The order in which the allocation is performed should be considered consistent with the order in which adjustments to the CSM are made (click here). 21 We are, of course, extremely appreciative of our (anonymous) peer reviewers, for their helpful feedback and encouraging comments. Whilst most items are common, there are some important differences in the adjustments that can be made to the CSM under the GMM and VFA. In opposition to option B, depending on the volume of business and the complexity of the product design, this approach has the risk of becoming an unmanageably complex method to track and implement and could be too complex an attempt to measure the provision of service. Under this method, companies could estimate the cost of capital or IRR a market participant will require to take on the obligations for the group of contracts being valued. Take a simplified example of a 5-year term assurance contract with a sum assured of 100. In this scenario, the future coverage units are adjusted for the time value of money and a revised denominator in the computation of amortisation rate is used. Either way, the result is a depression of subsequent periods profits (or accentuation of losses) and consequently an understatement of the insurers future profit profile. 4 .and the corresponding meeting summary notes: 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. Unless deemed impracticable for the purposes of transition, this assessment is to be performed based on expectations that prevailed when these contracts were written assuming the guarantees were accurately costed and charged for, and the contracts were expected to be profitable, these could still qualify for VFA measurement. Fundamentally, the approach taken should be consistent with the Principle and Practice of Fund Management (PPFM), or a similar document that sets out how the fund is managed in other jurisdictions. This also contradicts the definition of insurance service expenses as per paragraph 103. SII for the most part) when an insurer writes a new contract if the contract is profitable, the insurer recognises a negative liability (effectively an asset) but if the contract is loss-making, the insurer recognises a positive liability. Figure 7. It aggregates total coverage units expected to be provided in all years (see column C). The paper references IFRS 17 paragraphs from the following sources: IFRS 17 Insurance Contracts incorporating all amendments as issued in June 2020Footnote However, readers with less familiarity than this need not be repelled; the paper attempts to provide sufficient exposition of the requirements (with examples where possible) to help facilitate engagement with the material presented. Under this example, the IFRS 17 recognition date would be 1 February but the SII recognition date would be 1 January. However, if the closed fund is allowed to be considered as one single group, the contribution to the Estate will not happen until coverage has been provided to the last policy of the fund. With the savings and retirement phase within the same contract, an entity will have a very long coverage period, with very different types of service provided in both phases. The reinsurance contract is a quota share contract with 50% business ceded. If this computation results in a CSM at inception, then the CSM at transition is calculated by deducting the amount of CSM that relates to services provided before the transition. of the IFoA in the summer of 2018 in anticipation of the diversity of interpretation and application of the Standard. Note for completion that the PV of claims that appears on the balance sheet will be based on the current interest rates in line with the Standards requirements. Under the FVA, the CSM or LC at the transition date is calculated as the difference between the FV of the liabilities for a group of contracts, applying IFRS 13, and the fulfilment cash flows for that group, applying IFRS 17, at that date. For loss-making groups, losses must be recognised in the P&L immediately via the establishment of a LC; i.e. The policyholder is paid a regular monthly amount each period commencing from the future commencement date (i.e. 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. This represents the unearned profit that an entity expects to earn as it provides services. However, at TRG in September 2018, it was clarified that the contract boundary created by the substantive obligations arising from such a notice period will be fixed from the date the reinsurance treaty is recognised. In reality, it turns out that only 1 contract is written per month. Figure 9. Consequently, paragraph B70 explicitly mentions different practical approaches may be adopted, including the estimation at a higher level than the level of aggregation required. Given these features of the CSM, those who favour an approach that capitalises the expected economic profits upfront may therefore seek additional information to help further understand the performance of their business. Hence it may be very challenging, if not impossible, to distinguish GAO contracts from the general annuity population. This implication of the contract boundary requirements on reinsurance was discussed and acknowledged at the February 2018 TRG. This then has implications on the return-on-equity ratio (RoE; discussed further in 6.3). When profitable new business is written, the establishment of the CSM means that the IFRS 17 profit will be zero at initial recognition