate changes in the risk adjustment for non-financial risk into those caused by the time value of money and those caused by changes in non-financial risk.⁴⁷

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]

• the effect of the time value of money and changes in the time value of money, and the effect of financial risk and changes in financial risk (being (i) the effect, if any, on estimated future cash flows; (ii) if the effect is disaggregated, on the risk adjustment for non-financial risk; and (iii) the effect of a change in discount rate) (words in italics proposed by the ED);
• changes in estimates of fulfilment cash flows in the liability for incurred claims; and
• experience adjustments, except those described above that relate to future service.

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:

• applying the general model, experience adjustments arising from premiums received in the period that relate to future services adjust the contractual service margin. Premium adjustments related to current or past service should be recognised immediately in the statement of profit or loss as part of insurance revenue;
• although premium experience adjustments are not specifically referenced in paragraph B124 of IFRS 17 the purpose of that paragraph is to demonstrate an alternative analysis of insurance revenue as determined by paragraph B123 of IFRS 17 (see 15.1.1 below). Hence, applying the requirements in IFRS 17 should result in premium experience adjustments relating to current and past service being included in insurance revenue despite the lack of a specific reference in paragraph B124 of IFRS 17; and
• for the premium allocation approach, the requirements for allocating premium adjustments above, apply to expected premium receipts, including premium experience adjustments (see 15.1.2 below).

The TRG members also observed that:

• Given an entity is required to disclose an analysis of insurance revenue recognised in the period, an additional line item may be necessary in the reconciliation to reflect the effect of premium experience adjustments on the revenue recognised in the period (see 16.1.1 below).
• In some circumstances, judgement may be required to determine whether premium experience adjustments relate to future service and therefore adjust the contractual service margin rather than are recognised in the statement of profit or loss.⁵⁰

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].

8.7 Allocation of the contractual service margin to profit or loss

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]

• identifying the coverage units in the group. The number of coverage units in a group is the quantity of service coverage provided by the contracts in the group, determined by considering for each contract the quantity of the benefits provided under a contract and its expected coverage period duration;
• allocating the contractual service margin at the end of the period (before recognising any amounts in profit or loss to reflect the insurance contract services provided in the period) equally to each coverage unit provided in the current period and expected to be provided in the future; and
• recognising in profit or loss the amount allocated to coverage units provided in the period (changes proposed by ED identified above by italics and strikethrough).

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 contractual service margin should be allocated based on the pattern of expected cash flows or on the change in the risk adjustment for non-financial risk caused by the release of risk. However, the Board decided the pattern of expected cash flows and the release of the risk adjustment for non-financial risk are not relevant factors in determining the satisfaction of the performance obligation of the entity. They are already included in the measurement of the fulfilment cash flows and do not need to be considered in the allocation of the contractual service margin. Hence, the Board concluded that coverage units better reflect the provision of insurance coverage; and
• the contractual service margin should be allocated before any adjustments made because of changes in fulfilment cash flows that relate to future service. However, the Board concluded that allocating the amount of the contractual service margin adjusted for the most up-to-date assumptions provides the most relevant information about the profit earned from service provided in the period and the profit to be earned in the future from future service.

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.

8.7.2 Should the contractual service margin be allocated on the basis of coverage units that are determined by considering both insurance coverage and any investment return service?

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:

• an entity is required to identify coverage units for insurance contracts without direct participation features considering the quantity of benefits and expected period of investment-return service, if any, in addition to insurance coverage;
• specified criteria for determining when such contracts may provide investment-return service; and
• an entity is required to disclose quantitative information about when the entity expects to recognise in profit or loss the contractual service margin remaining at the end of the reporting period. An entity is also required to disclose the approach used to assess the relative weighting of the benefits from insurance coverage and investment-related services.

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:

• an investment component exists or the policyholder has a right to withdraw an amount;
• the entity expects the investment component, or amount the policyholder has a right to withdraw, to include a positive investment return (a positive investment return could be below zero, for example in a negative interest rate environment); and
• the entity expects to perform investment activity to generate that positive investment return.⁵⁶

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.

8.8 Measurement of onerous contracts

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:

• unfavourable changes relating to future service in the fulfilment cash flows allocated to the group arising from changes in estimates of future cash flows and the risk adjustment for non-financial risk relating to future service (words in italics and deletion proposed by the ED); and
• for a group of insurance contracts with direct participation features, the decrease in the amount of the entity's share of a decrease in the fair value of the underlying items (words in italics proposed by the ED).

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]

• the subsequent changes in fulfilment cash flows of the liability for remaining coverage on a systematic basis between:
  • the loss component of the liability for remaining coverage; and
  • the liability for remaining coverage, excluding the loss component.
• solely to the loss component until that component is reduced to zero:
  • any subsequent decrease relating to future service in fulfilment cash flows allocated to the group arising from changes in estimates of future cash flows relating to future service and the risk adjustment for non-financial risk; and
  • any subsequent increases in the amount of the entity's share of in the fair value of the underlying items solely to the loss component until that component is reduced to zero.

