fact patterns of two insurance contracts where the insurance entity assesses the risk
the level of a portfolio of insurance contracts and not at an individual contract level.
The TRG members noted that, in the specified fact patterns, the entity can reset the
premiums of the portfolios to which both of the example contracts belong annually
to reflect the reassessed risk of those portfolios. The entity has the practical ability
to reassess the risks of the specific portfolio of insurance contracts that contains the
contract and, as a result, can set a price that fully reflects the risk of that portfolio
and therefore meets the requirements of (b)(i) above. Additionally, premiums
increase in line with age each year based on the step-rated table – i.e. the contract
does not charge level premiums, consequently the staff analysis assumes that the
requirements in (b)(ii) above are also met. Accordingly, for those two situations
discussed at the TRG meeting, the cash flows resulting from the renewal terms should
not be included within the boundary of the existing insurance contract. However, the
TRG members observed that if, conversely, the fact patterns of the two contracts
described in the submission was changed such that the entity instead has a practical
ability to reassess risks only at a general level (for example, at a portfolio level) and,
as a result, can set a price for the portfolio of insurance contracts that contains the
contract (for example, using a step-rate table for the portfolio) then this would
provide the individual policyholders within the portfolios with a substantive right
and consequently, the cash flows resulting from these renewal terms should be
Insurance contracts (IFRS 17) 4479
included within the boundary of the existing contract. The TRG members also
observed that the two situations described in the IASB staff paper are for specific fact
patterns. In practice, the features of contracts and their repricing might be different
from those examples. The facts and circumstance of each contract should be assessed
to reach an appropriate conclusion applying the requirements of IFRS 17.5
8.1.1
Options to add insurance coverage
In May 2018, the TRG discussed an IASB staff paper that analysed how to determine
the contract boundary of insurance contracts that include an option to add insurance
coverage at a later date. The TRG members observed that:
• an option to add insurance coverage at a future date is a feature of the insurance
contract;
• an entity should focus on substantive rights and obligations arising from that option
to determine whether the cash flows related to the option are within or outside the
contract boundary;
• unless the entity considers that an option to add coverage at a future date is a
separate contract, the option is an insurance component that is not measured
separately from the remainder of the insurance contract;
• if an option to add insurance coverage is not a separate contract and the terms are
guaranteed by the entity, the cash flows arising from the option would be within
the boundary of the contract because the entity cannot reprice the contract to
reflect the reassessed risks when it has guaranteed the price for one of the risks
included in the contract;
• if an option to add insurance coverage is not a separate contract and the terms are
not guaranteed by the entity, the cash flows arising from the option might be either
within or outside of the contract boundary, depending on whether the entity has
the practical ability to set a price that fully reflects the reassessed risks of the entire
contract. The analysis in the IASB staff paper (i) assumed that the option to add
insurance coverage at a future date created substantive rights and obligations; and
(ii) noted that, if an entity does not have the practical ability to reprice the whole
contract when the policyholder exercises the option to add coverage, the cash
flows arising from the premiums after the option exercise date would be within the
contract boundary. The TRG members expressed different views about whether
an option with terms that are not guaranteed by the entity would create substantive
rights and obligations; and
• if the cash flows arising from an option to add coverage at a future date are within
the contract boundary, the measurement of a group of insurance contracts is
required to reflect, on an expected value basis, the entity’s current estimates of
how the policyholders in the group will exercise the option.6
8.1.2
Constraints or limitations relevant in assessing repricing
In May 2018, the TRG discussed an IASB staff paper which addresses what constraint
or limitations, other than those arising from the terms of an insurance contract, would
be relevant in assessing the practical ability of an entity to reassess the risks of the
particular policyholder (or of the portfolio of insurance contracts that contains the
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contract) and set a price or level of benefits that fully reflects those risks. The TRG
members observed that:
• a constraint that equally applies to new contracts and existing contracts would not limit
an entity’s practical ability to reprice existing contracts to reflect their reassessed risks;
• when determining whether it has the practical ability to set a price at a future date
that fully reflects the reassessed risks of a contract or portfolio, an entity shall (i)
consider contractual, legal and regulatory restrictions; and (ii) disregard restrictions
that have no commercial substance;
• IFRS 17 does not limit pricing constraints to contractual, legal and regulatory
constraints. Market competitiveness and commercial considerations are factors that
an entity typically considers when pricing new contracts and repricing existing
contracts. As such, sources of constraints may also include market competiveness and
commercial considerations, but constraints are irrelevant to the contract boundary if
they apply equally to new and existing policyholders in the same market; and
• a constraint that limits an entity’s practical ability to price or reprice contracts
differs from choices that an entity makes (pricing decisions), which may not limit
the entity’s practical ability to reprice existing contracts in the way envisaged by
paragraph B64 of IFRS 17.
