Measuring insurance cash flows Measuring insurance cash flows
Key development
The revised IFRS 17 was published in mid-2020 with amendments in eight key areas of the standard including a deferred effective date of 1 January 2023.
Exposure draft of amendments to IFRS 17
International Accounting Standards Board, June 2019
Noteworthy observations by TRG members
April 2019 TRG meeting
Accounting for insurance acquisition cash flows that relate to future contract renewals
March and January 2019 International Accounting Standards Board meetings
Determining discount rates using a top-down approach
September 2018 TRG meeting
Accounting for the risk adjustment in industry pools managed by an association
September 2018 TRG meeting
Determining the risk adjustment for individual and group reporting purposes
May 2018 TRG meeting
Insurance acquisition cash flows paid when contracts are issued
February 2018 TRG meeting
Exposure draft of amendments to IFRS 17
International Accounting Standards Board, June 2019
With the Board having published its exposure draft of the amendments to IFRS 17, you can find our latest insight and analysis at home.Kpmg/ifrs17amendments.
Noteworthy observations by TRG members
April 2019 TRG meeting
In some interesting discussions on IFRS 17’s requirements, TRG members made several noteworthy observations on measuring insurance cash flows.
Recognising changes in inflation assumptions
Assumptions about inflation that are based on an index of prices are treated as relating to financial risk even if the link to the index is not contractual. These changes are recognised as insurance finance income or expense in profit or loss (and other comprehensive income). In contrast, changes in inflation assumptions based on an insurer’s expectation of specific price changes do not relate to financial risk.
Considering reinsurance when determining the risk adjustment for non-financial risk
TRG members discussed whether reinsurance should be considered in the risk adjustment for non-financial risk of underlying contracts when an insurer also holds reinsurance. It was clarified that if an insurer considers the availability of reinsurance, including its cost, when determining the compensation it requires for bearing the non-financial risk of underlying contracts, then this would be reflected in the risk adjustment for the underlying contracts. The risk adjustment for reinsurance contracts held is always determined as the risk that is being transferred to the reinsurer.
Recognising changes in fulfilment cash flows that result from changes in underlying items
Some TRG members raised concerns about this topic – the Board will discuss this matter further at its April 2019 meeting.
The Board’s staff stated that changes to fulfilment cash flows that result from changes in underlying items should not adjust the CSM under the general measurement model. For the purposes of IFRS 17, they believe that these changes are considered changes in assumptions that relate to financial risk. The staff plans to recommend that the Board clarify this.
Although they agreed with this clarification for measurement purposes, some TRG members expressed concern about its impact on the separate presentation of insurance service and investment results, in particular where the changes in underlying items relate to non-financial assumptions – e.g. mortality expectations when insurance contracts are part of underlying items.
Accounting for insurance acquisition cash flows that relate to future contract renewals
March and January 2019 International Accounting Standards Board meetings
What’s the issue?
Under IFRS 17, insurance acquisition cash flows are accounted for by including them in the cash flows expected to fulfil contracts in a group of insurance contracts.
These cash flows may comprise commissions paid for new contracts issued that insurers expect policyholders to renew in the future, sometimes more than once. In some cases, the commissions may exceed the margins to cover such costs embedded in the premium for the initial contract because the insurer expects to recover some costs from future renewals of that contract.
If the commission is non-refundable, it has to be covered by the premiums within the ‘contract boundary’ of the newly issued contract under current IFRS 17 when it is initially recognised. When the expected renewal of the contract is outside the boundary of the newly issued contract, the contract could be onerous under IFRS 17.
What did the Board decide in January 2019?
The Board tentatively decided to amend IFRS 17 so that insurers would allocate part of the insurance acquisition cash flows directly attributable to newly issued contracts – e.g. initial commissions paid – to expected renewals of those contracts outside the contract boundary. This would address one of the issues discussed by the TRG in February 2018.
As a result of this, insurance acquisition cash flows allocated to future renewals would be recognised as an asset until the expected contract renewals are recognised. The Board proposes further amendments to the accounting for these assets. In particular, insurers would:
- assess the recoverability of the asset each period before the renewed contracts are recognised, basing the assessment on the expected fulfilment cash flows of the related group of contracts; and
- recognise in profit or loss:
- any unrecoverable amount as a loss; and
- any reversal of some or all of this loss when adverse conditions no longer exist.
- reconcile the asset created by these cash flows at the beginning and the end of the reporting period and its changes, specifically any loss for lack of recoverability or reversals recognised; and
- provide quantitative disclosures – in appropriate time bands – of when these cash flows are expected to be included in the measurement of the related insurance contracts.
What’s the impact?
For many insurers, the concept of deferring insurance acquisition cash flows and assessing the asset for recoverability is a familiar concept, similar to current practice.
However, the expectation of future renewals, allocation of acquisition costs and the recoverability test that would be required under the Board’s proposal may need to be performed at a more granular level compared with current practice – i.e. at the level of groups of insurance contracts.
