should reflect all non-financial risks associated with the insurance contracts. It should
not reflect the risks that do not arise from the insurance contracts, such as general
operational risk. [IFRS 17.B89].
The risk adjustment for non-financial risk should be included in the measurement in an
explicit way. The risk adjustment for non-financial risk is conceptually separate from
the estimates of future cash flows and the discount rates that adjust those cash flows.
The entity should not double-count the risk adjustment for non-financial risk by, for
example, also including the risk adjustment for non-financial risk implicitly when
determining the estimates of future cash flows or the discount rates. The yield curve (or
range of yield curves) used to discount cash flows that do not vary based on the returns
on underlying items which are required to be disclosed (see 16.1.5 below) should not
include any implicit adjustments for non-financial risk. [IFRS 17.B90].
IFRS 17 does not specify the estimation technique(s) used to determine the risk
adjustment for non-financial risk. This is because the Board decided that a principle-
based approach, rather than identifying specific techniques, would be consistent with
the Board’s approach on how to determine a similar risk adjustment for non-financial
risk in IFRS 13. Furthermore, the Board concluded that limiting the number of risk-
adjustment techniques would conflict with the Board’s desire to set principle-based
IFRSs and, given that the objective of the risk adjustment is to reflect an entity-specific
perception of non-financial risk, specifying a level of aggregation that was inconsistent
with the entity’s view would also conflict with that requirement. [IFRS 17.BC213].
Therefore, the risk adjustment under IFRS 17 should be determined based on the
principle of the compensation that an entity requires for bearing the uncertainty arising
from non-financial risk inherent in the cash flows arising from the fulfilment of the
group of insurance contracts. According to this principle, the risk adjustment for non-
financial risk reflects any diversification benefit the entity considers when determining
the amount of compensation it requires for bearing that uncertainty. [IFRS 17.BC213].
Different entities may determine different risk adjustments for similar groups of
insurance contracts because the risk adjustment for non-financial risk is an entity
specific perception, rather than a market participant’s perception, based on the
compensation that a particular entity requires for bearing the uncertainty about the
amount and timing of the cash flows that arise from the non-financial risks. Accordingly,
to allow users of financial statements to understand how entity-specific assessments of
risk aversion might differ from entity to entity, disclosure is required of the confidence
level used to determine the risk adjustment for non-financial risk or, if a technique other
than confidence level is used, the technique used and the confidence level
corresponding to the technique (see 16.2 below).
4500 Chapter 52
IFRS 17 states that risk adjustment for non-financial risk should have the following
characteristics: [IFRS 17.B91]
• risks with low frequency and high severity will result in higher risk adjustments for
non-financial risk than risks with high frequency and low severity;
• for similar risks, contracts with a longer duration will result in higher risk
adjustments for non-financial risk than contracts with a shorter duration;
• risks with a wider probability distribution will result in higher risk adjustments for
non-financial risk than risks with a narrower distribution;
• the less that is known about the current estimate and its trend, the higher the risk
adjustment will be for non-financial risk; and
• to the extent that emerging experience reduces uncertainty about the amount and
timing of cash flows, risk adjustments for non-financial risk will decrease and vice versa.
An entity should apply judgement when determining an appropriate estimation
technique for the risk adjustment for non-financial risk. When applying that judgement,
an entity should also consider whether the technique provides concise and informative
disclosure so that users of financial statements can benchmark the entity’s performance
against the performance of other entities. [IFRS 17.B92].
It is likely that some entities will want to apply a cost of capital approach technique to
estimate the risk adjustment for non-financial risk because this will be the basis of local
regulatory capital requirements. It is observed in the Basis for Conclusions that although
the usefulness of a confidence level technique diminishes when the probability
distribution is not statistically normal, as is often the case for insurance contracts, that
the cost of capital approach would be more complicated to calculate than a confidence
level disclosure. However, the Board expects that many entities will have the
information necessary to apply the cost of capital technique. [IFRS 17.BC217]. This implies
that the Board is anticipating some, or perhaps many, entities will use a cost of capital
technique to measure the risk adjustment for non-financial risk.
