As one would expect, the contract is identified by the entity as onerous at initial recognition and a LC balance of 98 is established. 4%), the excess of return above the minimum guarantee of other policies (e.g. As well as the opportunity to explore synchronising notice periods and reporting dates, the above interpretation of fixed contract boundaries has other advantages. For example, paragraph 44(e) states that the amount recognised as insurance revenue, i.e. Interpretation (1) is less likely to be adopted and it is easy to see why this may not always be appropriate with the help of an example: Assume that the impact of a change in longevity assumptions measured using locked-in financial assumptions (and locked-in discount rates) is 100 but that this impact becomes 110 when measured using current financial assumptions, e.g. It supersedes IFRS 4 Insurance Contracts. The discussion starts with an introduction to the logic of the CSM. Following stakeholder feedback, this requirement was relaxed; by December 2019, the IASB had confirmed that all types of reinsurance contracts would be in scope of the amendment. Subsequent recognition: as regular premiums and increments are received these will be included in the measurement of the CSM group of the original contract. Paragraphs B98-B100 deals with the treatment of discretionary feature of these indirect participating contracts within the GMM. Table 37. Existing EV or SII calculations could be used as one way of approaching the methods of adjusted fulfilment cash flows and using a cost of capital approach instead of approaching the calculations from a blank slate. However, the contractual terms do not clearly identify the pool of underlying assets on which these regular additions will be based on, instead, the contracts specify that any additions are at the discretion of the entity. The current industry view is that the IFRS 17 requirements make it challenging to continue the current approach of considering the two phases of these contracts separately. It should be noted that the assessment of contract boundaries will depend on the specific details of the products, consequently different conclusions could be drawn from those in this example. Table 12. Note that this ratio does not need to be calculated or disclosed, it is only being presented here for explanatory purposes. This could be achieved by adjusting the Mortality assumption with the resulting proportion being, say, 64.5% of AXC00 mortality tables though this method is less preferable and results in loss of distinguishability between variances due to mortality and reinsurer default. Considerations in making this judgement may include whether the systems are in place to apply premium reviews and the entitys past performance with respect to premium reviews. If you accept all cookies now you can always revisit your choice on ourprivacy policypage. Fundamentally this boils down to a trade-off between equity and future profits; a higher CSM will give rise to a lower equity at transition and more future profits whilst a lower CSM will give rise to a higher equity at transition and lower future profits. Example of Profit and Loss Entries Based on Three Methods of Amortisation for the Loss-Recovery Component, Table 33. This is important because the conclusion eventually drawn from this example only follows if this particular approach is adopted in practice (or other similar approaches whereby calculations are performed on, say, a discrete quarterly roll-forward basis). Further consistency and justification of changes will be required in subsequent measurements. Considering the implications for the CSM of whether there is a contract boundary at the review point or not: Contract boundary: the fulfilment cash flows, and hence the CSM, will be based only on cash flows up to the review point, and the CSM will be released over the coverage period up to that date. In order to determine how much profit should be recognised in each period, the entity is required to identify the amount of service provided by the group of contracts (known as coverage units). Interest rates are clearly a financial assumption and they should be locked in for subsequent CSM calculations (as explicitly stated in paragraph B96). As long as these indices are contractually clearly identified, contracts that depend on them will likely qualify for VFA measurement: indeed, IFRS 17 is explicit that insurers need not hold the identified pool of underlying items. if the new recognition date is more than 1 year apart from contracts in the original group of contracts. The UK market is a mix of participants of various sizes applying the Standard Formula or partial internal models or full internal models. In support of option B, some companies might consider the possibility to allow for, say, the higher amount of service provided on average in a year due to unexpected increases to sums assured by policyholders (but that do not result in modification or