In addition, insurers would need to:
- analyse their acquisition costs to identify which ones relate to expected contract renewals outside of the contract boundary;
- allocate costs; and
- evaluate their expectations of future contract renewals beyond contract boundaries.
Applying this amendment would therefore introduce some new steps. The amendment would also require insurers to exercise more judgement when assessing expected future renewals and developing their method for allocating insurance acquisition cash flows.
Insurers using the premium allocation approach would have the option to either:
- expense all insurance acquisition costs up front and avoid operational complexity and judgement; or
- recognise these costs as an asset.
- use the premium allocation approach; and
- choose to expense all insurance acquisition costs up front,
Determining discount rates using a top-down approach
September 2018 TRG meeting
What's the issue?
An insurer may determine the discount rates used to measure insurance contracts by basing its calculations on a yield curve reflecting the current market rates of return of a reference portfolio of assets (i.e. using a top-down approach).
In doing so, the insurer needs to adjust the yield curve to eliminate any characteristics of the assets that are not present in the insurance contracts – e.g. credit risk. However, it does not need to adjust for liquidity differences.
A question that arises is whether an insurer can use its own assets as the reference portfolio and, if so, whether changes in those assets should result in changes in the discount rates used to measure insurance contracts if it does not adjust for liquidity differences.
What did the TRG discuss?
TRG members observed that IFRS 17 does not impose any restrictions on the reference portfolio –therefore, it could be a portfolio of assets held by the insurer, as long as the discount rates achieve the objectives of:
- reflecting the characteristics of the insurance contracts; and
- consistency with observable current market prices.
If an insurer uses its own assets as the reference portfolio and – as IFRS 17 permits – does not adjust for liquidity differences, then the changes in the portfolio’s liquidity would be reflected in the changes in the discount rates used to measure the related insurance contracts, even if the liquidity characteristics of the insurance contracts themselves have not changed.
Insurers are required to adjust the yield curve of the reference portfolio to eliminate factors (other than liquidity differences) that are irrelevant to insurance contracts – e.g. credit risk changes. Therefore, changes related to credit risk would not impact the discount rate used to measure insurance contracts.
What's the impact?
Insurers will generally endeavour to match assets and liabilities closely, so a reference portfolio based on own assets might be expected to reflect a level of liquidity as similar as possible to that of its issued insurance contracts.
However, some differences will still arise and changes in the liquidity of the reference portfolio would flow through to the measurement of insurance contract liabilities if no adjustment is made for differences in liquidity. This would be the case if a greater proportion of illiquid assets are held – the measurement would reflect greater availability of illiquid investments in the market even though the liquidity characteristics of the insurance contract liabilities have not changed.
To enable financial statement users to compare different insurers, it is essential that IFRS 17’s disclosure requirements are applied, particularly in terms of how the insurer:
- identifies a reference portfolio; and
- adjusts the yield curve to determine the discount rates, including whether it adjusts for liquidity differences.
Under IFRS 17, entities are required to disclose significant judgements and changes in those judgements, including with respect to discount rates. Disclosing the effects of changes in the assets in the reference portfolio on the discount rates would provide useful information about the sources of changes to the insurance contract liabilities.
Accounting for the risk adjustment in industry pools managed by an association
September 2018 TRG meeting
What's the issue?
In some jurisdictions, all insurers issuing automobile insurance contracts are legally required to be members of a particular association, whose purpose is to provide insurance coverage to policyholders who would otherwise be unable to obtain it. This arrangement includes two types of industry pools.
| Pool 1 | Pool 2 |
| Some members are appointed to issue contracts that belong to the industry pool on behalf of all members | Members can choose to transfer some insurance contracts they have issued to the industry pool |
The results of each industry pool are allocated to all of the members of the association based on a sharing formula. Under current practice, the share of the results is included in each insurer’s own financial statements as direct business.
A question arises over how members should account for their share in the results of the industry pool, and whether the risk adjustment for non-financial risk related to contracts in industry pools should be determined at the association level or the individual member level.
What did the TRG discuss?
The terms of a contract need to be analysed to identify the substance of the rights and obligations under the contract and who the issuer is. Facts and circumstances may indicate that contracts in an industry pool are considered to be issued by all members together.
As IFRS 17 provides no specific guidance on contracts with more than one issuer, insurers may need to consider whether other standards apply – including IFRS 11 Joint Arrangements – to determine how to reflect their share in the results of industry pools in their financial statements.
The risk adjustment that an insurer requires for non-financial risk reflects the compensation it would require for bearing that risk. Therefore, the risk adjustment reflects the degree of diversification benefits an insurer includes when making this determination.
TRG members observed that issuing a contract within an industry pool arrangement may affect these diversification benefits and, therefore, the risk adjustment.TRG members noted the differing views expressed as to whether the risk adjustment applied to the same group of insurance contracts could differ depending on the reporting level within a group of entities (see Determining the risk adjustment for individual and group reporting purposes).
What's the impact?
