added to
transfer of
group
services
Contractual
Contractual
service margin
service margin
– start of
– end of
reporting
reporting
period
period
The changes in future cash flows that relate to future events which adjust the
contractual service margin for a group of insurance contracts without direct
participation features are as follows: [IFRS 17.B96]
• experience adjustments arising from premiums received in the period that relate
to future service, and related cash flows such as insurance acquisition cash flows
and premium-based taxes, measured at the discount rates applying at the date of
initial recognition;
• changes in estimates of the present value of the future cash flows in the liability for
remaining coverage (except those changes described below) measured at the
discount rates applying at the date of initial recognition;
• differences between any investment component expected to become payable in the
period and the actual investment component that becomes payable in the period,
measured at the discount rates applying at the date of initial recognition; and
• changes in the risk adjustment for non-financial risk that relate to future service.
In February 2018, the IASB staff responded to a submission made to the TRG asking
whether the adjustment of the contractual service margin for a difference in the
investment component as a result of the acceleration or delay of repayment was
appropriate since the contractual service margin is adjusted for changes solely in timing
of payments which appears to conflict with the principle underlying insurance revenue
recognition by referring to the Board’s reasons for this treatment in the Basis for
Conclusions.13 It is stated in the Basis for Conclusions that the Board did not regard as
useful information, for example, the recognition of a gain for a delay in repaying an
investment component accompanied by a loss that adjusts the contractual service margin
for the expected later repayment. Acceleration or delay in repayments of investment
components only gives rise to a gain or loss for the entity to the extent that the amount of
the repayment is affected by its timing. As IFRS 17 does not require an entity to determine
Insurance contracts (IFRS 17) 4505
the amount of an investment component until a claim is incurred, accordingly, when a
claim is incurred, IFRS 17 requires an entity to determine how much of that claim is an
investment component, and whether it was expected to become payable in that period.
IFRS 17 requires any unexpected repayment of an investment component to adjust the
contractual service margin. The contractual service margin will also be adjusted for
changes in future estimates of cash flows which will include (but not separately identify)
the reduction in future repayments of investment components. This achieves the desired
result of the net effect on the contractual service margin being the effect of the change in
timing of the repayment of the investment component. [IFRS 17.BC235].
The contractual service margin for contracts without direct participation features
should not be adjusted for the following changes in fulfilment cash flows because they
do not relate to future service: [IFRS 17.B97]
• the effect of the time value of money and changes in the time value of money, and
the effect of financial risk and changes in financial risk (being the effect, if any, on
estimated future cash flows and the effect of a change in discount rate);
• changes in estimates of fulfilment cash flows in the liability for incurred claims; and
• experience adjustments, except those described above that relate to future service.
IFRS 17 notes that some changes in the contractual service margin offset changes in the
fulfilment cash flows for the liability for remaining coverage, resulting in no change in
the total carrying amount of the liability for remaining coverage. To the extent that
changes in the contractual service margin do not offset changes in the fulfilment cash
flows for the liability for remaining coverage, an entity should recognise income and
expenses for the changes, applying the requirements at 8.6.1 above. [IFRS 17.46].
The terms of some insurance contracts without direct participation features give an
entity discretion over the cash flows to be paid to policyholders. A change in the
discretionary cash flows is regarded as relating to future service, and accordingly adjusts
the contractual service margin. To determine how to identify a change in discretionary
cash flows, an entity should specify at inception of the contract the basis on which it
expects to determine its commitment under the contract; for example, based on a fixed
interest rate, or on returns that vary based on specified asset returns. [IFRS 17.B98].
An entity should use that specification to distinguish between the effect of changes in
assumptions that relate to financial risk on that commitment (which do not adjust the
contractual service margin) and the effect of discretionary changes to that commitment
(which adjust the contractual service margin). [IFRS 17.B99].