IFRS 17 does not specify the level at which to determine the risk adjustment for non-
financial risk. Therefore, the question arises as to whether, in the individual financial
statements of a subsidiary, the risk adjustment for non-financial risk should reflect the
degree of risk diversification available to the entity or to the consolidated group as a whole
and whether, in the consolidated financial statements of a group of entities, the risk
adjustment for non-financial risk issued by entities in the group should reflect the degree
of risk diversification available only to the consolidated group as a whole. This issue was
discussed by the TRG in May 2018 and the results of the discussion were as follows:
• In respect of individual financial statements, the degree of risk diversification that
occurs at a level higher than the issuing entity level is required to be considered if,
and only if, it is considered when determining the compensation the issuing entity
would require for bearing non-financial risk related to the insurance contracts it
issues. Equally, risk diversification that occurs at a level higher than the issuing
entity level must not be considered when determining the risk adjustment for non-
financial risk if it is not considered when determining the compensation the issuing
entity would require for bearing non-financial risk related to the insurance
contracts it issues.
Insurance contracts (IFRS 17) 4501
• In respect of consolidated financial statements, the IASB staff opinion is that the
risk adjustment for non-financial risk is the same as the risk adjustment for non-
financial risk at the individual entity level because determining the compensation
that the entity would require for bearing nonfinancial risk related to insurance
contracts issued by the entity is a single decision that is made by the entity that is
party to the contract (i.e. the issuer of the insurance contract). However, differing
views were expressed by TRG members. Some TRG members agreed with the
measurement of the risk adjustment for non-financial risk for a group of insurance
contracts at different reporting levels if the issuing entity would require different
compensation for bearing non-financial risk than the consolidated group would
require. The TRG members also observed that in some cases the compensation an
entity requires for bearing non-financial risk could be evidenced by capital
allocation in a group of entities. It is not clear whether the IASB staff will bring
back this topic to the TRG for further discussion.12
8.5
The contractual service margin
The fourth element of the building blocks in the general model discussed at 8 above is
the contractual service margin. The contractual service margin is a new concept to IFRS,
introduced in IFRS 17 to identify the expected profitability of a group of contracts and
recognise this profitability over time in an explicit manner, based on the pattern of
services provided under the contract.
The contractual service margin is a component of the asset or liability for the group of
insurance contracts that represents the unearned profit the entity will recognise as it
provides services in the future. Hence, the contractual service margin would usually be
calculated at the level of a group of insurance contracts rather than at an individual
insurance contract level.
An entity should measure the contractual service margin on initial recognition of a group
of insurance contracts at an amount that, unless the group of contracts is onerous
(see 8.8 below), results in no income or expenses arising from: [IFRS 17.38]
• the initial recognition of an amount for the fulfilment cash flows (see 8.2 above);
• the derecognition at the date of initial recognition of any asset or liability
recognised for insurance acquisition cash flows (see 6 above); and
• any cash flows arising from the contracts in the group at that date.
Therefore, the contractual service margin on initial recognition, assuming a contract is
not onerous, is no more than the balancing number needed to eliminate any day 1
differences and thereby avoiding a day 1 profit being recognised. The contractual
service margin cannot depict unearned losses. Instead, IFRS 17 requires an entity to
recognise a loss in profit or loss for any excess of the expected present value of the
future cash flows above the expected future value of the premium inflows adjusted for
risk – see 8.7 below.
The approach above on initial recognition applies to contracts with and without
participation features including investment contracts with discretionary features.
4502 Chapter 52
For groups of reinsurance contracts held, the calculation of the contractual service
margin at initial recognition is modified to take into account the fact that such groups
are usually assets rather than liabilities and that a margin payable to the reinsurer rather
than making profits is an implicit part of the premium – see 10 below.
A contractual margin is not specifically identified for contracts subject to the premium
allocation approach although the same principle of profit recognition (i.e. no day 1
profits) applies – see 9 below.
For insurance contracts acquired in a business combination or transfer the contractual
service margin at initial recognition is calculated in the same way except that initial
recognition is the date of the business combination or transfer – see 13 below.