The TRG members also observed that an entity should apply judgement to decide
whether commercial considerations are relevant when considering the contract
boundary requirements of IFRS 17.7
8.1.3
Acquisition cash flows paid on an initially written contract
Accounting for the payment of insurance acquisition cash flows on insurance contracts
which are expected to last for many years but where the contract boundary is much shorter
may cause a profit or loss mismatch. For example, an insurer may pay significant up-front
insurance acquisition cash flows in the first year of a contract on the basis that the contract
will last for a number of years but the contract boundary may be only one year (for
example, because of the reasons explained in Example 52.20 above). In February 2018, the
TRG discussed an IA
SB staff paper regarding how to account for insurance acquisition cash
flows unconditionally paid when a contract is initially written (i.e. it is not refundable), the
entity expects renewals outside of the contract boundary to occur and has written new
business with that expectation. The TRG members observed that:
• insurance acquisition cash flows included in the measurement of a group are those
that are directly attributable to the portfolio of insurance contracts to which the
group belongs. Such cash flows include cash flows that are not directly attributable
to individual contracts or groups of insurance contracts within the portfolio;
• insurance acquisition cash flows directly attributable to the portfolio, but not
necessarily directly attributable to individual contracts (or a group), will need to be
allocated in an appropriate manner to the groups within the portfolio. An entity
shall use reasonable and supportable information to do so; and
• acquisition cash flows that are directly attributable to individual contracts (or a group)
should be included only in the measurement of the group to which the individual
contracts belong (or of that group) and not to other groups within the same portfolio.
Insurance contracts (IFRS 17) 4481
Based on the specific fact pattern, the TRG concluded that the acquisition cash flows
could not be allocated to future groups and accordingly the specified commission should
be included in the measurement of the group to which the initially issued contract
belongs (the impact of which was to make the group onerous).8
A distinction can be made when an insurer has paid an intermediary separately for
exclusivity or future services as these costs are not attributable to an insurance contract
and these payments would be outside the scope of IFRS 17 and may be within the scope
of another IFRS.
8.1.4
Contract boundary issues related to reinsurance contracts held
Contract boundary issues related to reinsurance contracts held are discussed at 10.2 below.
8.2
Estimates of expected future cash flows
The first element of the building blocks in the general model discussed at 8 above is an
estimate of future cash flows over the life of each contract.
This assessment should include all the future cash flows within the boundary of each
contract (see 8.1 above). [IFRS 17.33]. However, the fulfilment cash flows should not reflect
the non-performance risk (i.e. own credit) of the entity. [IFRS 17.31]. As discussed at 5
above, an entity is permitted to estimate the future cash flows at a higher level of
aggregation than a group and then allocate the resulting fulfilment cash flows to
individual groups of contracts.
The estimates of future cash flows should: [IFRS 17.33]
• incorporate, in an unbiased way, all reasonable and supportable information
available without undue cost or effort about the amount, timing and uncertainty of
those future cash flows. To do this, an entity should estimate the expected value
(i.e. the probability-weighted mean) of the full range of possible outcomes;
• reflect the perspective of the entity, provided that the estimates of any relevant
market variables are consistent with observable market prices for those variables
(see 8.2.3 below);
• be current – the estimates should reflect conditions existing at the measurement
date, including assumptions at that date about the future (see 8.2.4 below); and
• be explicit – the entity should estimate the adjustment for non-financial risk
separately from the other estimates. The entity also should estimate the cash flows
separately from the adjustment for the time value of money and financial risk,
unless the most appropriate measurement technique combines these estimates
(see 8.4 below).
