IFRS 17 – Measuring the CSM | KPMG | GLOBAL
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Measuring the CSM

Measuring the CSM

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Key observation

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Insurers may be able to measure contracts with a risk-sharing mechanism at a higher level than the annual cohort only if they can achieve the same accounting outcome.

Applying the annual cohorts requirement to contracts that share in the return of a specified pool of underlying items

September 2018 TRG meeting

What's the issue?

Some insurance contracts share in the return of a specified pool of underlying items, with some of the return contractually passed from one group of policyholders to another – e.g. because of guarantees and proportionate sharing in the returns of the pool. 

The basis for conclusions to IFRS 17 explains that, for contracts that fully share risks, the groups of contracts considered together will give the same results as a single combined risk-sharing portfolio.

It adds that IFRS 17 does not specify the methodology to be used to arrive at the reported amounts, and in some cases it is not necessary to restrict groups to annual cohorts to achieve the same accounting outcome.

The question that arises is: when would measuring the CSM at a higher level than an annual cohort level (e.g. portfolio level) achieve the same accounting outcome as measuring it at an annual cohort level? 

 

What did the TRG discuss?

TRG members observed that when contracts share in 100 percent of the returns of a pool of underlying items that includes the insurance contracts themselves, the insurer would not be affected by the expected cash flows of each individual contract issued; and for groups of such contracts, the CSM would be zero. Accordingly, measuring the CSM at a level higher than the annual cohort would achieve the same outcome as applying the annual cohorts requirement.

TRG members observed that where the effects of risk sharing between policyholders comprise less than 100 percent of the returns, the expected cash flows could affect the insurer, resulting in a CSM being recognised for each group. In these cases, insurers would need to determine whether measuring the contracts at a higher level than the annual cohort would still result in the same outcome as applying the annual cohorts requirement. 

 

What's the impact?

Insurers may be able to measure contracts with a risk-sharing mechanism at a higher level than the annual cohort only if they can achieve the same accounting outcome. They would need to assess whether these contracts share risks to an extent that would allow them to achieve that outcome.

Insurers would also be expected to perform an analysis to confirm that the different measurement levels would not impact the measurement outcome.

 

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Accounting for insurance risk consequent to an incurred claim

September 2018 TRG meeting

What's the issue?

There are certain situations where an incurred claim creates an insurance risk for an insurer that would not exist if no claim were made. 

A common example is a disability contract that provides coverage for a policyholder becoming disabled during a specified period. If a claim is made, then the insurer is required to make regular payments to the policyholder until they either recover, reach a specified age or die. In this scenario, the amount of the claim is uncertain and subject to insurance risk.

A question that arises is whether an insurer should record such an obligation as: 

  • a liability for incurred claims – i.e. the insured event in the example above is the policyholder becoming disabled; or
  • liability for remaining coverage – i.e. the insured event is the policyholder becoming and remaining disabled.

 

What did the TRG discuss?

TRG members observed that different interpretations of what the insured event is for these types of contracts are possible when applying IFRS 17. Therefore, the obligation may be treated as a liability for incurred claims or a liability for remaining coverage. 

TRG members observed that determining the appropriate accounting policy requires the exercise of judgement, based on the specific facts and circumstances, considering which interpretation provides the most useful information about the nature of the services provided. These accounting policies should be applied consistently to similar transactions and over time. 

 

What's the impact?

Whether expected regular payments are classified as a liability for incurred claims or as a liability for remaining coverage has no impact on the cash flows that are included in the insurance contract measurement. However, it directly impacts the determination and allocation of the CSM to profit or loss as shown below.

 

Accounting for payments to the policyholder     Effect on profit recognition Effect on recognition of changes in estimates of future cash flows Complexity of the approach
Liability for incurred claims Shorter recognition period Changes are recognised immediately, which can lead to volatility in profit or loss Less complex
Liability for remaining coverage Longer recognition period

Volatility related to changes is partly absorbed by the CSM More complex

 

In some cases, the classification may also impact the accounting model applicable to the insurance contracts – e.g. whether a group of contracts qualifies for the premium allocation approach. 

It will be crucial for insurers to make transparent disclosures as required by IFRS 17, including those about significant judgements, to allow financial statement users to understand and compare the performance of insurers.

 

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How to identify coverage units for CSM allocation (for contracts with no investment components)

May and February 2018 TRG meetings

What’s the issue?

The CSM of a group of insurance contracts is recognised in profit or loss based on identifying the coverage units in the group. These are determined by considering, for each contract, the quantity of benefits provided and its expected coverage duration.

