Accounting for reinsurance contracts held Accounting for reinsurance contracts held

Accounting for recovery of losses on initial recognition through reinsurance held

International Accounting Standards Board meeting, December 2019 

 

Exposure draft of amendments to IFRS 17

International Accounting Standards Board, June 2019

 

Accounting for reinsurance of onerous insurance contracts

January 2019 International Accounting Standards Board meeting

 

Boundaries of reinsurance contracts with repricing mechanisms

May 2018 TRG meeting

 

Boundaries of reinsurance contracts held

February 2018 TRG meeting

 

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What’s the issue?

The exposure draft (ED) proposed an amendment to the measurement of a group of reinsurance contracts held. That proposed amendment would require an entity to adjust the contractual service margin (CSM) of a group of reinsurance contracts held that provide ‘proportionate coverage’, and as a result recognise income, when the entity recognises a loss on initial recognition of an onerous group of underlying insurance contracts, or on addition of onerous contracts to the group.

The Board received feedback from respondents that, while they supported the objective of this change, they found the definition of ‘proportionate coverage’ too narrow and took the view that the amendment would only apply to a few reinsurance contracts. Some respondents expressed concern that the proposed calculation of income for reinsurance contracts held was too restrictive, whereas others were concerned that it could result in an entity recognising income on a reinsurance contract that is in a net cost position.

What did the Board decide in December 2019?

The Board did not identify a reason to change the definition, but instead decided to extend the scope of the proposed amendment to apply to any type of reinsurance contracts held – i.e. not limited to proportionate reinsurance. This would allow an entity to adjust the CSM of a group of reinsurance contracts held, and as a result recognise income:

• when the entity recognises a loss on initial recognition of an onerous group of underlying insurance contracts; or 
• on addition of onerous contracts to that group.

The Board also decided to amend the proposed calculation of income as a consequence of extending the scope above. The revised proposed calculation would require an entity to determine the amount of a loss recovered from a reinsurance contract held by multiplying:

• the loss recognised on the group of the underlying insurance contracts; and
• the percentage of claims on underlying insurance contracts the entity expects to recover from the reinsurance contract held.

The Board also decided to confirm that the amendment to IFRS 17 would only apply when the reinsurance contract held is recognised before, or at the same time as, the loss is recognised on the underlying insurance contracts. The accounting mismatch that the proposed amendment addresses cannot exist on initial recognition of a loss on an underlying contract, if the reinsurance contract held does not exist at the time that the loss is recognised. This limits the possibility of abuse of the proposed amendment. It will also have implications when accounting for reinsurance contracts held which provide coverage for underlying contracts issued both before and after initial recognition of the reinsurance contract.

What’s the impact and what should preparers be doing now?

Accounting for reinsurance held has been seen as one of the most complex parts of IFRS 17 and one that insurers have paused, knowing that there were some significant amendments under discussion.  

• Those uncertainties have now been resolved – the complexities on contract boundary remain but this amendment is broader than many had dared hope for. It will broaden the circumstances in which an entity can recognise income on reinsurance held when the entity recognises a loss on initial recognition of an onerous group of underlying insurance contracts, or adds onerous contracts to a group of contracts. Insurers will now be able to apply the amendment to any type of reinsurance contracts held, which aims to provide better information about the economic effect of those reinsurance contracts held by reducing accounting mismatches.
• The amendments assume that the loss on insurance contracts is caused solely by claims. In cases where the reinsurer’s share in the direct insurer’s losses differs overall from the share in claims, more or less profit from the reinsurance contract is recognised, depending on the circumstances.

“Insurers will be pleased with the Board’s decision to extend the amendment on reinsurance of onerous contracts to all types of reinsurance. It was clear from the feedback that the original proposal was too narrow – this extension allows better information about the economic effect of reinsurance contracts held.”

Joachim Kölschbach
KPMG’s global IFRS insurance leader

 

“Now we know what’s changing and what’s not, what’s needed is action, especially if, like many insurers I meet, you’ve held back from implementation activities relating to reinsurance held, knowing that IFRS 17’s requirements were likely to change.  

Mary Trussell
KPMG’s Global Lead, Insurance Accounting Change  

 

Some things you might like to consider include:

• updating your plans to reflect these changes;
• assessing and classifying reinsurance contracts if not already performed – generally using the general measurement model for multi-year treaties;
• determining when and how reinsurance contracts held are initially recognised, how their contract boundaries are to be determined and how future underlying business yet to be written should be included;
• assessing whether commissions and reinstatement premiums in reinsurance contracts held are contingent on premiums or claims and recharacterising them accordingly;
• developing appropriate assumptions, level of aggregation and coverage units for reinsurance contracts held, which may differ from underlying business if reinsurance treaties cover multiple portfolios and underlying business from different regions, and building up projections accordingly;
• working through the impact of these changes on systems and processes – modelling gross and reinsurance cash flows separately for assumed business and reinsurance held; 
• developing a methodology to account for intra-group reinsurance (which may vary depending on whether the focus is on solo or consolidated financial statements);
• ensuring disclosures about reinsurance contracts held provide information to users about the nature of the gain and loss components recognised;
• shifting the mindset from reporting results of underlying policies and reinsurance held together to separate recognition and measurement under IFRS 17; and
• analysing the calculation method across all the different types of reinsurance contracts held to assess the impact on profit or loss recognition profiles.