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]

• estimates of the present value of future cash flows for claims and expenses released from the liability for remaining coverage because of incurred insurance service expenses;
• changes in the risk adjustment for non-financial risk recognised in profit or loss because of the release from risk; and
• insurance finance income or expenses.

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.

8.9 Reinsurance contracts issued

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.

8.9.3 Accounting for ceding commissions and reinstatement premiums

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:

• common types of commission due to the cedant; and
• reinstatement premiums charged to the cedant in order to continue coverage following the occurrence of an insured event.

The TRG members discussed the analysis in an IASB staff paper and observed that:

• The requirements set out in paragraph 86 of IFRS 17 for the presentation of income and expenses from reinsurance contracts held are based on the economic effects of exchanges between the reinsurer and the cedant and it would be appropriate to apply an assessment of the economic effect of such exchanges to reinsurance contracts issued as well.
• The economic effect of amounts exchanged between a reinsurer and a cedant that are not contingent on claims is equivalent to the effect of charging a different premium. Therefore, these amounts would be recognised as part of insurance revenue.
• Unless a cedant provides a distinct service to the reinsurer that results in a cost to the reinsurer for selling, underwriting and starting a group of reinsurance contracts that it issues, a ceding commission is not an insurance acquisition cash flow of the insurer. The IASB staff observed that, unlike insurance acquisition costs that are paid to a third-party intermediary, ceding commissions are paid by the reinsurer to the cedant who is the policyholder of the contract.
• Amounts exchanged between the reinsurer and the cedant that are not contingent on claims may meet the definition of an investment component if they are repaid to the cedant in all circumstances. However, an amount deducted from the initial premium up-front is not an investment component (although the impact on insurance revenue is the same).

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:

• A ceding commission charged as a fixed amount or as a percentage of premiums on the underlying insurance contracts is a reduction in insurance revenue. If paid after the premium is received, the ceding commission may meet the definition of an investment component, provided the amounts are repaid to the policyholder in all circumstances.
• A ceding commission contingent on claims (i.e. excluding any minimum amounts that are, in effect, non-contingent) is part of claims and recognised as part of insurance service expense.
• A mandatory reinstatement premium contingent on a claim amount and settled net with the claims paid to the cedant is equivalent to reimbursing a different amount of claims to the cedant and should be recognised as part of insurance service expenses when incurred.
• A voluntary reinstatement premium which is not contingent on claims (i.e. the cedant can decide not to pay the additional premium and the contract terminates) is equivalent to the effect of charging a higher premium to extend the contract coverage to an additional period, or higher level of exposure, and is recognised as insurance revenue. The IASB staff observed that when the reinsurer has no right to exit or reprice the contract (the reinstatement premium is at predetermined rates), the expected cash flows related to the reinstatement premium are within the boundary of the initial reinsurance contract and voluntary reinstatement premiums cannot be considered cash flows related to a future contract.⁶⁴

The following flowchart may assist in the assessment of how to account for exchanges between a reinsurer and a cedant.

8.10 Impairment of assets recognised for insurance acquisition cash flows

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:

• for assets directly attributable to a group, recognise an impairment loss in profit or loss and reduce the carrying amount of any asset for insurance acquisition cash flows recognised so that the carrying amount of each asset does not exceed the expected net fulfilment cash inflows for the related group; and
• for assets attributable to groups that are expected to arise from future renewals, recognise an impairment loss in profit or loss and reduce the carrying amount of the related assets for insurance acquisition cash flows to the extent that:
  • the entity expects those insurance acquisition cash flows to exceed the net fulfilment cash inflow for the expected renewals; and
  • the excess determined in the bullet point above has not already been recognised as an impairment loss applying the requirements for assets directly attributable to a group.⁶⁸

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

8.11 Insurance contracts issued by mutual entities

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:

• liabilities attributable to policyholders in their capacity as policyholders; and
• liabilities attributable to policyholders with the most residual interest in the entity.

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:

• the requirements of IFRS 17 are consistent with the principles to include in the fulfilment cash flows all future cash flows that arise within the boundary of insurance contracts in a group of contracts, regardless of timing and counterparty;
• if a mutual entity that issues an insurance contract accounted for that contract in one way and a non-mutual entity that issues the same contract accounted for it in a different way, compatibility across entities would be reduced; and
• a robust definition of a mutual entity that could be applied consistently from jurisdiction to jurisdiction would be difficult to create.⁷²

8.12 Other matters

9.1 Criteria for use of the premium allocation approach

The premium allocation approach is permitted if, and only if, at the inception of the group of contracts: [IFRS 17.53]

• the entity reasonably expects that such simplification would produce a measurement of the liability for remaining coverage for the group that would not differ materially from the one that would be produced applying the requirements for the general model discussed at 8 above (i.e. the fulfilment cash flows related to future service plus the contractual service margin); or
• the coverage period of each contract in the group (including insurance contract services coverage (words in italics and deletion proposed by ED) arising from all premiums within the contract boundary determined at that date applying the requirements discussed at 8.1. above) is one year or less.