de-recognition). An entity should consider the cost/benefit trade-off associated with the granularity of groups. Do the contracts have the same distribution channel? That is, future coverage units must not be recalculated as at the start of the current reporting period as this distorts the view of coverage provided in the current period. The paper acknowledges the possibility under IFRS 17 of justifying a contract not being the lowest unit of aggregation i.e. Moodys Analytics: Using Stochastic Scenarios to assess VFA Eligibility. The motivation behind option B is the view that coverage units in a given period should reflect the fact that service stops being provided for those policies that go off the books (as and when they go off the books). Each book is priced separately under the overarching treaty and reflects the demographics of the underlying policyholders. Depending on a companys transition approach, this may be deemed to be unnecessary (e.g. This scenario arises when an approach used to determine the SAR consistently results in a ratio that is lower than its optimum. 68.6 = 70 (amount released in revenue) 98% (year 2 SAR). 22 On a retrospective basis, with-profits policies valued under the VFA would likely gradually end up having their CSM collapse into LC to reflect the dual negative impacts of continuously decreasing interest rates and generally improving annuitant longevity. Rebecca, our previous Chair, set the direction of the working party and laid the groundwork for us to build on. The WP fund ceases to bear any liability or risks, as these are passed to the non-profit fund which now bears the longevity risk, etc. This brings the discussion to the second relevant aspect. Both approaches would be allowed under IFRS 17 despite resulting in two possible extremes as shown in the graph below: the potential for excessive profit deferral when not allowing for time value and the potential for undue profit acceleration when allowing for time value. Further, the requirement applies irrespective of whether those reinsurance contracts held are net cost or net gain overall.Footnote We are grateful to Andrew Beattie, Victor Iglesias and Olive Gaughan for their generosity in sharing their views on issues pertaining to KPIs and related financial ratios. Observation 1: The proposed mechanism functions as a trade-off. It is the hypothetical exit price at which the liability will be transferred in an orderly transaction between market participants at the measurement date. However, there is one peculiarity that emerges in this method that was not possible in the previous two. Balazs is a Partner of Deloitte Central Europe and the regional CE VCS leader. Components of a contract can be repriced separately. This may particularly be an issue for companies writing long-term index-linked business (such as annuities), where inflation assumptions may vary significantly between initial recognition and transition. future expected inflation (but still locked-in discount rates). The information and expressions of opinion contained in this publication are not intended to be a comprehensive study, nor to provide actuarial advice or advice of any nature and should not be treated as a substitute for specific advice concerning individual situations. Most notably, unlike SII, the calculation of the RA is not prescribed under IFRS 17 and consequently, it is up to companies to determine for themselves the techniques they will use to calculate the RA. Once an entity has determined the recognition date for a group of contracts, they will need to work through practical considerations. As a result, measurement of the group in isolation would lead to a CSM (assuming profitable) or LC (assuming it is onerous). The CSM is a fundamental concept introduced by IFRS 17 that embodies these principles at its core. There are several technical complications that companies must consider during implementation. ) primarily measure the likelihood of insured events occurring which is not the objective of coverage units. Components of a contract can lapse separately. In the staff analysis of requests from stakeholders to permit entities to develop their own modificationsFootnote As with other business lines, in determining the level of aggregation for WP business, companies typically look to achieve the minimum number of groups to both minimise the operational complexity and reduce Income Statement volatility. Adjustments to the CSM for changes in estimates of future liabilities, measured at the locked-in discount rate. Figure 2. With the introduction of the CSM, a reasonable amount of change is anticipated with regards to how new business profitability might be reported in an IFRS 17 world. benefits that escalate, either at a fixed rate or in line with inflation). The working party expects this paper to sit most comfortably in the hands (or on the screens) of readers who have prior knowledge of IFRS 17 and are broadly familiar with its various concepts