Industry clarity on the IFRS 17 implementation road

The September Transition Resource Group (TRG) meeting provided further clarity in a range of areas related to insurance under IFRS 17. Our analysis addresses the points that we expect will affect most insurers. Other topics discussed applicable to mutuals and associations will be analysed in a separate blog.

1.      Factors that can affect the length of the coverage period

Consequential insurance coverage:

Insurance liability is the insurer’s obligation to investigate and pay valid claims arising from insured events and is split into two components based on whether the insured event has already occurred:

When does the insured event occur if the insurance risk is consequent to an incurred claim? For example, in the case of disability coverage in the form of an annuity for the period in which the policyholder is disabled: is the insured event a) the accident or illness that made the policyholder disabled or b) the policyholder becoming disabled following an accident or illness specified in the contract?

Practical aspect: In reality either interpretation could apply. Different interpretations will give rise to different coverage periods, ie the coverage period will be longer in the case of disability coverage if b) is the insured event rather than a). A longer coverage period means that in the case of view b) revenue is recognised over an extended period. Judgement is required to determine the accounting policy that will provide the most useful information to the users of the insurer’s financial statements.

Premium waiver:

Premium waiver can be in the form of a contractual term that allows a policyholder not to pay premiums in specified circumstances. For example, a term life contract that provides primary coverage for mortality risk might allow the policyholder not to pay premiums for that contract if the policyholder becomes unable to work due to a disability.

Practical aspect: The premium waiver does not depend on the death of the policyholder (primary coverage – mortality risk) but on an additional insurance risk of the policyholder becoming disabled. The additional adverse effect of the policyholder becoming disabled suggests the insurer provide the same benefits without receiving consideration, ie additional coverage. Additionally, coverage units for mortality and disability risk can lead to a different coverage period over which the contractual service margin will be recognised when the coverage period with the waiver differs from the coverage period related to the base contract without the waiver.

2.      Discount Rates:  top down approach for non-VFA contracts

Under the top down approach, the starting point to determine the IFRS 17 discount rate is an asset rate that is adjusted to exclude factors present in the assets but not present in the group of insurance contracts, for example expected credit losses and differences in amount, timing or uncertainty of cash flows.

However, there is a simplification in the standard not to adjust the asset rate for differences in liquidity between a reference portfolio of assets and the group of insurance contracts. The simplification is available on the basis that the asset rate will be derived from a reference portfolio that is expected to have similar liquidity characteristics to the group of insurance contracts.

Practical aspect: if the simplification is used, measurement will be easier on initial recognition, but, subsequently, more disclosures may be required. That is because small fluctuations in the liquidity of the reference portfolio may lead to discount rate changes. Discount rate changes, even if small, may lead to material changes to the insurance liabilities measured.

Disclosure point: any material effect of a change in the composition of the reference portfolio of assets on the discount rates would be required to be disclosed in accordance with paragraph 117 of IFRS 17.

3.      Premium and acquisition cash flow experience adjustments

Premium experience adjustments are differences between expected and actual premiums. Judgment should be applied in deciding whether the premium experience adjustments relate to current, past or future service. For example, in the case of workers’ compensation coverage, if the premium is based on the expected headcount and the expected headcount differs from the actual one, then the difference between expected vs actual premiums should:

• be recognised as revenue if it relates to current or past service.
• adjust the contractual service margin if it relates to future service. That could happen when the actual premium received in the current period for coverage to be provided in the future differs from the expected premium because lapses differ from those expected.

Consistently with premium experience adjustments, acquisition cash flows might be settled in an amount different from the one originally expected (acquisition cash flows experience adjustments). Acquisition cash flow experience variances adjust the contractual service margin if they relate to future coverage or affect insurance revenue and insurance service expense if they relate to current or past service.

Practical aspect: The additional premium recognised as revenue in the current period because the actual headcount was higher than the expected does not affect the release of CSM, i.e. CSM is based on expected coverage units. Instead the premium experience adjustment is an additional component of revenue based on paragraph B124 of IFRS 17.

4.      Acquisition cash flows and their recoverability

Not all commissions meet the definition of IFRS 17 insurance acquisition cash flows. For example, policy administration and maintenance costs in the form of recurring commissions due to intermediaries do not meet the definition of insurance acquisition cash flows, instead they are treated as administrative or maintenance costs.