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]

• the extent of future cash flows related to any derivatives embedded in the contracts; and
• the length of the coverage period of the group of contracts.

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:

• a choice whether or not to recognise acquisition cash flows as an expense on initial recognition or to include those cash flows within the liability for remaining coverage (and hence amortise those cash flows over the coverage period). The ability to recognise acquisition cash flows as an expense on initial recognition is available provided that the coverage period of each contract in the group on initial recognition is no more than one year. Otherwise acquisition cash flows must be included within the liability for remaining coverage; [IFRS 17.59(a)] and
• a choice whether or not to adjust the liability for remaining coverage to reflect the time value of money and the effect of financial risk. An entity is not required to adjust the liability for remaining coverage to reflect the time value of money and the effect of financial risk if, at initial recognition, the entity expects that the time between providing each part of the insurance contract services coverage (words in italics and deletion proposed by ED) and the related premium due date is no more than one year. Otherwise, the liability for remaining coverage must be adjusted to reflect the time value of money and the effect of financial risk using the discount rates as determined on initial recognition if the insurance contracts in the group have a significant financing component. [IFRS 17.56].

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).

9.2 Initial measurement

An entity should measure the liability for remaining coverage on initial recognition as follows: [IFRS 17.55]

• the premium, if any, received at initial recognition;
• minus any insurance acquisition cash flows at that date, unless the entity chooses to recognise the payments as an expense (see 9.1 above); and
• plus or minus any amount arising from the derecognition at that date of the asset or liability (deletion proposed by ED) recognised for insurance acquisition cash flows that the entity pays before the related group of insurance contracts is recognised as an asset (see 6.1 above).

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]

• the carrying amount of the liability for the remaining coverage as determined above; and
• the fulfilment cash flows (see 8.2 to 8.4 above) that relate to the remaining coverage of the group of contacts.

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.

9.3 Subsequent measurement – liability for remaining coverage

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)]

• plus the premiums received in the period;
• minus insurance acquisition cash flows: unless the entity chooses to recognise the payments as an expense (see 9.2 above);
• plus any amounts relating to the amortisation of the insurance acquisition cash flows recognised as an expense in the reporting period unless the entity chooses to recognise insurance acquisition cash flows as an expense (see 9.2 above);
• plus any adjustment to the financing component;
• minus the amount recognised as insurance revenue for insurance contract services coverage (words added in italics and deletion proposed by ED) provided in that period; and
• minus any investment component paid or transferred to the liability for incurred claims.

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]

• on the basis of the passage of time; but
• if the expected pattern of release of risk during the coverage period differs significantly from the passage of time (which might be the case for example if claims were skewed towards a particular time of year such as the ‘hurricane season’), on the basis of the expected timing of incurred insurance service expenses.

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.

9.4 Subsequent measurement – liability for incurred claims

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).

10.1 Level of aggregation

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:

• a group of contracts on which there is a net gain on initial recognition, if any;
• a group of contracts that have no significant possibility of a net gain arising subsequent to initial recognition, if any; and
• a group of the remaining contracts in the portfolio.

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].

10.2 The boundary of a reinsurance contract held

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:

• A substantive right to receive services from the reinsurer ends when the reinsurer has the practical ability to reassess the risks transferred to the reinsurer and can set a price or level of benefits for the contract to fully reflect the reassessed risk or the reinsurer has a substantive right to terminate the contract.
• Accordingly, the boundary of a reinsurance contract held could include cash flows from underlying contracts covered by the reinsurance contract that are expected to be issued by the cedant in the future.⁷⁶

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:

• is issued and recognised on 1 January;
• covers a proportion of all risks arising from underlying insurance contracts issued in a 24-month period; and
• provides the unilateral right to both the cedant and the reinsurer to terminate the contract with a three-month notice period to the other party with respect to only new business ceded,

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:

• For reinsurance contracts held, cash flows are within the contract boundary if they arise from substantive rights and obligations that exist during the reporting period in which the entity (i.e. the holder) is compelled to pay amounts to the reinsurer or in which the entity has a substantive right to receive services from the reinsurer.
• A right to terminate coverage that is triggered by the reinsurer's decision to reprice the reinsurance contract is not relevant when considering whether a substantive obligation to pay premiums exists. Such a right is not within the entity's control and therefore the entity would continue to be compelled to pay premiums for the entire contractual term.
• The entity's expectations about the amount and timing of future cash flows, including with respect to the probability of the reinsurer repricing the contract, would be reflected in the fulfilment cash flows.