Having worked through the operational aspects of these changes, insurers will want to work through their commercial implications– e.g. can the results of reinsurance contracts held be optimised by amending repricing rights or changing the basis on which risks attach? The basis of reporting reinsurance contracts held is changing due to IFRS 17 and insurers will need to consider how best to communicate this to users and investors. The time for waiting is over – the time for action is now.

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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.

 

What’s the issue?

IFRS 17 currently requires an insurer to recognise losses in profit or loss when it initially recognises onerous insurance contracts. However, no corresponding gains are recognised in profit or loss if the losses are covered by reinsurance contracts recognised at the same time. This can result in an accounting mismatch.

After initial recognition, if a group of insurance contracts that underlies a group of reinsurance contracts held becomes onerous, then the resulting changes in the fulfilment cash flows of the group of reinsurance contracts held is recognised in profit or loss. This avoids accounting mismatches that would arise otherwise.

 

What did the Board decide?

The Board has tentatively decided to propose amendments to IFRS 17 to address the accounting mismatch at initial recognition.

The amendments would require an insurer that recognises losses on underlying insurance contracts assessed as onerous at initial recognition, to also recognise a gain at the same time in profit or loss on reinsurance contracts held, to the extent that the reinsurance contracts cover the losses of the underlying contracts on a proportionate basis.

This gain would apply only to reinsurance contracts entered into before – or at the same time as – the onerous underlying contracts are issued.

The amendments would apply to contracts measured under the premium allocation approach and the general measurement model.

 

What’s the impact?

These amendments aim to provide better information about the economic effect of reinsurance contracts held by reducing an accounting mismatch and, as a result, reduce complexity for users of financial statements.

The discussion at the Board table clarified that the amendment applies to reinsurance contracts covering claims of each underlying contract on a proportionate basis, which will require careful drafting as the standard is updated. This scope differs from what is commonly known as proportional reinsurance, under which both claims and premiums are proportional to those of the underlying insurance contract. Non-proportionate reinsurance contracts are not covered by the amendment given there is no direct linkage between the underlying onerous contracts and the reinsurance contracts held.

As the Board’s discussions on reinsurance contracts held progress, insurers will need to continue developing new systems and processes to account for these contracts under IFRS 17 and may consider impacts on reinsurance programmes. They will have to consider how these activities could be impacted by the proposed amendments for reinsurance accounting.

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What's the issue?

Some reinsurance contracts include terms that allow the reinsurer to reprice the remaining coverage under a contract prospectively, after giving notice to the cedant. Only if the reinsurer provides notice of repricing does the cedant have the right to terminate cover mid-term.

These features raise the question of whether an insurer holding such a contract should include in the contract boundary all expected cash flows on initial recognition, or only the expected future cash flows up until the end of the notice period.

 

What did the TRG discuss?

Previously, TRG members observed that cash flows within the boundary of a reinsurance contract held arise from the substantive rights and obligations of the cedant (see Boundaries of reinsurance contracts held). 

For reinsurance contracts held:

• a substantive right is a right to receive services from the reinsurer; and
• a substantive obligation is an obligation to pay amounts to the reinsurer – i.e. the reinsurer can compel the cedant to pay reinsurance premiums.

Therefore, cash flows are within the contract boundary of a reinsurance contract held if they arise from substantive rights and obligations that exist during the reporting period in which the cedant:

• is compelled to pay amounts to the reinsurer; or 
• has a substantive right to receive services from the reinsurer.  

The TRG members observed that since the cedant does not have control over its ability to terminate the coverage of the reinsurance contract, it remains compelled to pay premiums to the reinsurer. Therefore, the contract boundary for the cedant would include expected cash flows after the notice period.

 

What's the impact?

In some cases, the cedant can be compelled to pay reinsurance premiums for reinsurance contracts held. This obligation might impact the cash flows that will be used to measure the reinsurance contract.

Insurers should carefully analyse the terms and conditions of the reinsurance contracts that they hold and all of the relevant facts and circumstances to determine the contract boundary. This involves looking at the rights and obligations of both parties to the contract.

 

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What's the issue?

IFRS 17’s contract boundary requirements – which determine which cash flows are included in the measurement of contracts – appear to use terminology specific to insurance contracts issued by insurers.

This raises a question over how the requirements should be applied to reinsurance contracts held by insurers.

 

What did the TRG discuss?

TRG members appeared to agree that these requirements should be adapted in an appropriate way for determining the contract boundaries of reinsurance contracts held. Therefore, cash flows are within the boundary of a reinsurance contract held when the entity has a substantive right to receive services from the reinsurer.

This substantive right ends when the reinsurer:

• has the practical ability to reassess the risks transferred to it; and
• can set a price or level of benefits for the contract that fully reflects the reassessed risk.
  

 

What's the impact?

Many reinsurance contracts provide coverage for claims that occur on underlying contracts that are issued during a period of time.

Currently, most insurers holding these reinsurance contracts recognise and measure them to the extent the underlying contracts are written – i.e. without reflecting expectations of future underlying contracts that will be covered by the reinsurance contract held.

This may change under IFRS 17, because the initial and subsequent measurement of the reinsurance contract held can include cash flows from underlying contracts that are expected to be issued in the future if they are considered to be inside the boundaries of the reinsurance contract.

Consequently, the recognition pattern for reinsurance costs could change for many insurers. The processes and systems that are used to measure reinsurance contracts held might also need to change.

Insurers should analyse the terms and conditions of the reinsurance contracts they hold. For example, a term that provides the reinsurer with the ability to stop covering future underlying contracts with a few months’ notice, which is common in practice, might limit the cash flows included within the contract boundary.

 

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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.

 

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