If an entity cannot specify at inception of the contract what it regards as its commitment
under the contract and what it regards as discretionary, it should regard its commitment
to be the return implicit in the estimate of the fulfilment cash flows at inception of the
contract, updated to reflect current assumptions that relate to financial risk. [IFRS 17.B100].
8.6.3
The liability for incurred claims
The liability for incurred claims is an entity’s obligation to investigate and pay valid
claims for insured events that have already occurred, including events that have
occurred but for which claims have not been reported, and other incurred insurance
expenses. [IFRS 17 Appendix A].
4506 Chapter 52
At initial recognition of a group of contracts, the liability for incurred claims is
usually nil as no insured events have occurred. Subsequently, at each reporting date,
the liability for incurred claims is measured using the fulfilment cash flow
requirements discussed at 8.1 above. That is, it comprises the present value of the
expected cash flows required to settle the obligation together with an adjustment
for non-financial risk.
The liability for incurred claims under the general model, including claims arising from
contracts with direct participation features, is discounted at a current rate (i.e. the rate
applying as at the reporting date).
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 assumptions 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 (see 8.3 above).
There is no direct relationship between the liability for incurred claims and the liability
for remaining coverage. That is, the creation of a liability for incurred claims (or a
reduction in the value of incurred claims) does not necessarily result in an equal and
opposite reduction to the liability for remaining coverage. There is no contractual
service margin attributable to the liability for incurred claims as the contractual service
margin relates to future service and incurred claims relate to past service.
Consequently, the establishment of a liability for incurred claims should give rise to the
following accounting entry:
DR CR
Insurance service expense – profit or loss
X
Liability for incurred claims
X
Subsequent to initial recognition, an entity should recognise income and expenses for
the following changes in the carrying amount of the liability for incurred claims:
[IFRS 17.42]
• insurance service expenses – for the increase in the liability because of claims
and expenses incurred in the period, excluding any investment components
(see 15.2 below);
• insurance service expenses – for any subsequent changes in fulfilment cash flows
relating to incurred claims and incurred expenses (see 15.2 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).
IFRS 17 does not distinguish between or require separate disclosure of the components
of the liability for incurred claims which represent claims notified to the insurer
Insurance contracts (IFRS 17) 4507
(sometimes described as ‘outstanding claims’) and claims incurred but not reported
(sometimes described as ‘IBNR claims’).
Disclosure of the liability for incurred claims is required showing the development of
actual claims compared with previous estimates of the liability for incurred claims,
except for those claims for which uncertainty about the amount and timing of payments
is typically resolved within one year (see 16.3.3 below).
8.7
Allocation of the contractual service margin to profit or loss
Determining how to release the contractual service to profit or loss is a key aspect of
IFRS 17 and one of the key challenges implementing the Standard. Guidance in this area
is still developing as at the date of writing this chapter.
The basic principle is that an amount of the contractual service margin for a group of
insurance contracts is recognised in profit or loss in each period to reflect the services
provided under the group of insurance contracts in that period.
The amount recognised in profit or loss is determined by: [IFRS 17.B119]
• identifying the coverage units in the group. The number of coverage units in a
group is the quantity of coverage provided by the contracts in the group,
determined by considering for each contract the quantity of the benefits provided
under a contract and its expected coverage duration;
• allocating the contractual service margin at the end of the period (before
recognising any amounts in profit or loss to reflect the services provided in the
period) equally to each coverage unit provided in the current period and expected
to be provided in the future; and
• recognising in profit or loss the amount allocated to coverage units provided in
the period.