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

10.3 Initial recognition

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]

• if the reinsurance contracts provide proportionate coverage, at the later of:
  • the beginning of the coverage period of the group or at the initial recognition of the underlying contract, whichever is the later; or
  • if the entity recognises an onerous group of underlying contracts before the beginning of the coverage period of the group of reinsurance contracts held – at the same time as the onerous group of underlying contracts.
• in all other groups of reinsurance contracts held cases, from the beginning of the coverage period of the group (words in italics and deletion proposed by ED).

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.

10.4 Measurement – initial recognition

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:

• the estimates of the present value of the future cash flows for the group of reinsurance contracts held should reflect the effect of any risk of non-performance by the issuer of the reinsurance contract, including the effects of collateral and losses from disputes. [IFRS 17.63]. This is because an entity holding a reinsurance contract faces the risk that the reinsurer may default or may dispute whether a valid claim exists for an insured event. [IFRS 17.BC308]. The estimates of expected credit losses are based on expected values; and
• the estimate of the risk adjustment for non-financial risk should be determined so that it represents the amount of risk being transferred by the holder of the group of insurance contracts to the issuer of those contracts. [IFRS 17.64]. The risk adjustment does not include an adjustment for the risk of non-performance (which is already contained within the estimates of the present value of future cash flows), a fact confirmed by the IASB staff to TRG members in May 2018 (the TRG members did not disagree with the IASB staff's statement).⁸⁴

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]

• the fulfilment cash flows;
• the amount derecognised at that date of any asset or liability previously recognised for cash flows related to the group of reinsurance contracts held;
• any cash flows arising at that date; and
• any income recognised in profit or loss when an entity recognises a loss on initial recognition of an onerous group of underlying contracts (new wording proposed by ED – see 10.4.1 below).

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.

10.5 Subsequent measurement

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]

• the effect of any new contracts added to the group;
• interest accreted on the carrying amount of the contractual service margin, measured at the discount rates determined at the date of initial recognition of a group of contracts using the discount rates as determined by the general model;
• income recognised in profit or loss when an entity recognises income on a proportionate reinsurance contract to offset a loss on an onerous group of underlying contracts – see 10.4.1 above (amendments in italics proposed by ED);
• changes in the fulfilment cash flows to the extent that the change:
  • relates to future service; unless
  • the change results from a change in fulfilment cash flows allocated to a group of underlying insurance contracts that does not adjust the contractual service margin for the group of underlying insurance contracts;
• the effect of any currency exchange differences arising on the contractual service margin; and
• the amount recognised in profit or loss because of services received in the period, determined by the allocation of the contractual service margin remaining at the end of the reporting period (before any allocation) over the current and remaining coverage period of the group of reinsurance contracts held.

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].

10.6 Allocation of the contractual service margin to profit or loss

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

10.7 Premium allocation approach for reinsurance contracts held

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]

• the entity reasonably expects the resulting measurement would not differ materially from the result of applying the requirements in the general model for reinsurance contracts held discussed above; or
• the coverage period of each contract in the group of reinsurance contracts held (including insurance coverage from all premiums within the contract boundary determined at that date applying the definition in the general model) is one year or less (word in italics proposed by ED).

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 extent of future cash flows relating to any derivatives embedded in the contracts; and
• the length of the coverage period of the group of reinsurance contracts held.

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

10.8 Reinsurance contracts held and the variable fee approach

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].

11.1 Contracts with cash flows that affect or are affected by cash flows to policyholders of other contracts (mutualisation)

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]

• the policyholder to share with policyholders of other contracts the returns on the same specified pool of underlying items; and
• either:
  • the policyholder to bear a reduction in their share of the returns on the underlying items because of payments to policyholders of other contracts that share in that pool, including payments arising under guarantees made to policyholders of those other contracts; or
  • policyholders of other contracts to bear a reduction in their share of returns on the underlying items because of payments to the policyholder, including payments arising from guarantees made to the policyholder.

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]

• include payments arising from the terms of existing contracts to policyholders of contracts in other groups, regardless of whether those payments are expected to be made to current or future policyholders; and
• exclude payments to policyholders in the group that, applying the above, have been included in the fulfilment cash flows of another group.

