5.1 Insurance Contract Accounting (IFRS 17)
3 min read•august 7, 2024
Insurance contracts are complex financial instruments that require specialized accounting treatment. revolutionizes how insurers report these contracts, aiming to boost transparency and comparability across the industry.
The standard introduces three measurement models: the , , and . Each model suits different types of insurance contracts, ensuring accurate financial reporting for various insurance products.
Insurance Contracts and Measurement Models
IFRS 17 Overview
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- IFRS 17 establishes principles for recognition, measurement, presentation and disclosure of insurance contracts
- Aims to provide relevant information to faithfully represent insurance contracts
- Replaces IFRS 4, which allowed various accounting practices resulting in lack of comparability
- Effective for annual reporting periods beginning on or after January 1, 2023
Defining an Insurance Contract
- Insurance contract transfers significant insurance risk from policyholder to insurer
- Insurer compensates policyholder if a specified uncertain future event adversely affects them
- Excludes contracts that do not transfer significant insurance risk (investment contracts)
- Assessed on a contract-by-contract basis considering all substantive rights and obligations
General Measurement Model (GMM)
- Default model for measuring insurance contracts under IFRS 17
- Applies to all insurance contracts, unless eligibility criteria met for premium allocation approach or variable fee approach
- Measures insurance contracts based on a current fulfillment value using updated assumptions
- Comprises estimates of future cash flows, discounting, , and
Premium Allocation Approach (PAA)
- Simplified approach for measuring liability for remaining coverage
- Permitted for contracts with coverage period of one year or less, or if it approximates general measurement model
- Measures liability for remaining coverage based on premiums received less acquisition costs
- Liability for incurred claims measured using general measurement model
Variable Fee Approach (VFA)
- Modification of general measurement model for direct participating contracts
- Applies to insurance contracts that provide investment-related services and payments to policyholders that vary with underlying items
- Contractual service margin adjusted for changes in variable fee (insurer's share of fair value changes in underlying items)
- Reflects that insurer substantially provides investment-related services to policyholder
Key Components of Insurance Liabilities
Contractual Service Margin (CSM)
- Represents unearned profit insurer expects to recognize as it provides services under insurance contract
- Determined at initial recognition as difference between expected inflows and outflows, including risk adjustment
- Recognized in profit or loss over coverage period based on passage of time or units of coverage provided
- Adjusted for changes in estimates of future cash flows related to future services
Risk Adjustment
- Compensation insurer requires for bearing uncertainty about amount and timing of cash flows that arise from non-financial risk
- Reflects insurer's degree of diversification benefit and risk aversion
- Determined using a confidence level technique (cost of capital approach) or a conditional tail expectation technique
- Recognized in profit or loss as insurer is released from risk over time
Fulfilment Cash Flows
- Estimates of future cash inflows (premiums) and outflows (claims, benefits, expenses) that will arise as insurer fulfills insurance contract
- Includes all cash flows within boundary of each contract in the group
- Incorporates financial risk (effect of discounting) and non-financial risk (risk adjustment)
- Updated at each reporting period to reflect current estimates using consistent, unbiased, probability-weighted assumptions
Specific Contract Types and Transition
Onerous Contracts
- Insurance contract is onerous at initial recognition if fulfilment cash flows, risk adjustment, and contractual service margin result in a net outflow
- Loss component recognized immediately in profit or loss
- Subsequent changes in fulfilment cash flows allocated to loss component until it is eliminated
Reinsurance Contracts Held
- accounted for separately from underlying insurance contracts
- Gains on purchasing recognized in profit or loss immediately (net cost or net gain approach)
- Measurement follows general measurement model, with modifications for non-performance risk and timing of payments
Transition Approaches
- (default) applies IFRS 17 retrospectively to each group of insurance contracts
- permits specific modifications if full retrospective approach impracticable
- determines contractual service margin or loss component at transition date as difference between fair value and fulfilment cash flows
- Choice of transition approach applied consistently to each group of insurance contracts
Key Terms to Review (25)
Contractual service margin: The contractual service margin (CSM) represents the unearned profit from an insurance contract that the insurer expects to recognize as it provides services in the future. This margin is a key component of the new accounting model under IFRS 17, as it reflects the insurer's obligation to provide coverage and manage risks over the life of the contract while ensuring that profits are recognized in a way that matches the delivery of those services.