8.6 Subsequent
measurement
The carrying amount of a group of insurance contracts at the end of each reporting
period should be the sum of: [IFRS 17.40]
• the liability for remaining coverage comprising:
• the fulfilment cash flows related to future service allocated to the group at
that date, measured applying the requirements discussed at 8.2 above –
see 8.6.1 below;
• the contractual service margin of the group at that date, measured applying
the requirements discussed at 8.6.2 below; and
• the liability for incurred claims, comprising the fulfilment cash flows related to past
service allocated to the group at that date, measured applying the requirements
discussed at 8.2 above – see 8.6.3 below.
Hence, after initial recognition, the fulfilment cash flows comprise two components:
• those relating to future service (the liability for remaining coverage); and
• those relating to past service (the liability for incurred claims).
8.6.1
The liability for remaining coverage
The liability for remaining coverage is an entity’s obligation to investigate and pay valid
claims for insured events that have not yet occurred (i.e. the obligation that relates to
the unexpired portion of the coverage period). [IFRS 17 Appendix A].
At initial recognition the liability for remaining coverage should include all future
cash inflows and outflows under an insurance contract. Subsequently, at each
reporting date, the liability for remaining coverage, excluding the contractual service
margin, is re-measured using the fulfilment cash flow requirements discussed at 8.2
above. That is, it comprises the present value of the best estimate of the cash flows
required to settle the obligation together with an adjustment for non-financial risk.
The fulfilment cash flows for the liability for remaining coverage for contracts
without direct participation features are discounted at the date of initial recognition
of the group (under both the general model and the premium allocation approach
where applicable) – see 8.3 above.
Usually, the fulfilment cash flows should reduce over the contract period as the
number of future insured events that have not occurred decline. When future insured
Insurance contracts (IFRS 17) 4503
events can no longer occur then the fulfilment cash flows of the liability for remaining
coverage should be nil.
An entity should recognise income and expenses for the following changes in the
carrying amount of the liability for remaining coverage: [IFRS 17.41]
• insurance revenue – for the reduction in the liability for remaining coverage
because of services provided in the period, measured (see 15.1.1 below);
• insurance service expenses – for losses on groups of onerous contracts, and
reversals of such losses (see 8.8 below); and
• insurance finance income or expenses – for the effect of the time value of money
and the effect of financial risk (see 15.3 below).
When finance income or expense is disaggregated (see 15.3.1 below), the amount of
finance income and expense included in profit or loss is:
• for groups of contracts for which changes in assumption that relate to financial risk are
not substantial – the discount rates at initial recognition of the group of contracts; and
• for groups of contracts for which changes in assumptions that relate to financial
risk have a substantial effect on the amounts paid to policyholders:
• discount rates that allocate the remaining revised expected finance income or
expense over the remaining duration of the group of contracts at a constant
rate; or
• for co
ntracts that use a crediting rate to determine amounts due to
policyholders, using a rate that is based on the amounts credited in the period
and expected to be credited in future periods (see 8.3 above).
8.6.2
Subsequent measurement of the contractual service margin (for
insurance contracts without direct participation features)
The contractual service margin at the end of the reporting period represents the profit
in the group of insurance contracts that has not yet been recognised in profit or loss
because it relates to the future service to be provided under the contracts in the group.
[IFRS 17.43].
At the end of each reporting period, the carrying amount of the contractual service
margin of a group of insurance contracts without direct participation features comprises
the carrying amount at the start of the reporting period adjusted for: [IFRS 17.44]
• the effect of any new contracts added to the group (see 6 above);
• interest accreted on the carrying amount of the contractual service margin during the
reporting period, measured at the discount rates at initial recognition (see 8.3 above);
• the changes in fulfilment cash flows relating to future service (see below), except
to the extent that:
• such increases in the fulfilment cash flows exceed the carrying amount of the
contractual service margin, giving rise to a loss (see 8.8 below); or
• such decreases in the fulfilment cash flows are allocated to the loss
component of the liability for remaining coverage (see 8.8 below);
4504 Chapter 52
• the effect of any currency exchange differences (see 7.3 above) on the contractual
service margin; and
• the amount recognised as insurance revenue because of the transfer of services in
the period, determined by the allocation of the contractual service margin
remaining at the end of the reporting period (before any allocation) over the
current and remaining coverage period (see 8.7 below)
Accretion of
Change in
interest
fulfilment
cash flows
Currency
Revenue
related to
exchange
New contracts
reflecting
future services
differences
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 890