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:

• when a specified pool of underlying items consists of insurance contracts issued to the policyholders that share in the returns of that pool, the criteria for mutualisation is met regardless of whether the policyholders' share is 100% of the return of the pool of underlying items or only part of the pool of underlying items;
• for contracts that share in 100% of the return of a pool of underlying items consisting of insurance contracts, the contractual service margin will be nil. Therefore, measuring the contractual service margin at a higher level than the annual cohort level, such as a portfolio level, would achieve the same accounting outcome as measuring the contractual service margin at an annual cohort level;
• when contracts share to a lesser extent in the return on a pool of underlying items consisting of insurance contracts, an entity could be affected by the expected cash flows of each contract issued. Therefore, the contractual service margin of the groups of contracts may differ from the contractual service margin measured at a higher level, such as a portfolio level. To assess whether measuring the contractual service margin at a higher level would achieve the same accounting outcome as measuring the contractual service margin at an annual cohort level, an entity would need to determine what the effect would be (i.e. the accounting outcome would need to be the same in all circumstances, regardless of how assumptions and experience develop over the life of the contract).

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

11.2 Insurance contracts with direct participation features

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]

• the obligation to pay the policyholder an amount equal to the fair value of the underlying items; and
• a variable fee that the entity will deduct from the obligation in exchange for the future service provided by the insurance contract comprising:
  • the amount of the entity's share of the fair value of the underlying items (words in italics proposed by ED); less
  • fulfilment cash flows that do not vary based on the returns on underlying items.

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]

• the entity's share of the underlying items; and
• financial risks other than those arising from the underlying items, for example the effect of financial guarantees.

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].

11.3 Investment contracts with discretionary participation features

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]

• that are expected to be a significant portion of the total contractual benefits;
• the timing or amount of which are contractually at the discretion of the issuer; and
• that are contractually based on:
  • the returns on a specified pool of contracts or a specified type of contract;
  • realised and/or unrealised investment returns on a specified pool of assets held by the issuer; or
  • the profit or loss of the entity or fund that issues the contract.

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 and insurance contracts that specify a link to returns on underlying items are sometimes linked to the same underlying pool of assets. Sometimes investment contracts with discretionary participation features share in the performance of insurance contracts. Using the same accounting for both types of contracts will produce more useful information for users of financial statements because it enhances comparability within an entity. It also simplifies the accounting for those contracts. For example, some cash flow distributions to participating policyholders are made in aggregate both for insurance contracts that specify a link to returns on underlying items and for investment contracts with discretionary participation features. This makes it challenging to apply different accounting models to different parts of that aggregate participation.
• Both of these types of contract often have characteristics, such as long maturities, recurring premiums and high acquisition cash flows that are more commonly found in insurance contracts than in most other financial instruments. The Board developed the model for insurance contracts specifically to generate useful information about contracts containing such features.
• If investment contracts with discretionary participation features were not accounted for by applying IFRS 17, some of the discretionary participation features might be separated into an equity component in accordance with the Board's existing requirements for financial instruments. Splitting these contracts into components with different accounting treatments would cause the same problems that would arise if insurance contracts were separated. Also, in the Board's view, the accounting model it has developed for insurance contracts, including the treatment of discretionary cash flows is more appropriate than using any other model for these types of contracts.

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]

• the date of initial recognition is the date the entity becomes party to the contract. This is consistent with the requirements for recognition of a financial instrument in IFRS 9 and is likely to be earlier than the date of initial recognition for an insurance contract (see 6 above);
• the contract boundary (see 8.1 above) is modified so that cash flows are within the contract boundary if they result from a substantive obligation of the entity to deliver cash at a present or future date. The entity has no substantive obligation to deliver cash if it has the practical ability to set a price for the promise to deliver the cash that fully reflects the amount of cash promised and related risks; and
• the allocation of the contractual service margin is modified so that the entity should recognise the contractual service margin over the duration of a group of contracts in a systematic way that reflects the transfer of investment services under the contract. This requirement is similar to the revenue recognition guidance contained in IFRS 15 which seems logical as IFRS 15 would apply to the asset management component of an investment contract without discretionary participation features.

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).

12.1 Modification of an insurance contract

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]

• if the modified terms had been included at contract inception:
  • the modified contract would have been excluded from the scope of IFRS 17;
  • an entity would have separated different components from the host insurance contract (see 4 above) resulting in a different insurance contract to which IFRS 17 would have applied;
  • the modified contract would have had a substantially different contract boundary; or
  • the modified contract would have been included in a different group of contracts at initial recognition (e.g. the contracts would have been onerous at initial recognition rather than had no significant possibility of being onerous subsequently – see 5 above);
• the original contract met the definition of an insurance contract with direct participation features but the modified contract no longer meets that definition or vice versa; or
• the entity applied the premium allocation approach (see 9 above) to the original contract but the modifications mean that the contract no longer meets the eligibility criteria for that approach.

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.

12.2 Derecognition of an insurance contract

An insurance contract is derecognised when, and only when [IFRS 17.74]

• it is extinguished, i.e. when the obligation specified in the insurance contract expires or is discharged or cancelled; or
• any of the conditions for modifications which result in derecognition (see 12.1 above) are met.

