IFRS 17 – Insurance Contracts
Overview and scope
This standard replaces IFRS 4, which was intended as an interim solution and permitted a variety of accounting practices. IFRS 17 establishes a single model for the recognition, measurement presentation and disclosure of insurance contracts, rather than adopting different models according to product type. This model is intended to reflect the fact that key attributes of insurance contracts are that they combine features of both a financial instrument and a service contract, and can generate cash flows which vary substantially over a long period. The entities within the scope of IFRS 17 are those that issue insurance contracts, issue or hold reinsurance contracts, or issue investment contracts with a discretionary participation feature, as long as insurance contracts are also issued.
The general model set out in the standard uses current assumptions when estimating the amount, timing and uncertainty of future cash flows, taking into account market interest rates and the impact of policyholder options and guarantees. There is an explicit measure of the cost of risk (the uncertainty), whilst estimates make as much use as possible of observable information. Deferred acquisition costs are taken into account in the initial measurement of the insurance contract, rather than being accounted for and released separately.
A simplified version of the general model called the Premium Allocation Approach (PAA) can be adopted, where it can reasonably be expected that this approximates the general model, or the coverage period of each contract in the group is one year or less. Under PAA, the initial liability for remaining coverage comprises the premiums received at initial recognition, less any insurance acquisition cash flows. In determining the subsequent amount of the liability, the initial amount is adjusted for premiums subsequently received (less insurance acquisition cash flows), plus amortisation of acquisition cash flows, less the amount for coverage provided in the period (which is recognised as insurance revenue) and any investment component paid or transferred to the liability for incurred claims.
A contract may have components which are within the scope of another standard. IFRS 17 has criteria to establish when these components should be separated out, including that they should be distinct from the insurance element. Components could include an embedded derivative or investment component (which are subject to IFRS 9), or a sale of a non-insurance good or service (which are subject to IFRS 15).
Recognition
Insurance contracts will be aggregated into portfolios, which comprise policies that are subject to similar risks (for example, due to the type of cover) and are managed together. Each portfolio should be divided into groups, which include at a minimum, those onerous at initial recognition, those that at initial recognition have no significant chance of becoming onerous, and other contracts. A group cannot consist of contracts issued over a year apart, and once the groups have initially been established, they are not subsequently reassessed. There is a similar grouping process for reinsurance contracts, based on whether the purchaser has a net gain on recognition (as opposed to the criterion of whether a contract may be onerous).
Measurement
A group of contracts is measured as the sum of its fulfilment cash flows (’FCF’) and the contractual service margin (‘CSM’). FCF consists of estimated future net cash flows, adjusted for the time value of money, the financial risks of future cash flows and non-financial risk (reflecting the compensation needed for bearing the associated uncertainty). For reinsurance contracts, the estimates also include the risk of non-performance by the reinsurer. The estimated adjustment for non-financial risk represents the transfer of risk from the holder of the reinsurance contract to the reinsurer.
CSM is the profit which is a component of the carrying amount of the asset or liability for a group of insurance contracts. This profit will be recognised in the Statement of Comprehensive Income as services are provided in the future. The total CSM cannot be negative, as this indicates that the group is onerous.For reinsurance contracts, the CSM is determined similarly on initial recognition, but for reinsurance, the CSM represents the net gain or loss on the purchase of the reinsurance. This gain or loss is deferred, unless a net loss relates to events that occurred before purchasing the reinsurance contract, in which event it is expensed immediately.
A contract is onerous at initial recognition if the total of the FCF, any previously-recognised acquisition cash flows and any cash flows arising from the contract at that date is a net outflow. The liability for the group of contracts will be the FCF and the CSM will be zero. To achieve this position, a loss is recognised in profit or loss for the net outflow, which takes account of the FCF.
At the end of subsequent reporting periods, the entity determines the liability for remaining coverage (comprising FCF relating to future services, and CSM yet to be earned) - ‘A’, and for incurred claims (comprising the FCF relating to past service, and taking into account claims incurred but not yet reported) - ‘B’. The changes in A and B above, recognised separately, determine the insurance revenue and expenses.
Insurance finance income or expense arises from both A and B and represents the change in the carrying amount of the group of contracts that arises from the time value of money (and changes therein) and the effect of changes in assumptions relating to financial risk. Such changes would, however, be dealt with through an adjustment to the CSM where a group of contracts has direct participating features.
Reinsurance contracts are subsequently accounted for similarly to direct insurance contracts under the general model. However, changes in the reinsurer’s risk of non-performance are reflected in profit or loss, rather than via an adjustment to the CSM.
Presentation
In the statement of financial position, the balances of insurance and reinsurance contracts are presented separately. Within these two groups, the contracts that are assets and those which are liabilities are presented separately.
The two key headings in the statement of financial performance are the insurance service result being insurance revenue, less insurance service expense, and the insurance finance income or expense, which are described above. The results arising from insurance contracts are presented separately to those arising from reinsurance contracts, and any investment element is excluded.
An entity can choose whether to include all of insurance finance income or expense in profit or loss, or to disaggregate the total between profit or loss and OCI. Under the general model, any insurance finance income or expense presented in OCI will be released to profit or loss over the duration of the contracts, so that profit or loss reflects a systematic allocation of the total. When the group of contracts is de-recognised, any amounts remaining in OCI are reclassified to profit or loss.
Disclosure
IFRS 17 requires extensive disclosure of information concerning the amounts recognised, judgements made and the insurance and financial risks (and how these are managed) arising from insurance contracts, and the impact of regulatory requirements. Detailed guidance is provided on how to determine the level of detail and emphasis appropriate to meet this overall disclosure objective. The disclosure guidance covers the detailed content of information to be provided in reconciliations and a tabular format, the analysis of insurance revenue, insurance finance income or expenses and the impact on the statement of financial position and future profit or loss. There are specific disclosures for contracts with direct participation features, such as the fair value of the underlying items.
Effective date and transition
The standard is effective for reporting periods beginning on or after 1 January 2021, with earlier adoption permitted so long as IFRS 9 and IFRS 15 are also adopted. Application of IFRS 17 is retrospective, or where this is impracticable, a modified retrospective or fair value approach may be adopted.