Industry pool arrangements are common in many jurisdictions. However, the diverse legal and contractual forms these take will require careful analysis in order to account for them appropriately. It is important to evaluate all relevant facts and circumstances of each arrangement to determine:
- who the issuer of the contracts is;
- how each member should account for its share in the pool; and
- how the risk adjustment for non-financial risk reflects the substance of the arrangements.
Determining the risk adjustment for individual and group reporting purposes
May 2018 TRG meeting
What's the issue?
The objective of the risk adjustment for non-financial risk is to reflect the entity’s perception of the economic burden of the non-financial risk that it bears. Therefore, the risk adjustment for an entity reflects the degree of diversification benefit that it includes when determining the compensation it requires for bearing that risk.
The question that arises is whether an entity or its group can consider diversification benefits beyond the single entity – e.g. those available at the consolidated group level – when determining the risk adjustment.
What did the TRG discuss?
TRG members observed that when determining the risk adjustment, the entity that issues the contracts considers benefits of diversification that occur at a level higher than the entity if, and only if, they have been included when determining the compensation that the issuing entity requires for bearing non-financial risk. This compensation could be evidenced by the capital allocation in a group of entities.
For the purposes of group reporting, two methods were discussed.
The staff and some TRG members believed that determining the risk adjustment involves a single decision made by the entity that issues the contracts. Therefore, the risk adjustment at the consolidated group level should be the same as the risk adjustment at the individual issuing-entity level.
Other TRG members believed that the risk adjustment is based on an entity’s perception of the economic burden of the non-financial risk that it bears, and an individual entity within a group may have a different perception of non-financial risks from that of the consolidated group. This could result in different risk adjustments being applied for the same group of insurance contracts depending on the reporting level.
TRG members noted that the method selected by a group of entities should be applied consistently across all groups of insurance contracts.
What's the impact?
Insurers may want to use the same risk adjustment at the consolidated group level and at the individual issuing-entity level for the same group of contracts. This may be operationally simpler than determining multiple risk adjustments for measurement purposes – one at the level of the individual entity that issued the contracts and another at the consolidated group level.
IFRS 17 is principles-based and does not prescribe how to determine the risk adjustment. However, insurers applying IFRS 17 may need to look at:
- how they price business;
- how capital is allocated and target returns are determined; and
- whether issuing entities operate within a group-wide risk appetite and risk management framework that reflects the benefits of group-wide risk diversification.
Insurance acquisition cash flows paid when contracts are issued
February 2018 TRG meeting
What's the issue?
Insurers may unconditionally pay insurance acquisition cash flows – e.g. commissions paid to sales agents – for contracts initially written with the expectation that they will be renewed. Sometimes these acquisition cash flows paid exceed the initial premium charged for the contract.
The insurer generally expects to recover these costs from future renewals. However, if those cash flows are outside the contracts’ boundaries, then they cannot be included when measuring the initially written contracts under IFRS 17.
This raises the question of whether future premiums can be allocated to insurance acquisition cash flows that are unconditionally paid when the contract is issued, if they are partly associated with future renewals.
Update, January 2019: The International Accounting Standards Board has proposed amendments to IFRS 17 that aim to address this issue.
What did the TRG discuss?
TRG members appeared to agree that any insurance acquisition cash flows that are:
- directly attributable to individual contracts; and
- unconditionally paid on initially written contracts,
should be included in the measurement of the group containing those contracts. Because the costs are paid unconditionally for each initially written contract, they cannot be allocated to future groups recognised on renewal or other groups that do not contain these contracts.
Various TRG members believed that the accounting outcome would not reflect the economic substance of the contract because it would not reflect the insurer’s long-term expectations.
The TRG members observed that if the facts and circumstances were different, then the outcome could be different. For example, if the insurance acquisition cash flows were not paid unconditionally, then it might be appropriate to allocate a part to future renewals.
What's the impact?
If a part of the insurance acquisition cash flows cannot be allocated to future renewals, then these types of contracts are more likely to be considered onerous on initial recognition. This is because the entire insurance acquisition cash flow would be reflected in the measurement of the initially written contracts.
When these cash flows result in an onerous contract on initial recognition, it will be in a group of contracts that are onerous at initial recognition. Therefore, contracts within the portfolio that are renewed, and that are expected to be profitable, would not be included within the same group.
When these cash flows result in an onerous contract on initial recognition, it will be in a group of contracts that are onerous at initial recognition. Therefore, contracts within the portfolio that are renewed, and that are expected to be profitable, would not be included within the same group.
Some insurers currently use cost allocation techniques to allocate some insurance acquisition cash flows. These techniques may need to be reviewed and potentially adapted to reflect the approach described above. Insurers may also consider adjusting their terms and conditions for commission payments to make them conditional on future renewals.
About this page
This topic page is part of our Insurance – Transition to IFRS 17 series, which covers the discussions of the International Accounting Standards Board and its Transition Resource Group (TRG) regarding the new insurance contracts standard.
You can also find more insight and analysis on the new insurance contracts standard at IFRS – Insurance.
Other topics in this series