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].

12.3 Accounting for derecognition

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.

13.1 Subsequent treatment of contracts acquired in their settlement period

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:

• an entity applies the general model for contracts acquired in their settlement period because the period over which claims could develop is longer than one year whilst entities expect to apply the premium allocation approach for similar contracts that they issue; and
• an entity recognises revenue for the contracts acquired in their settlement period over the period the claims can develop, while revenue is no longer recognised over this period for similar contracts issued.

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).

13.2 Business combinations under common control

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.

13.3 Practical issues

15.1 Insurance revenue

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]

• adjusted for financing effect (i.e. adjusted for the time value of money); and
• excluding any investment components.

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]

• amounts related to the provision of services, comprising:
  • insurance service expenses, excluding any amounts related to the risk adjustment included below (words in italics added by ED) and any amounts allocated to the loss component of the liability for remaining coverage;
  • the risk adjustment for non-financial risk, excluding any amounts allocated to the loss component of the liability for remaining coverage; and
  • the contractual service margin; and
• amounts related to insurance acquisition cash flows.

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.

15.2 Insurance service expenses

Insurance service expenses comprise the following: [IFRS 17.84]

• incurred claims (excluding repayments of investment components);
• other incurred service expenses;
• amortisation of insurance acquisition cash flows;
• changes that relate to past services, i.e. changes in fulfilment cash flows relating to the liability for incurred claims; and
• changes that relate to future service, i.e. losses on onerous groups of contracts and reversals of such losses.

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.

15.3 Insurance finance income or expenses

Insurance finance income or expenses comprises the change in the carrying amount of the group of insurance contracts arising from: [IFRS 17.87]

• the effect of the time value of money and changes in the time value of money; and
• the effect of financial risk and changes in financial risk; but
• excluding any such changes for groups of insurance contracts with direct participation features that would adjust the contractual service margin but do not do so in certain circumstances. These circumstances are when the entity's share of a decrease in the fair value of the underlying items exceeds the carrying amount of the contractual margin and gives rise to a loss (or a reversal of that loss), increases in the fulfilment cash flows which exceed the carrying amount of the contractual margin and give rise to a loss and decreases in fulfilment cash flows which are allocated to the loss component of the liability for remaining coverage. These are included in insurance service expenses.

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]

• assumptions about inflation based on an index of prices or rates or on prices of assets with inflation-linked returns are assumptions that relate to financial risk;
• assumptions about inflation based on an entity's expectation of specific price changes are not assumptions that relate to financial risk; and
• changes in the measurement of a group of insurance contracts caused by changes in the fair value of underlying items (excluding additions and withdrawals) are changes arising from the effect of the time value of money and financial risk and changes therein.

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:

15.4 Reporting the contractual service margin in interim financial statements

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:

• entities with different interim reporting periods, but equal in all other aspects, are likely to report different results;
• for subsidiaries issuing their own IFRS financial statements, differences between the numbers reported by a subsidiary in its own financial statements and those reported in the consolidated IFRS financial statements of the parent in which the subsidiary is consolidated are likely to emerge if the reporting frequency of a subsidiary's own IFRS financial statements differs from the reporting frequency of the consolidated IFRS financial statements of the parent.

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.

15.5 Changes in accounting policies and accounting estimates

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.

16.1 Explanation of recognised amounts

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]

• disclose, in a table, the reconciliations set out at 16.1.1 to 16.1.2 below; and
• for each reconciliation, present the net carrying amounts at the beginning and at the end of the period, disaggregated into a total for portfolios groups of contracts that are assets and a total for portfolios groups of contracts that are liabilities, that equal the amounts presented in the statement of financial position as set out at 14 above (amendments in italics proposed by ED as per 14 above).

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].

16.2 Significant judgements in applying IFRS 17

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 methods used to measure insurance contracts within the scope of IFRS 17 and the processes for estimating the inputs to those methods. Unless impracticable, an entity should also provide quantitative information about those inputs;
• any changes in the methods and processes for estimating inputs used to measure contracts, the reason for each change, and the type of contracts affected;
• to the extent not covered above, the approach used:
  • to distinguish changes in estimates of future cash flows arising from the exercise of discretion from other changes in estimates of future cash flows for contracts without direct participation features;
  • to determine the risk adjustment for non-financial risk, including whether changes in the risk adjustment for non-financial risk are disaggregated into an insurance service component and an insurance finance component or are presented in full in the insurance service result;
  • to determine discount rates; and
  • to determine investment components; and
  • to determine the relative weighting of the benefits provided by insurance coverage and investment-return service (for insurance contracts without direct participation features) or insurance coverage and investment-related service (for insurance contracts with direct participation features).

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]

• the technique used; and
• the confidence level corresponding to the results of that technique.