Current value: Current value refers to the present worth of an asset or liability, taking into account the time value of money. In the context of insurance contract accounting, current value is crucial for measuring the future cash flows associated with insurance contracts, as it reflects the amounts that an insurer expects to receive or pay in present-day terms.
Disclosure Requirements: Disclosure requirements refer to the rules and regulations that mandate organizations to provide specific information in their financial statements and reports. These requirements ensure transparency and accountability, enabling stakeholders such as investors, regulators, and analysts to make informed decisions based on a clear understanding of the organization's financial position and performance.
Earned premium: Earned premium refers to the portion of the insurance premium that has been recognized as income by the insurer for the coverage provided during a specific period. This concept is crucial in understanding how insurers recognize revenue, as it reflects the proportion of premiums that corresponds to the time coverage is in force, directly tying into revenue recognition practices and claims liabilities.
Fair value approach: The fair value approach is a method used to measure assets and liabilities at their current market value rather than at historical cost. This method provides a more accurate reflection of an entity's financial position by considering the actual market conditions and potential cash flows associated with these assets and liabilities, which is particularly relevant in insurance contract accounting.
Financial Accounting Standards Board: The Financial Accounting Standards Board (FASB) is an independent organization responsible for establishing and improving financial accounting and reporting standards in the United States. It plays a crucial role in shaping how financial information is reported by companies, ensuring transparency and consistency for investors and other stakeholders. The FASB's standards impact various sectors, including insurance and consolidation practices, guiding how entities recognize revenue, assess liabilities, and prepare financial statements.
Fulfillment cash flows: Fulfillment cash flows are the expected future cash inflows and outflows associated with fulfilling insurance contracts. These cash flows provide a basis for measuring the liability for an insurance contract under the accounting framework, reflecting the insurer's obligation to policyholders and the expected performance of the insurance portfolio. Understanding fulfillment cash flows is crucial for accurate financial reporting and assessing an insurer's financial position and performance.
Full retrospective approach: The full retrospective approach is an accounting method where an entity applies new accounting standards as if they had always been in effect. This means that all prior periods are adjusted to reflect the changes, resulting in financial statements that are comparable across all periods presented. This approach is particularly significant for insurance contract accounting under IFRS 17, as it ensures consistency and transparency in how insurance liabilities are measured and reported over time.
General measurement model: The general measurement model is a framework for recognizing and measuring insurance contracts under IFRS 17, focusing on the estimation of future cash flows, the time value of money, and the uncertainty of those cash flows. It emphasizes a systematic approach to valuing insurance liabilities, taking into account both expected claims and the costs associated with fulfilling those obligations. This model is essential for providing a clearer picture of an insurer's financial position and performance over time.
IFRS 17: IFRS 17 is an International Financial Reporting Standard that establishes principles for the recognition, measurement, presentation, and disclosure of insurance contracts. This standard aims to provide a more consistent and transparent approach to accounting for insurance contracts, enhancing comparability among insurers and providing clearer information to stakeholders. By aligning the financial reporting of insurance contracts with the principles of other financial instruments, IFRS 17 significantly impacts how insurers account for their obligations and rights in both direct insurance and reinsurance contexts.
Insurance liability: Insurance liability refers to the obligations an insurance company has to pay out claims to policyholders or beneficiaries based on the terms of insurance contracts. This liability arises when an insurer collects premiums from policyholders and commits to cover certain risks, meaning it must set aside enough funds to meet future claims. Accurate measurement of insurance liabilities is essential for maintaining financial stability and transparency in the insurance sector.
International Accounting Standards Board: The International Accounting Standards Board (IASB) is an independent organization that develops and establishes global financial reporting standards known as International Financial Reporting Standards (IFRS). The IASB plays a crucial role in enhancing the transparency and comparability of financial statements across different jurisdictions, facilitating cross-border investment and improving the consistency of financial reporting in the financial services industry.
International Financial Reporting Standards: International Financial Reporting Standards (IFRS) are a set of accounting standards developed by the International Accounting Standards Board (IASB) to provide a global framework for how public companies prepare and disclose their financial statements. These standards aim to bring transparency, accountability, and efficiency to financial markets around the world, making it easier for investors and other stakeholders to understand and compare financial information across different countries and industries.