In February 2018, responding to a submission to the TRG as to how to allocate
contractual service margin to coverage units, the IASB staff observed that the
contractual service margin is allocated equally to each coverage unit provided in the
current period and expected to be provided in the future. Therefore, the allocation is
performed at the end of the period, identifying coverage units that were actually
provided in the current period and coverage units that are expected at this date to be
provided in the future.14
It is observed in the Basis for Conclusions that the Board views the contractual
service margin as depicting the unearned profit for coverage and other services
provided over the coverage period. Insurance coverage is the defining service
provided by insurance contracts and an entity provides this service over the whole
of the coverage period, and not just when it incurs a claim. Consequently, the
contractual service margin should be recognised over the coverage period in a
pattern that reflects the provision of coverage as required by the contract. To
achieve this, the contractual service margin for a group of insurance contracts
remaining (before any allocation) at the end of the reporting period is allocated over
the coverage provided in the current period and expected remaining future
coverage, on the basis of coverage units, reflecting the expected duration and
4508 Chapter 52
quantity of benefits provided by contracts in the group. The Board considered
whether: [IFRS 17.BC279]
• the contractual service margin should be allocated based on the pattern of
expected cash flows or on the change in the risk adjustment for non-financial risk
caused by the release of risk. However, the Board decided the pattern of expected
cash flows and the release of the risk adjustment for non-financial risk are not
relevant factors in determining the satisfaction of the performance obligation of
the entity. They are already included in the measurement of the fulfilment cash
flows and do not need to be considered in the allocation of the contractual service
margin. Hence, the Board concluded that coverage units better reflect the
provision of insurance coverage; and
• the contractual service margin should be allocated before any adjustments made
because of changes in fulfilment cash flows that relate to future service. However,
the Board concluded that allocating the amount of the contractual service margin
adjusted for the most up-to-date assumptions provides the most relevant
information about the profit earned from service provided in the period and the
profit to be earned in the future from future service.
The Board also considered whether the allocation of the contractual service margin
based on coverage units would result in profit being recognised too early for insurance
contracts with fees determined based on the returns on underlying items. For such
contracts, IFRS 17 requires the contractual service margin to be determined based on
the total expected fee over the duration of the contracts, including expectations of an
increase in the fee because of an increase in underlying items arising from investment
returns and additional policyholder contributions over time. The Board rejected the
view that the allocation based on coverage units results in premature profit recognition.
The Board noted that the investment component of such contracts is accounted for as
part of the insurance contract only when the cash flows from the investment component
and from insurance and other services are highly interrelated and hence cannot be
accounted for as distinct components. In such circumstances, the entity provides
>
multiple services in return for an expected fee based on the expected duration of
contracts, and the Board concluded the entity should recognise that fee over the
coverage period as the insurance services are provided, not when the returns on the
underlying items occur. [IFRS 17.BC280].
IFRS 17 requires the contractual service margin remaining at the end of the reporting
period to be allocated equally to the coverage units provided in the period and the
expected remaining coverage units. IFRS 17 does not specify whether an entity should
consider the time value of money in determining that equal allocation and consequently
does not specify whether that equal allocation should reflect the timing of the expected
provision of the coverage units. The Board concluded that should be a matter of
judgement by an entity. [IFRS 17.BC282].
Consistent with the requirements in IFRS 15, the settlement of a liability is not
considered to be a service provided by the entity. Thus, the recognition period for the
contractual service margin is the coverage period over which the entity provides the
coverage promised in the insurance contract, rather than the period over which the
liability is expected to be settled. The margin the entity recognises for bearing risk is
Insurance contracts (IFRS 17) 4509
recognised in profit or loss as the entity is released from risk in both the coverage period
and the settlement period. For contracts with a coverage period of one year, this means
that the contractual service margin will be released over that one year period (possibly,
a single reporting period). [IFRS 17.BC283]. For longer-term contracts, with a coverage
period lasting many years, an entity will have to use judgement in order to determine an
appropriate allocation of the contractual service margin to each reporting period.
8.7.1
Determining the quantity of benefits for identifying coverage units
The question of how to determine the quantity of benefits for coverage units was
discussed by the TRG in both February 2018 and May 2018. In May 2018, the TRG
analysed an IASB staff paper that contained the IASB staff’s views on sixteen examples
of different types of insurance contracts. The TRG members observed that:
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