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].

16.3 Nature and extent of risks arising from contracts within the scope of IFRS 17

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]

• the exposures to risks and how they arise;
• the entity's objectives, policies and processes for managing the risks and the methods used to measure the risks; and
• any changes in the above from the previous period.

An entity should also disclose, for each type of risk: [IFRS 17.125]

• summary quantitative information about its exposure to that risk at the end of the reporting period. This disclosure should be based on the information provided internally to the entity's key management personnel; and
• the disclosures detailed at 16.3.1 to 16.3.5 below, to the extent not provided by the summary quantitative information required above.

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:

• the structure and organisation of the entity's risk management function(s), including a discussion of independence and accountability;
• the scope and nature of its risk reporting or measurement systems, such as internal risk measurement models, sensitivity analyses, scenario analysis, and stress testing, and how these are integrated into the entity's operating activities. Useful disclosures might include a summary description of the approach used, associated assumptions and parameters (including confidence intervals, computation frequencies and historical observation periods) and strengths and limitations of the approach;
• the processes for accepting, measuring, monitoring and controlling insurance risks and the entity's underwriting strategy to ensure that there are appropriate risk classification and premium levels;
• the extent to which insurance risks are assessed and managed on an entity-wide basis;
• the methods employed to limit or transfer insurance risk exposures and avoid undue concentrations of risk, such as retention limits, inclusion of options in contracts, and reinsurance;
• asset and liability management (ALM) techniques; and
• the processes for managing, monitoring and controlling commitments received (or given) to accept (or contribute) additional debt or equity capital when specified events occur.

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:

• information about the nature of the risk covered, with a brief summary description of the class (such as annuities, pensions, other life insurance, motor, property and liability);
• information about the general nature of participation features whereby policyholders share in the performance (and related risks) of individual contracts or pools of contracts or entities. This might include the general nature of any formula for the participation and the extent of any discretion held by the insurer; and
• information about the terms of any obligation or contingent obligation for the insurer to contribute to government or other guarantee funds established by law which are within the scope of IAS 37.

17.1 Effective date

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]

• the date of initial application is the beginning of the annual reporting period in which an entity first applies IFRS 17 (i.e. 1 January 2022 for an entity first applying the standard with an annual reporting period ending 31 December 2022); and
• the transition date is the beginning of the annual reporting period immediately preceding the date of initial application (i.e. 1 January 2021 for an entity first applying the standard with an annual reporting period ending 31 December 2022 which reports only one comparative period).

17.2 Transition

An entity should apply IFRS 17 retrospectively from the transition date unless impracticable. When applying IFRS 17 retrospectively, an entity should: [IFRS 17.C4]

• identify, recognise and measure each group of insurance contracts as if IFRS 17 had always applied;
• derecognise any existing balances that would not exist had IFRS 17 always applied; and
• recognise any resulting net difference in equity.

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]

• a modified retrospective approach (see 17.3 below); or
• a fair value approach (see 17.4 below).

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 estimates of cash flows at the date of initial recognition;
• the risk adjustment for non-financial risk at the date of initial recognition;
• the changes in estimates that would have been recognised in profit or loss for each accounting period because they did not relate to future service, and the extent to which changes in the fulfilment cash flows would have been allocated to the loss component;
• the discount rates at the date of initial recognition; and
• the effect of changes in discount rates on estimates of future cash flows for contracts for which changes in financial assumptions have a substantial effect on the amounts paid to policyholders.

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:

17.3 The modified retrospective approach

This approach contains a series of permitted modifications to retrospective application as follows: [IFRS 17.C7]

• assessment of insurance contracts or groups of insurance contracts that would have been made at the date of inception or initial recognition – see 17.3.1 below;
• amounts related to the contractual service margin or loss component for insurance contracts without direct participation features – see 17.3.2 below;
• amounts related to the contractual service margin or loss component for insurance contracts with direct participation features – see 17.3.3 below; and
• insurance finance income or expenses – see 17.3.4 below.

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]

• use reasonable and supportable information. If the entity cannot obtain reasonable and supportable information necessary to apply the modified retrospective approach, it should apply the fair value approach; and
• maximise the use of information that would have been used to apply a fully retrospective approach but need only use information available without undue cost or effort.

‘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 undue cost or effort exemption is not intended to be a low hurdle. This is because an entity is required to carefully weigh the expected effects of applying the exemption on the users of the financial statements against the cost or effort of complying with the related requirement. In particular, the IASB observed that it would expect that if an entity already had, or could easily and inexpensively acquire, the information necessary to comply with a requirement, any related undue cost or effort exemption would not be applicable. This is because, in that case, the benefits to the users of the financial statements of having the information would be expected to exceed any further cost or effort by the entity; and
• that an entity must make a new assessment of whether a requirement will involve undue cost or effort at each reporting date.¹³²

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

17.4 The fair value approach

The fair value approach is:

• permitted as an alternative to the modified retrospective approach for a group of contracts when full retrospective application of that group of contracts is impracticable (see 17.2 above); or
• required when full retrospective application of a group of contracts is impracticable and an entity cannot obtain reasonable and supportable information for that group of contracts necessary to use the modified retrospective approach (see 17.3 above).