The objective of estimating future cash flows is to determine the expected value, or
probability-weighted mean, of the full range of possible outcomes, considering all
reasonable and supportable information available at the reporting date without undue
cost or effort. Reasonable and supportable information available at the reporting date
without undue cost or effort includes information about past events and current
conditions, and forecasts of future conditions. Information available from an entity’s
own information systems is considered to be available without undue cost or effort.
[IFRS 17.B37].
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The estimates of future cash flows must be on an expected value basis and therefore
should be unbiased. This means that they should not include any additional estimates
above the probability-weighted mean for ‘uncertainty’, ‘prudence’ or what is
sometimes described as a ‘management loading’. Separately, a risk adjustment for
non-financial risk (see 8.4 below) is determined to reflect the compensation for
bearing the non-financial risk resulting from the uncertain amount and the timing of
the cash flows.
The starting point for an estimate of future cash flows is a range of scenarios that reflects
the full range of possible outcomes. Each scenario specifies the amount and timing of
the cash flows for a particular outcome, and the estimated probability of that outcome.
The cash flows from each scenario are discounted and weighted by the estimated
probability of that outcome to derive an expected present value. Consequently, the
objective is not to develop a most likely outcome, or a more-likely-than-not outcome,
for future cash flows. [IFRS 17.B38].
When considering the full range of possible outcomes, the objective is to incorporate
all reasonable and supportable information available without undue cost or effort in an
unbiased way, rather than to identify every possible scenario. In practice, developing
explicit scenarios is unnecessary if the resulting estimate is consistent with the
measurement objective of considering all reasonable and supportable information
available without undue cost or effort when determining the mean. For example, if an
entity estimates that the probability distribution of outcomes is broadly consistent with
a probability distribution that can be described completely with a small number of
parameters, it will be sufficient to estimate the smaller number of parameters. Similarly,
in some cases, relatively simple modelling may give an answer within an acceptable
range of precision, without the need for many detailed simulations. However, in some
cases, the cash flows may be driven by complex underlying factors and may respond in
a non-linear fashion to changes in economic conditions. This may happen if, for
example, the cash flows reflect a series of interrelated options that are implicit or
explicit. In such cases, more sophisticated stochastic modelling is likely to be necessary
to satisfy the measurement objective. [IFRS 17.B39].
The scenarios developed should include unbiased estimates of the probability of
catastrophic losses under existing contracts. Those scenarios exclude possible claims
under possible future contracts. [IFRS 17.B40]. Therefore, consistent with IFRS 4 (see
Chapter 51 at 7.2.1), catastrophe provisions and equalisation provisions (provisions
generally build up over years following a prescribed regulatory
formula which are
permitted to be released in years when claims experience is high or abnormal) are not
permitted to the extent that they relate to contracts that are not in force at the reporting
date. Although IFRS 17 prohibits the recognition of these provisions as a liability, it does
not prohibit their segregation as a component of equity. Consequently, insurers are free
to designate a proportion of their equity as an equalisation or catastrophe provision.
When a catastrophe or equalisation provision has a tax base but is not recognised in the
IFRS financial statements, then a taxable temporary difference will arise that should be
accounted for under IAS 12 – Income Taxes.
An entity should estimate the probabilities and amounts of future payments under
existing contracts on the basis of information obtained including: [IFRS 17.B41]
Insurance contracts (IFRS 17) 4483
• information about claims already reported by policyholders;
• other information about the known or estimated characteristics of the insurance
contracts;
• historical data about the entity’s own experience, supplemented when necessary
with historical data from other sources. Historical data is adjusted to reflect current
conditions, for example, if:
• the characteristics of the insured population differ (or will differ, for example,
because of adverse selection) from those of the population that has been used
as a basis for the historical data;
• there are indications that historical trends will not continue, that new trends
will emerge or that economic, demographic and other changes may affect the
cash flows that arise from the existing insurance contracts; or
• there have been changes in items such as underwriting procedures and claims
management procedures that may affect the relevance of historical data to
the insurance contracts;
• current price information, if available, for reinsurance contracts and other financial
instruments (if any) covering similar risks, such as catastrophe bonds and weather
derivatives, and recent market prices for transfers of insurance contracts. This
information should be adjusted to reflect the differences between the cash flows that
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 886