even though positive economic value has been created for the insurer. (3) Unlike scenario A, the SAR changes to reflect the view that the relevant PV of claims to consider is that measured at current rates instead of locked-in rates. In other, more common cases, new contracts may be included in a group of contracts at various dates throughout the period. Table 21. For example, a rise of 20% in the mortality rate might completely deplete the CSM for the most recent cohorts of protection contracts. In either instance, the revised cash flows (after revising the mortality assumptions) would be discounted at rates based on initial recognition. Consequently, companies should determine for themselves how they wish to approach their reinsurance methodology in response to these issues. Tables10 and 11 summarise the requirements. Discount rate at initial recognition: 5%. A challenge with this is how to effectively measure those identified dominating risks. The key disadvantage of this approach is that it results in the smallest amount of revenue in a given reporting period compared to all other methods. As above, lets consider whether there is a contract boundary at the point where the vested annuities are bought out by the non-profit fund of the same entity which owns the WP fund (i.e. The IASB finalized its deliberations in February 2016 and made the last set of amendments in February 2017 as a result of the field test activities conducted during the summer of 2016. Separating policies in this way could give rise to data and modelling challenges. would be CU350) and the fulfilment cash flows of the second group would exclude CU100 of the guaranteed amount.. If it was locked-in, it would increase the CSM by 15, with an adjustment of 5 going to insurance finance and expense line directly in the P&L. (1) To be consistent with the measurement of the CSM, the company measures the LC assuming a locked-in discount rate of 5%. Consequently, groups of such contracts are expected to have a CSM. 6 Strictly speaking, the terms general measurement model or variable fee approach are not actually terms used by the Standard this is jargon used in the industry to differentiate between the two non-simplified measurement approaches. Consequently, information that can capture this change in economic value will be of interest and it is noted that this will be available from the disclosed roll-forward of the CSM that accompanies the financial statements. Table28 summarises which scenarios can apply for the three methods that were explored in this section. Whilst for GMM contracts it might be easier (but not easy) to identify the PV of cash outflows separately from the PV of cash inflows, for VFA contracts (like UL business), cash outflows like investment expenses may be implicit (i.e. This section discusses the consistency requirement between assumptions used for the valuation of reinsurance contracts held and the underlying insurance contracts as per paragraph 63. 13 What is presented here is based on how the issue is generally interpreted in the industry and presented in the wider literature. For subsequent CSM measurements at the end of year 3, should the 5-year inflation-linked cash flows be adjusted for circa 28% (5% accumulated for 5 years) or 20% (3% accumulated for 3 years and 5% accumulated for 2 years) inflation? The ISSB will deliver a global baseline of sustainability disclosures to meet capital market needs. Other insurers recognise profit only when the contract terminates. The proportion of directly attributable and non-attributable costs at inception will change the pattern at which expenses are recognised (including the impact on day 1). IFRS 17 supersedes IFRS 4 Insurance Contracts and related interpretations and is effective for periods beginning on or after 1 January 2021, with earlier adoption permitted if both IFRS 15 Revenue from Contracts with Customers and IFRS 9 Financial instruments have also been applied. It is important to note, as per paragraph B102, that the classification is set at inception of the contract and is not changed thereafter (unless the contract is modified). However, for the reinsurance unit of account, the company will need to recognise estimated cash flows for the 6 contracts it expects under the quota share in this quarter; the PVFCF on the balance sheet will be 600 and the CSM will be 600 giving a reinsurance LRC of 0 as well. Since this can have a material impact on the amounts and timing of profit recognition, the paper dedicates section 4.2 to identify the challenges that arise in deciding which measurement model will apply using the VFA is not simply a matter of choice for companies, instead IFRS 17 describes the eligibility criteria that must be met to qualify for the VFA. combines current measurement of the future cash flows with the recognition of profit over the period that services are provided under the contract; presents insurance service results (including presentation of insurance revenue) separately from insurance finance income or expenses; and. Example of Opening and Closing Loss Component Calculation using a Systematic Allocation Ratio of 100% in the First Year. IFRS 17 is effective for annual reporting periods beginning on or after 1 January 2023 with earlier application permitted as long as IFRS9 is also applied. Ultimately, entities will need to form their own views on what measure for quantity of benefits best reflects the service provided for the business managed by them based on considerations provided in this section. 