IFRS 17 – Measuring insurance cash flows | KPMG | MU
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Measuring insurance cash flows

Measuring insurance cash flows

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Key observation

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When measuring the risk adjustment, the individual entity issuing the contracts considers any benefits of diversification that occur at a level higher than the entity if, and only if, they have been included when determining the compensation it requires for bearing non-financial risk. Insurers may want to use the same risk adjustment at group level and at the individual issuing entity level for the same group of insurance contracts.

Determining the risk adjustment for individual and group reporting purposes

May 2018 TRG meeting

What's the issue?

The objective of the risk adjustment for non-financial risk is to reflect the entity’s perception of the economic burden of the non-financial risk that it bears. Therefore, the risk adjustment for an entity reflects the degree of diversification benefit that it includes when determining the compensation it requires for bearing that risk.

The question that arises is whether an entity or its group can consider diversification benefits beyond the single entity – e.g. those available at the consolidated group level – when determining the risk adjustment.

 

What did the TRG discuss?

TRG members observed that when determining the risk adjustment, the entity that issues the contracts considers benefits of diversification that occur at a level higher than the entity if, and only if, they have been included when determining the compensation that the issuing entity requires for bearing non-financial risk. This compensation could be evidenced by the capital allocation in a group of entities.

For the purposes of group reporting, two methods were discussed.

The staff and some TRG members believed that determining the risk adjustment involves a single decision made by the entity that issues the contracts. Therefore, the risk adjustment at the consolidated group level should be the same as the risk adjustment at the individual issuing-entity level.

Other TRG members believed that the risk adjustment is based on an entity’s perception of the economic burden of the non-financial risk that it bears, and an individual entity within a group may have a different perception of non-financial risks from that of the consolidated group. This could result in different risk adjustments being applied for the same group of insurance contracts depending on the reporting level.

TRG members noted that the method selected by a group of entities should be applied consistently across all groups of insurance contracts.

 

What's the impact?

Insurers may want to use the same risk adjustment at the consolidated group level and at the individual issuing-entity level for the same group of contracts. This may be operationally simpler than determining multiple risk adjustments for measurement purposes – one at the level of the individual entity that issued the contracts and another at the consolidated group level.

IFRS 17 is principles-based and does not prescribe how to determine the risk adjustment. However, insurers applying IFRS 17 may need to look at:

  • how they price business;
  • how capital is allocated and target returns are determined; and
  • whether issuing entities operate within a group-wide risk appetite and risk management framework that reflects the benefits of group-wide risk diversification.

 

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Insurance acquisition cash flows paid when contracts are issued

February 2018 TRG meeting

What's the issue?

Insurers may unconditionally pay insurance acquisition cash flows – e.g. commissions paid to sales agents – for contracts initially written with the expectation that they will be renewed. Sometimes these acquisition cash flows paid exceed the initial premium charged for the contract.

The insurer generally expects to recover these costs from future renewals. However, if those cash flows are outside the contracts’ boundaries, then they cannot be included when measuring the initially written contracts under IFRS 17.

This raises the question of whether future premiums can be allocated to insurance acquisition cash flows that are unconditionally paid when the contract is issued, if they are partly associated with future renewals.

 

What did the TRG discuss?

TRG members appeared to agree that any insurance acquisition cash flows that are:

  • directly attributable to individual contracts; and
  • unconditionally paid on initially written contracts,

should be included in the measurement of the group containing those contracts. Because the costs are paid unconditionally for each initially written contract, they cannot be allocated to future groups recognised on renewal or other groups that do not contain these contracts.

Various TRG members believed that the accounting outcome would not reflect the economic substance of the contract because it would not reflect the insurer’s long-term expectations.

The TRG members observed that if the facts and circumstances were different, then the outcome could be different. For example, if the insurance acquisition cash flows were not paid unconditionally, then it might be appropriate to allocate a part to future renewals.

 

What's the impact?

If a part of the insurance acquisition cash flows cannot be allocated to future renewals, then these types of contracts are more likely to be considered onerous on initial recognition. This is because the entire insurance acquisition cash flow would be reflected in the measurement of the initially written contracts.

When these cash flows result in an onerous contract on initial recognition, it will be in a group of contracts that are onerous at initial recognition. Therefore, contracts within the portfolio that are renewed, and that are expected to be profitable, would not be included within the same group.

Some insurers currently use cost allocation techniques to allocate some insurance acquisition cash flows. These techniques may need to be reviewed and potentially adapted to reflect the approach described above. Insurers may also consider adjusting their terms and conditions for commission payments to make them conditional on future renewals.

 

 

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About this page

This topic page is part of our Insurance – Transition to IFRS 17 series, which covers the discussions of the IASB's Transition Resource Group (TRG) for Insurance Contracts.

You can also find more insight and analysis on the new insurance contracts standard at kpmg.com/ifrs17.