IFRS 17 – Defining contract boundaries | KPMG | MU
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Contract boundary

Defining contract boundaries

Defining contract boundaries

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Key observation

Map and compass

When assessing which cash flows are within the contract’s boundary, an entity considers its ability to reassess the risks of the contract. The reassessed risks are policyholder risks.

Considering constraints when assessing the contract boundary

May 2018 TRG meeting

What's the issue?

When an insurer has a substantive obligation to provide services to its policyholders, the cash flows that arise from the substantive rights and obligations are within the contract boundary and are included within the measurement of the group of contracts to which they relate.

A substantive obligation to provide services ends when the insurer has the practical ability to reassess the risks of the particular policyholder (or of the portfolio of insurance contracts) and, as a result, can set a price or a level of benefits that fully reflects the reassessed risks.

A question that arises is what constraints may limit an insurer’s practical ability to reprice a contract.

 

What did the TRG discuss?

Under IFRS 17, an insurer’s practical ability is not constrained if it can:

  • set the same price it would for a new contract with the same characteristics as the existing contracts issued on that date; or
  • amend the benefits to be consistent with the price it will charge.

TRG members agreed that a constraint that applies equally to new contracts and existing contracts would not limit an insurer’s practical ability to reprice existing contracts to reflect their reassessed risks.

Given that IFRS 17 does not specify the sources of potential constraints on these reassessments, it does not limit these constraints to those of a contractual, legal or regulatory nature.

 

 

What's the impact?

It may be more readily apparent when regulatory or legal requirements impose constraints on an insurer’s practical ability to reprice its contracts than market and other constraints.

When making this assessment, it will be important to consider whether market or other constraints apply equally to all insurers operating in the same jurisdiction for new and renewed contracts. If all insurers can reprice ‘as good as new’ – i.e. how they would set prices on new contracts – then there is effectively no constraint on their practical ability to reprice for the purpose of assessing the contract boundary.

 

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Contract boundaries for contracts with the option to add coverage

May 2018 TRG meeting

What's the issue?

Insurers may issue contracts that give the policyholders the option to add insurance coverage at a future date. If a policyholder exercises that option, then the insurer is obliged to provide additional coverage.

The question that arises is whether the expected cash flows resulting from the future exercise of the option are included within the contract boundary, and therefore within the measurement of the group of contracts that it relates to.

 

 

What did the TRG discuss?

TRG members observed that before determining the contract boundary at the inception of an insurance contract, an insurer should consider whether:

  • the contract needs to be separated into multiple insurance components to reflect the insurer’s rights and obligations under the contract (see Separating insurance components of a single contract); and
  • the obligation to provide additional coverage at a future date is substantive.

TRG members appeared to agree that as long as the option:

  • is not considered to be a separate contract; and
  • reflects a substantive obligation at inception,

the insurer should assess the contract boundary for the entire contract, including the option.

TRG members also observed that the cash flows related to such an option would be:

  • outside the contract boundary if the insurer has the practical ability to reprice the whole contract when the policyholder exercises the option; and
  • inside the contract boundary if the insurer has the practical ability to reprice only the additional future coverage when the policyholder exercises the option.

TRG members expressed different views about whether an option would create substantive rights and obligations if the insurer sets the premiums for the additional coverage only when the policyholder exercises the option.

In addition, it was noted that the insurer’s intention to reassess risk or reprice is irrelevant to the contract boundary assessment – i.e. the contract boundary ends when the insurer has the practical ability to reprice the whole contract, even if it is unlikely to actually exercise its right to reprice.

 

 

What's the impact?

To determine whether cash flows are inside the contract boundary of an existing insurance contract, insurers need to evaluate whether these contracts need to be separated into multiple insurance components. If not, insurers need to consider whether providing the policyholder with an option to acquire future additional coverage gives rise to substantive rights and obligations.

Currently, when measuring insurance contracts that give the policyholders the option to add insurance coverage at a future date, it is common to consider the premium for each component (i.e. the base contract and the option) separately. Under IFRS 17, if the rights and obligations related to the option are substantive and the contract is not separated into multiple components, then the contract boundary is established for the contract as a whole. Insurers may need to develop new estimates for some of the cash flows in order to measure these contracts under IFRS 17.

 

 

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Boundaries of contracts with annual renewable terms

February 2018 TRG meeting

What's the issue?

Step-rated yearly renewable term (YRT) contracts and unit-linked contracts with additional insurance benefits contain several features that could impact the accounting under IFRS 17. Contracts, like these, contain all or some of the following.

 

Contract feature Further details
Annual renewal guarantee The contract is guaranteed renewable every year
Annual premium increases Increases in premiums/insurance fees are set at inception and based on the policyholder’s age
Annual repricing mechanism The insurer can reprice the premium/insurance fee annually, based on the emergence of risks within the portfolio to which the contract belongs – i.e. there is no further underwriting of the individual policyholder


These features raise the question of whether the different cash flows on initial recognition should include expected cash flows that relate to expected renewals after the next annual repricing date – i.e. whether the contract boundary should be greater than one year.

 

What did the TRG discuss?

TRG members appeared to agree that insurers should only consider the ability to reassess and reprice policyholder risks when determining contract boundaries. They observed that policyholder risks are risks transferred from the policyholder to the insurer. The IASB staff noted that these can include insurance and financial risks but exclude risks that are not transferred from the policyholder to the entity under such contracts – e.g. lapse and expense risk.

TRG members also noted a distinction between repricing based on a reassessment of:

  • portfolio risks based on the emergence of risk within the existing portfolio; and 
  • more general community risks based on the emergence of risk within a broader group of policyholders.

The former was the subject of the types of contracts discussed above and would therefore result in a contract boundary that excludes expected future contract renewals. 

 

What's the impact?

Management needs to consider all of the terms and conditions when assessing the contract boundary under IFRS 17, including which risks are reassessed and repriced and at what level.

Under IFRS 17, the boundaries of these contracts may be limited to the year for which premiums have been received. 

One possible outcome of having shorter contract boundaries might be that contracts initially written and priced to reflect an entity’s expectation of future renewals are measured in a manner that does not reflect that expectation. This may cause contracts to be considered onerous when they are initially written (e.g. due to significant insurance acquisition cash flows incurred when the contract is initially written) and only profitable if and when they are renewed. This is considered further in Measuring insurance cash flows.

 

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Further details
Further details
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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.