23 See February 2020 IASB AP2A Contractual service margin attributable to investment services. Each book is priced separately under the overarching treaty and reflects the demographics of the underlying policyholders. Example of PVFCF, CSM and LRC Calculations for Gross and Reinsurance Units of Account Assuming Future New Business will only be Recognised as and when it is Recognised for the Gross Unit of Account, Impact of Financial and Non-Financial Assumptions in Gross (VFA) Business, Impact of Financial and Non-Financial Assumptions in Reinsurance held (GMM) Business. There are some points to consider making this work: Does the wording of existing reinsurance treaties, particularly with respect to notice period clauses, need to be amended to achieve synchronisation? 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. This example is a slight variation of the example used in the previous section. Insurance contract services include coverage for an insured event but should additionally allow for: investment-return services provided to the policyholder for insurance contracts without direct participating features; investment-related services provided to the policyholder for insurance contracts with direct participating features. European Financial Reporting Advisory Group; International Accounting Standards Board; International Financial Reporting Standards; Principles and Practices of Financial Management; A freely available copy of IFRS 17 Insurance Contracts (incorporating all amendments as issued in June 2020) can be found here: https://cdn.ifrs.org/-/media/project/amendments-to-ifrs-17/ifrs-17-incorporating-the-june-2020-amendments.pdf. However, one approach could be to adjust the resulting recovery cash flows for the risk of non-performance by the reinsurer. It then provides a simplified illustrative example to indicate the impact of the requirements and make key observations. For reinsurance contracts held, paragraphs 6070 apply and according to this, reinsurance contracts held would be aggregated in the following three profitability groups: (a) Groups of reinsurance contracts are in net gain position at initial recognition. Current interest rates are 2%. Table 6. IFoA IFRS 17 Transversal Working Party: Impact on UK with-profits business. 19 As a result of the above impacts, there could be a number of operational and commercial implications, e.g. the contract does not provide compensation for a specified uncertain event that adversely affects the insured person; (b) There are also a number of permitted modifications relating to the determination of insurance finance income or expenses and the calculation of other comprehensive income (OCI) where an entity might struggle to calculate these retrospectively. Entities should also consider whether the policyholder expectations at the point of sale (that the product will meet their financial needs) could create a substantive obligation (noting that the Standard does not say contractual right or obligation). Singapore Actuarial Society: IFRS 17 Workgroup Resources: Coverage Units. The future date where the insuranceundertaking has a unilateral right to terminate the contract; (b) Example 4.11 An insurer has just launched a term assurance product. Instead, the principles here are merely intended to illustrate the basic thrust of the requirements. Alternatively, some companies may decide to develop more inclusive ratios such as the CSM for a portfolio of business expressed as a percentage of the cost of capital required to support the business to tie in the two views of IFRS 17 and SII. Institute of Chartered Accountants in England and Wales (ICAEW): Coverage period and CSM release for deferred annuities. See 4.8.2 for a discussion relevant to reinsurance contracts held. Figure 4. demographic basis updates, implies that such updates will (to the extent that a CSM can absorb them) have a net-zero impact on the LRC, and hence IFRS 17 equity. (Note as will be shown later in this section, the exact date of recognition of the reinsurance contract is critical to the contract boundary conclusions). WP products under IFRS 17 is one of the most discussed subjects by the insurance industry in the UK and overseas. DTTL does not provide services to clients. The above questions were discussed in various agenda papers published by the TRG. It does this by expressing net-of-tax profits (or losses) generated in a given reporting period, as a percentage of the average shareholder equity in that period. IFRS 4 and Solvency II treatment generally reflect this view. In this example, the key question is whether there is a contract boundary at the premium review date. Consequently, even though As RoE considered in isolation that year suggests that A has performed better than B, in reality, only B arguably provides a more sustainable and stable source of earnings for investors. A company might consider this to be a more desirable situation than one with a LC. However, for funds with new business, the split of business into annual cohorts does not reflect inter-generational mutualisation. 11 The entity now needs to decide how to reflect this experience in its determination of coverage units. DTTL and each DTTL member firm and related entity is liable only for its own acts and omissions, and not those of each other. How sophisticated does this UK insurers approach need to be in assessing what a market participants view of cost of capital will be? However, there are requirements of IFRS 17 that may create economic or accounting mismatches of its own. It finally takes a closer look at the specific wording of the Standard and the associated challenges, interpretive issues and implications. 