Due to the variety and complexity of insurance products, determining the quantity of benefits provided under each contract in a group of insurance contracts is an area of judgement. 

The question that arises is what factors should be considered in determining the coverage units in a group of contracts, considering both the contracts’ expected duration and quantity of benefits.

 

What did the TRG discuss?

The objective of the release of the CSM is to reflect services provided in each period. Since IFRS 17 does not specify how to determine the coverage units in a group, TRG members agreed that an insurer needs to apply judgement to determine a systematic and rational method for estimating the services provided for each group of contracts. 

TRG members observed that coverage units should reflect:

  • expectations of lapses and cancellations of contracts, as well as the likelihood of an insured event occurring to the extent that they it would affect the expected duration of contracts in the group; and
  • different levels of service across the periods being covered – because the benefits of being able to make a claim are affected by the amount that a policyholder can claim. 

Depending on the facts and circumstances, methods that may achieve the objective include:

  • a straight-line allocation over the passage of time, reflecting the number of contracts in a group;
  • using the maximum contractual cover in each period;
  • using the amount that the insurer expects the policyholder to be able to validly claim in each period if an insured event occurs;
  • methods based on expected cash flows; and
  • methods based on premiums.

It was noted that methods based on premiums would not be appropriate if the premiums:

  • are receivable in periods different from those in which services are provided;
  • reflect different probabilities of claims for the same type of insured event in different periods (rather than different levels of service of standing ready to meet the claims); or
  • reflect different levels of profitability in contracts.

TRG members also appeared to agree that methods that result in no CSM allocation to periods in which the insurer stands ready to meet valid claims would not meet the objective.

 

What’s the impact?

Many groups of insurance contracts will contain contracts with similar risks and levels of cover provided.

For groups like these, a method primarily based on the passage of time that reflects the number of contracts in the group may be a reasonable proxy for services provided in each period.

For other, more complex groups of insurance contracts (e.g. groups that contain contracts with different or multiple risks, or contracts with different levels of cover provided over different periods), other methods would need to be developed to achieve the objective of the CSM release. 

Identifying a practical and systematic approach for determining the quantity of benefits provided by these contracts using information available to the insurer may ease the operational challenges of this new requirement.

 

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How to identify coverage units for CSM allocation (for contracts with investment components)

June 2018 IASB meeting and May 2018 TRG meeting

What's the issue?

A variety of insurance contracts provide investment-related services. A key question is whether their coverage period and coverage units should be determined with reference to insurance coverage only, or with reference to insurance coverage and the investment-related services. Answering this question is necessary for determining the CSM recognised in profit or loss in each period.

 

What did the TRG discuss in May?

IFRS 17 identifies direct participating contracts as contracts that provide both insurance services and investment-related services. Based on this, TRG members agreed that, for direct participating contracts, determining the quantity of benefits provided and the expected coverage duration – and hence, the CSM recognised in profit or loss in each period – should reflect both insurance and investment-related services provided under the contract.

For contracts with investment-related services that are not direct participating contracts, the staff and some TRG members believed that, based on the wording of IFRS 17, the coverage period and coverage units are determined by reference to insurance services only. However, most TRG members disagreed that such contracts should be treated as providing only insurance services. 


What did the IASB discuss in June?

The Board decided to amend the definition of the coverage period for direct participating contracts in the next cycle of annual improvements to IFRS. The amendment would clarify that the coverage period for these contracts includes periods in which the entity provides coverage for insured events or investment-related services.

At a future meeting, the Board will receive a more comprehensive list of items that have been identified as raising practical, interpretative and other implementation challenges.  

 

What's the impact?

The proposed amendment for direct participating contracts appears consistent with the way these contracts are identified and accounted for (i.e. applying the variable fee approach), and reflects the contracts’ characteristics. Given the wide range of these contracts, assessing the pattern of service provision reflecting both insurance and investment-related services will require judgement. 

However, at the May TRG meeting some TRG members observed that if investment-related services provided are reflected in CSM allocation only for direct participating contracts, then this could result in what they believe are economically similar contracts having significantly different recognition patterns, depending on whether they qualify as direct participating contracts or not. This is because they consider that insurance contracts that are not direct participating contracts may still provide significant investment-related services. 

Although the June Board meeting has provided additional clarity, some uncertainty still remains over whether the Board will hold a substantive discussion about contracts with investment-related services that are not direct participating contracts. Many preparers will want to continue to progress the overall design of their IFRS 17 systems and processes, but will need to be mindful to build in flexibility to accommodate the continuation of this discussion. We recommend that you stay tuned for further developments in this area.

 

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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.

 

 

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