and themes. These principles can be illustrated using simplified examples as shown in Tables2 and 3. This gives the fulfilment cash flows at initial recognition and subsequent measurement as shown in Table21. Methodology has a clear role to play in the transition strategy for companies. Therefore, firms are permitted to use estimates when using the FRA (and the MRA) and the use of estimates does not preclude a company from using the FRA. These estimates would need to be discussed and agreed with auditors and a company should be aware that if an estimate is in breach of the requirements of the FRA (i.e. Whilst a shadow acquisition cash flow balance does need to be tracked under IFRS 17, the release of this balance under IFRS 17 (in insurance service revenue and insurance service expenses) does not generate any impact in the P&L and so does not lead to any ongoing impact on the RoE. For this reason, the paper has had to be necessarily restricted to the CSM in its scope. At this point, the contract boundary would only include future new business up to and including 27 February 2023, despite the insurer knowing that, as notice has not been given, they must cede new business up to and including 30 March. Permitted Modifications under the GMM Approach, http://creativecommons.org/licenses/by/4.0/, https://cdn.ifrs.org/-/media/feature/supporting-implementation/ifrs-17/08-ifrs-17-level-of-aggregation-slides-2020.pdf, http://www.efrag.org/News/Project-307/EFRAG-issues-IFRS-17-background-briefing-paper-on-level-of-aggregation, https://www.moodysanalytics.com/-/media/whitepaper/2018/level-of-aggregation-in-ifrs17.pdf, https://inform.pwc.com/show?action=applyInformContentTerritory&id=2046151104129637&tid=76, https://www.moodysanalytics.com/-/media/whitepaper/2019/Moodys-Analytics-Using-Stochastic-Scenarios-to-assess-VFA-Eligibility.pdf, https://www.hkicpa.org.hk/-/media/HKICPA-Website/New-HKICPA/Standards-and-regulation/SSD/06_New-and-major-stds/hkfrs-17/pocket-summary/CB2019.pdf, https://www.actuaries.org.uk/documents/ifrs17-wp-locked-stochastic-discount-rates, https://www.icaew.com/-/media/corporate/files/technical/financial-services/ifrs17-and-iasb/locked-in-csm-discount-rates.ashx?la=en, https://cia-ica.ca/docs/default-source/2019/219131e.pdf, https://www.actuaries.org.sg/sites/default/files/2020-09/SAS%2017WG%20%E2%80%93%20Coverage%20Unit%20v1.0.pdf, https://www.icaew.com/-/media/corporate/files/technical/financial-services/ifrs17-and-iasb/coverage-period-and-csm-release-for-deferred-annuities.ashx?la=en, https://www.efrag.org/Assets/Download?assetUrl=%2Fsites%2Fwebpublishing%2FSiteAssets%2FIFRS%252017%2520Background%2520briefing%2520paper%2520CSM%2520allocation.pdf, https://www.hkicpa.org.hk/-/media/HKICPA-Website/New-HKICPA/Standards-and-regulation/SSD/06_New-and-major-stds/hkfrs-17/2020-Agenda-papers-and-meeting-summaries/paper30507.pdf, https://www.hkicpa.org.hk/-/media/HKICPA-Website/New-HKICPA/Standards-and-regulation/SSD/06_New-and-major-stds/hkfrs-17/2020-Agenda-papers-and-meeting-summaries/ms0507.pdf, https://www.icaew.com/-/media/corporate/files/technical/financial-services/ifrs17-and-iasb/icaew---np-business-in-a-wp-fund.ashx?la=en, https://www.icaew.com/-/media/corporate/files/technical/financial-services/ifrs17-and-iasb/icaew---accounting-for-annuties-that-have-vested-from-wp-contracts-under-ifrs-17-sg-copy.ashx?la=en, https://www.efrag.org/Assets/Download?assetUrl=%2Fsites%2Fwebpublishing%2FMeeting%20Documents%2F1907221354563005%2F06-03%20-%20Issues%20paper%20-%20Contracts%20that%20change%20nature%20over%20time%20-%20EFRAG%20TEG%2020-05-06.pdf, https://www.actuaries.org.uk/documents/ifrs-17-impact-uk-profits-business-20200128, https://www.actuaries.org.sg/sites/default/files/2020-09/SAS%2017WG%20%E2%80%93%20Singapore%20Gated%20Par%20v1.0.pdf, https://cdn.ifrs.org/-/media/project/amendments-to-ifrs-17/ifrs-17-incorporating-the-june-2020-amendments.pdf, https://cdn.ifrs.org/-/media/project/amendments-to-ifrs-17/inbrief-IFRS17-factsheet-april2020.pdf?la=en, https://www.ifrs.org/-/media/feature/supporting-implementation/ifrs-17/ifrs-17-and-mutual-entities.pdf. An entity may simplify the measurement of the liability for remaining coverage of a group of insurance contracts using the premium allocation approach on the condition that, at initial recognition, the entity reasonably expects that doing so would produce a reasonable approximation of the general model, or the coverage period of each contract in the group is one year or less. Again, the answer will depend on the specifics of the product, so instead of giving an explicit answer, this section lays out some of the points to consider in this scenario. In doing so, the Standard aims to increase the usefulness, comparability, transparency and quality of insurers financial statements. For contracts under the VFA, such as UK-style WP business, the proxy method under MRA could be significantly less onerous than a full retrospective calculation. However, certain