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. Experienced IFRS 17 practitioners, who already have an intimate awareness of issues, may find this paper useful to validate their own conclusions or pick up on new points of detail. 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. Section 4.2.2 highlights some of the criteria that must be met for contracts to be measured under the VFA. The ability to transfer out (withdraw) the account balance to another provider. The remaining part of the premium experience variance will be regarded as related to the current or past periods and will be recorded in the relevant part of the IFRS 17 income statement. Complexity of calculation more complex approaches, e.g. Readers may find this paper particularly useful to understand the challenges that can arise: IFoA IFRS 17 Future of Discount Rates Working Party: Locked-in stochastic discount rates under IFRS 17. https://www.actuaries.org.uk/documents/ifrs17-wp-locked-stochastic-discount-rates. Figure 1. Principle 5 consequently modifies the logic of Principle 1 to make it appropriate for reinsurance held: when an insurer (or reinsurer) purchases reinsurance, it is forced to avoid the immediate recognition of not only the expected cost of that reinsurance, but also any expected gains. From a practical point of view, the method described in Example 4.6 is necessarily simplistic and does not reflect that entities will perform assumption updates at regular intervals. The IASB believes that the adjustments to fulfilment cash flows have a clear purpose and that tracking contracts with mutualisation by annual cohorts provides useful information to users of financial statements around how the business is expected to develop. 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. Changes covered by such a notice period may include: stopping future new business from being ceded to or accepted for reinsurance; changes to the reinsurance premiums payable on reinsurance of future new business. IFRS 17 began as an IASB project to undertake a comprehensive review of accounting for insurance contracts when the IASB added the project to its agenda in September 2001, taking over the equivalent project started in April 1997 by the IASB's predecessor body. On a practical note, this method will require additional calculations to determine the SAR. The remainder is based on the 55 of expected reinsurance cash flows that have now emerged. The reinsurance CSM can only be recognised in the profit or loss statement on a gradual and systematic basis over time, as and when reinsurance services are received. This is not considered insurance coverage as a policyholder does not need to wait for an insurance event to occur to be able to transfer the account balance out. The TRG indicated that they do not think an insured event can happen in the period before the annuity starts. IFRS4 permitted entities to use a wide variety of accounting practices for insurance contracts, reflecting national accounting requirements and variations of those requirements, subject to limited improvements and specified disclosures. Using our website, IFRS Sustainability Disclosure Standards (in progress), Multi-currency Groups of Insurance Contracts (IFRS 17 and IAS 21), Amendments to IFRS 17 Insurance Contracts, Applying IFRS 9 Financial Instruments with IFRS 4 Insurance Contracts, IFRS Accounting Taxonomy UpdateInitial Application of IFRS 17 and IFRS 9Comparative Information, IFRS Taxonomy UpdateAmendments to IFRS 17, IFRS 4 and IAS 16, IFRS Taxonomy UpdateIFRS 17 Insurance Contracts, Initial Application of IFRS 17 and IFRS 9Comparative Information (Amendment to IFRS 17), Transfer of Insurance Coverage under a Group of Annuity Contracts (IFRS 17), Aplicacin Inicial de las NIIF 17 y NIIF 9 Informacin Comparativa, Initial Application of IFRS 17 and IFRS9Comparative Information, Premire application dIFRS 17 et dIFRS 9 Informations comparatives, International Sustainability Standards Board, Integrated Reporting and Connectivity Council, General Sustainability-related Disclosures, Supporting materials for IFRS Accounting Standards, Supporting materials for IFRS Sustainability Disclosure Standards, Supporting materials for IFRS for SMEs Accounting Standard. At the same time, current discount rates will be used to calculate the PVFCF shown on the balance sheet. The discussion starts with an introduction to the logic of the CSM. There are two fundamental problems with the results presented here: (1) The total reported insurance revenue over the 2 years is 100. Ultimately, companies must form their own opinions as to the considerations raised here. clarifying that the risk here should be interpreted as policyholder risks (e.g. The difference between the adjustments calculated at locked-in and current interest rates in the GMM will have to be appropriately allocated to the finance income or expenses line. Why does IFRS 17 require the systematic reversal of LC? These must be considered when adjusting the CSM. In addition, assessing how the CSM may be affected under a variety of stresses (both economic and non-economic) can provide valuable strategic insights for the company. 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