Those cash flows that are insurance acquisition cash flows under IFRS 17 may also be higher than the premiums, i.e. not fully recoverable. In this regard, the Standard does not require entities to separately identify the recoverable amount of insurance acquisition cash flows at each reporting date. The remeasurement of fulfilment cash flows at each reporting date will capture any lack of recoverability arising from all expected cash flows including acquisition cash flows.

Practical aspect: The insurance revenue cannot exceed the amount the entity is expected to receive as consideration for services provided. If, for example, the acquisition cash flows cannot be recovered from premiums, they should be expensed in profit or loss because the CSM cannot be negative. Insurance revenue, in other words, will be the total reduction of the liability for remaining coverage (closing LRC minus opening LRC) relating to services for which the entity expects to receive consideration, excluding the loss component (that will reflect the irrecoverable cash flows)

5.      Contract boundary considerations

Contract boundary determines which cash flows pertain to existing contracts and which to future contracts. Cash flows that pertain to expected claims or premiums arising from future contracts are outside the initial contract boundary.

Practical aspect: a proportional reinsurance contract held that covers all risks arising from underlying insurance contracts issued in a 24-month period and provides the unilateral right to both the entity and the reinsurer to terminate the contract with a three month notice period has a contract boundary of 3 months (1 January – 31 March). This is because the cedant has no substantive right to receive services with respect to new business that may be ceded in the following 21 months.

Contract boundaries are reassessed in each reporting period if there are changes in circumstances on the entity’s substantive rights and obligations. The contract boundary reassessment should be based on ‘changes in circumstances’ that are ‘narrow’, such as changes in the economic environment (debt spiral situations) or contract term whose commercial substance status has changed from one reporting period to the other.

Practical aspect: a restriction previously assessed as having no commercial substance, could in later years begin to have commercial substance. For example, in the case of a five year health insurance contract which can be re-priced annually, the insurer may initially determine the contract boundary as 1 year, but at the end of the year restrictions on re-pricing that had no commercial substance initially, may have commercial substance at the reporting date. In that case, at the end of the reporting period, the contract boundary is no longer 1 year but reassessed to be 5 years.

6.      Commissions and reinstatement premiums

Commissions due to a policyholder and reinstatement premiums charged to a policyholder are amounts exchanged between the (re)insurer and the policyholder and should be accounted for under IFRS 17 based on their economic substance and not based on what they are called in the contract.

In this regard the following two questions are relevant:

Question 1: Is the amount contingent on claims?

• Yes. For example, an additional ‘premium’ is charged to the cedant as claims incur. In this case the extra amount charged should be part of the claims and not of the premiums. One TRG member interpreted differently the additional premium charged to the cedant as buying additional coverage to increase the cover, ie as a pricing consideration once you have ‘exhausted’ the first claims’ capacity, ie as part of the premiums.
• No. For example, profit ‘commission’ due to a cedant does not change as claims incur. In this regard the amount paid to the cedant is effectively a deduction from the premium. The economic effect is a lower premium charge.

Question 2: Is the amount repaid in all circumstances (eg even if the contract is cancelled or the maximum claim limit is reached)?

• Yes. For example, part of premiums in a retroactively rated insurance contract is refunded to the policyholder in all circumstances. Under these circumstances the amount meets the definition of an investment component and is presented as financial income or expenses and not as part of insurance revenue.

KPI point: the above guidance applies to both insurance (property/casualty contracts with experience-rating provisions or similar features) and reinsurance contracts issued (where the cedant is the policyholder) and is different from existing practice. It is expected to have an impact on important metrics, eg loss ratio and may have an impact on the information provided on the claims development tables.

Future discussions

The challenges brought about by IFRS 17 are significant and many insurers are looking for solutions that capitalise on existing practice. The extent to which these solutions and implementation approaches will reflect IFRS 17’s new principles is an area of much interest. It is expected that many of these views and approaches will be deliberated and positions clarified through discussion forums and as implementation experience develops.

With the application date of IFRS 17 approaching, insurers are trying to understand what changes need to be made in order to be IFRS 17-ready. If you would like to discuss your transition to IFRS 17, please feel free to contact Maria Karamanou or any other member of the Mazars Financial Reporting Advisory team.

Blog author: Maria Karamanou, Insurance specialist, Mazars Financial Reporting Advisory