Life insurance contracts: Life insurance contracts are agreements between an insurer and a policyholder where the insurer provides a sum of money upon the death of the insured or after a specified period. These contracts are crucial for providing financial security to beneficiaries and involve various features such as premiums, coverage amounts, and policy terms that impact their accounting treatment under specific regulations.
Modified retrospective approach: The modified retrospective approach is a method of transitioning to new accounting standards that allows entities to apply the new standard to prior periods while making adjustments only for the most recent period. This approach simplifies the adoption process by reducing the amount of historical data that needs to be restated, making it particularly useful when transitioning from older standards like IAS 39 to newer ones such as IFRS 9, or when accounting for insurance contracts under IFRS 17. It allows for a smoother shift while still providing some continuity in reporting.
Non-life insurance contracts: Non-life insurance contracts are agreements that provide coverage for various risks excluding life-related events, such as health or mortality. These contracts typically cover property, liability, and other types of risks, ensuring that individuals and businesses are financially protected against unexpected events. They play a crucial role in the insurance market by offering stability and support for managing financial uncertainties.
Onerous contracts: Onerous contracts are agreements in which the unavoidable costs of fulfilling the contract exceed the economic benefits expected from it. These contracts represent a financial liability for the entity involved, particularly in the context of insurance contract accounting under IFRS 17. The recognition and measurement of onerous contracts involve assessing the future cash flows and determining whether a provision should be recognized for the expected loss.
Policyholder behavior assumptions: Policyholder behavior assumptions are estimates made by insurance companies regarding how policyholders will act in terms of their insurance contracts, including the likelihood of policy lapses, surrenders, and renewals. These assumptions are critical as they directly impact the measurement and reporting of insurance liabilities, influencing the overall financial statements under the guidelines of IFRS 17.
Premium allocation approach: The premium allocation approach is a method used in insurance contract accounting that allows insurers to recognize premiums earned over the coverage period. This approach is particularly relevant for short-duration contracts, where the timing of premium recognition aligns closely with the coverage provided to policyholders. It simplifies the measurement of insurance liabilities and provides a clear framework for recognizing revenue as it is earned, ensuring that financial statements reflect the insurer's performance more accurately.
Reinsurance: Reinsurance is a financial arrangement in which an insurance company transfers a portion of its risk to another insurer, known as the reinsurer. This process helps primary insurers manage their risk exposure, stabilize loss experience, and maintain solvency while allowing reinsurers to diversify their portfolio and spread risk across multiple policies. Reinsurance plays a crucial role in the financial stability of the insurance industry and directly relates to how insurance contracts are accounted for under IFRS 17.
Reinsurance Contracts Held: Reinsurance contracts held are agreements in which an insurance company transfers a portion of its risk to another insurer, known as the reinsurer, to mitigate potential losses. This allows the primary insurer to reduce its liability, manage capital more effectively, and stabilize its financial position by sharing risks associated with insurance policies.
Risk adjustment: Risk adjustment refers to the process of modifying financial data to account for the inherent uncertainties and potential variability in outcomes associated with certain activities or contracts. This is especially relevant in insurance accounting, where it helps assess the profitability and financial stability of insurance contracts by taking into consideration the expected risks and uncertainties related to policyholder behavior, claims, and future cash flows.
Transitional provisions: Transitional provisions refer to the guidelines and rules set forth in accounting standards that dictate how companies should implement new accounting policies while managing their existing financial reporting. These provisions are crucial when significant changes occur, such as the introduction of new standards like IFRS 17 for insurance contract accounting, helping entities transition smoothly without disrupting their financial statements or operations.
Unearned Premium: Unearned premium refers to the portion of an insurance premium that has been collected but not yet earned by the insurer, as it relates to future coverage. This means that the insurer has received payment for insurance coverage that has not yet been provided, and it represents a liability on the insurer's balance sheet until the policy period progresses. The recognition of unearned premium is critical in understanding how insurers manage their revenue and liabilities, especially when considering revenue recognition and claims liabilities.
Variable Fee Approach: The variable fee approach is a method used in accounting for insurance contracts under IFRS 17 that focuses on recognizing the variable fees paid to the insurer based on the underlying investment returns. This approach is particularly relevant for contracts where the policyholder's benefits are linked to the performance of underlying assets, thus allowing insurers to report profits as investment returns are realized.