experience variances, which are recorded in the income statement in the current period, may have a knock-on impact on the fulfilment cash flows related to future service. (The liquidity premium is set to zero due to the contracts being able to lapse any time.) An entity shall present in profit or loss revenue arising from the groups of insurance contracts issued, and insurance service expenses arising from a group of insurance contracts it issues, comprising incurred claims and other incurred insurance service expenses. Similarly, in year 2, service expenses were reduced from 70 in Example 4.4 to 1.4 in Example 4.5. After nearly 20 years of discussion, the International Accounting Standards Board (IASB) published IFRS 17 on Thursday 18 May. In the case of those contracts with both lump sum and regular payment benefits, this would likely otherwise lead to the regular payment benefits being ignored in the quantity of benefits. The total reported insurance service expense is 100 and is now exactly equal to the actual claims and expenses incurred over the lifetime of the contract. This leaves room for judgement because many insurance contracts typically tend to expose companies to more than one type of risk (e.g. As the pattern of coverage units most significantly influences profit recognition under IFRS 17, ultimately a significant part of the definition of profit is down to the judgement of individual entities in how to combine these different types of coverage. If so, it potentially does not have a substantive obligation. This section considers the discount rate at initial recognition (or locked-in discount rate) for GMM business how it might be determined and the potential impacts of selecting a suitable alternative. There is no right or wrong choice, however, it is important to have consistency between various elements such as calculation of interest unwind or insurance revenue. Method B: Method B fixes the underlying problem with Method A. As this section indicates, assessing VFA eligibility will not always be a straightforward exercise. 11.5 and 12.5. When an entity recognises losses on initial recognition of onerous groups of underlying contracts, IFRS 17 requires that entity to simultaneously recognise gains from reinsurance contracts held (provided those reinsurance contracts were recognised before or at the same time as the loss on the underlying contracts). On the other hand, the MRA will reflect an updated view of the unamortised CSM yet to be recognised as profits. Typically, any discretionary crediting rate will classify as an economic assumption. Example of PVFCF, CSM and LRC Calculations for Gross and Reinsurance Units of Account. Figure 3. If these parameters turn out to be different and diverge over time between the ones applicable to a group of insurance contracts and the ones that are applicable for corresponding reinsurance treaties, these differences and divergence should be appropriately documented and justified. First, paragraphs 66AB make it clear that adjusting the reinsurance CSM and establishing a loss-recovery component is mandatory when an entity recognises a loss at initial recognition of an onerous group of underlying insurance contracts. waiver of premium riders. However, the IFRS 17 approach differs; insurance contracts measured under the GMM and VFA requires directly attributable insurance acquisition cash flows to be allowed for by a reduction in the CSM, rather than through the establishment of an explicit DAC asset on the balance sheet. If the policy continues after the review point, a new contract will need to be recognised and a new CSM established. Contracts will need to be moved into new CSM groups at the review point. There are often separate views of capital companies hold based on their own economic capital models. Methods should be carefully considered in terms of what financial and operational implications it commits entities to considerations for in-force business may result in completely different conclusions compared to considerations for new business. We thank Maaz Mushir, an eagle-eyed follower of our Linkedin articles, who provided us with invaluable insights to improve on our analysis further across several topics including contract boundaries, reinsurance contracts held and interim reporting requirements. The extent to which these impacts at initial recognition or at subsequent measurement will be visible in the headline RoE figure will depend, e.g. the locked-in discount rate, being the discount rate used for CSM accretion. For example: 29.4 = 30 (amount released in revenue) 98% (year 1 SAR). What do we do once weve issued a Standard? One possibility is to perform scenario tests or sensitivity analyses. The impact on RoE arising from the systematic reversal of LC: At subsequent measurement, as illustrated in section 4.7 the systematic reversal of the LC does not give rise to future profits or losses.
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