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]

• how to identify groups of insurance contracts;
• whether an insurance contract meets the definition of an insurance contract with direct participation features; and
• how to identify discretionary cash flows for insurance contracts without direct participation features.

In addition, the general requirements of IFRS 17 are modified as follows when the fair value approach is used:

• when determining groups of insurance contracts, an entity may include as a group contracts issued more than one year apart. An entity is only allowed to divide groups into those only including contracts issued within a year or less if it has reasonable and supportable information to make the decision. This reflects the Board's expectation that grouping of contracts issued within a year (or less) will be challenging in situations where the fair value approach is applied; [IFRS 17.C23]
• an entity determines the discount rate at the date of initial recognition of a group of contracts and the discount rates of the date of the incurred claims under the premium allocation approach (when discounting has been elected – see 9.4 above) at the transition date instead of the date of the initial recognition or incurred claim; [IFRS 17.C23]
• if an entity chooses to disaggregate insurance finance income or expense between profit or loss and other comprehensive income, it is permitted to determine the cumulative amount of insurance finance income or expense recognised in other comprehensive income at the transition date: [IFRS 17.C24]
  • retrospectively, but only if it has reasonable and supportable information to do so; or
  • as nil, unless the below applies; and
  • for insurance contracts with direct participation features where the entity holds the underlying items, as equal to the cumulative amount recognised in other comprehensive income from the underlying items.

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:

• applying the fair value transition approach meant that the amount of insurance acquisition cash flows included in the measurement of the contractual service margin will only be the amount occurring after the transition date that is also included in the fulfilment cash flows. When this approach to transition is applied the entity is not required nor permitted to include in the measurement of the contractual service margin any insurance acquisition cash flows occurring prior to the date of transition;
• the fair value approach is intended to provide an entity with a ‘fresh start’ approach to transition; and
• since insurance acquisition cash flows that occurred prior to the transition date are not included in the measurement of the contractual service margin at the transition date, they are not included in the presentation of insurance revenue and expenses for reporting periods subsequent to the transition date.

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

17.5 Redesignation of financial assets – when IFRS 9 has previously been applied

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]

• may reassess whether an eligible financial asset is held within a business model whose objective is to hold financial assets in order to collect contractual cash flows or is held within a business model whose objective is achieved by both collecting contractual cash flows and selling financial assets. A financial asset is eligible only if the financial asset is held in respect of an activity that is connected with contracts within the scope of IFRS 17. Examples of financial assets that would not be eligible for reassessment are financial assets held in respect of banking activities or financial assets held in respect of investment contracts that are outside the scope of IFRS 17;
• should revoke its designation of a financial asset measured at fair value through profit or loss if the original designation was made to avoid or reduce an accounting mismatch and that accounting mismatch no longer exists because of the application of IFRS 17;
• may designate a financial asset as measured at fair value through profit or loss if in doing so eliminates or significantly reduces an accounting mismatch that would otherwise arise from measuring assets or liabilities or recognising the gains and losses on them on different bases;
• may make an irrevocable election to designate an investment in an equity instrument as at fair value through other comprehensive income provided that equity instrument is neither held for trading nor contingent consideration recognised by an acquirer in a business combination to which IFRS 3 applies; and
• may revoke its previous designation of an investment in an equity instrument as at fair value through other comprehensive income.

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:

• the previous carrying amount of those financial assets; and
• the carrying amount of those financial assets at the date of initial application. [IFRS 17.C31].

Other disclosure requirements when redesignation of financial assets is applied are as follows:

• the basis for determining financial assets eligible for redesignation;
• the measurement category and carrying amount of the affected financial assets determined immediately before the date of initial application of IFRS 17;
• the new measurement category and carrying amount of the affected financial assets determined after redesignation;
• the carrying amount of financial assets in the statement of financial position that were previously designated as measured at fair value through profit or loss in order to significantly reduce or avoid an accounting mismatch that are no longer so designated; [IFRS 17.C32] and
• qualitative information that would enable users of the financial statements to understand: [IFRS 17.C33]
  • how the entity applied the various options available for reassessment, revocation and designation described above;
  • the reasons for any designation or de-designation of financial assets measured at fair value through profit or loss in order to significantly reduce or avoid an accounting mismatch; and
  • why the entity came to any different conclusion in the new assessments applying the requirements of the business model test.

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

17.6 Entities that have not previously applied IFRS 9

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.