CIA.IFRS17 - Comparison

Question 1

What principles does IFRS 17 establish?

Answer 1

For insurance contracts within the IFRS 17 Standard:
- Recognition
- Measurement
- Presentation
- Disclosure

Question 2

Briefly describe the 3 building blocks for measuring liabilities under IFRS 17

Answer 2

Present Value of future cash flows
- Similar to PV(liabilities) without PfADs
- but IFRS 17 includes provisions for financial risk, unlike with current CIA practice

risk adjustment for non-economic/financial risk
- similar to PfADs for non-economic risk

Contractual Service Margin (CSM)
- Represents unearned profit from a group of insurance contracts (leads to no front-ending of profits)
- Current CIA standards do allow front-ending of profits

Question 3

Define the term Fulfilment Cash Flows (FCF)

Answer 3

FCF
= (IFRS17 building block 1) + (IFRS17 building block 2)
= PV(future cash flows) + (risk adjustment for non-financial risk)

note: PV for IFRS 17 includes financial risk, unlike current CIA practice

Question 4

When is a CSM (Contractual Service Margin) amount established and what is the amount?

Answer 4

When:
FCF < 0

Amount:
CSM = -FCF

Question 5

What is meant by front-ending of profits

Answer 5

Essentially, by front-ending profits, the insurer could already declare a profit when FCFs are below 0. IFRS 17 doesn’t allow this due to the existence of the CSM.

Question 6

Identify and briefly describe 2 valuation methods under IFRS 17

Answer 6

GMA (General Measurement Approach)
- This is the default approach

PAA (Premium Allocation Approach)
- Simplified version of the GMA
- Certain eligibility requirements must be met (assessed at contract inception)

Question 7

Define the term Liability for Incurred Claims (LIC)

Answer 7

Insurer’s obligation to pay claims for events that have already occurred

Question 8

Define the term Liability for Remaining Coverage (LRC)

Answer 8

Insurer’s obligation to provide insurance coverage for events that have not yet occurred (basically just the premium liabilities)

Question 9

Identify examples where PAA may be used instead of GMA for measuring IFRS 17 liabilities

Answer 9

Criteria 1: Short-term contracts (policy term of max 1 year)

Criteria 2: Longer-duration contracts if PAA is a reasonable approximation to GMA over life of contract (both apply only to LRC component liabilities)

Question 10

Define the term “insurance contract” under IFRS17

Answer 10

A contract under which 1 party (the issuer)
- accepts significant insurance risk from another party (the policy holder)
- by agreeing to compensate the policyholder
- if a specified uncertain future event (the insured event) adversely affects the policyholder

Question 11

Identify components of an insurance contract under IFRS17

Answer 11

Insurance components
- non-financial risk that is the “normal” part of any insurance contract

Service Components
- Claims adjudication with reinsurance protection

Investment Components
- Amounts included in premiums that are returned to customers, regardless of the occurrence of an event

Embedded derivatives

Question 12

What is the formula for contract liability in terms of LIC & LRC

Answer 12

Insurance contract liability = LIC + LRC

Question 13

What is the formula for LRC under PAA

Answer 13

LRC = UEP - (premiums receivable) - DAC

Question 14

Identify differences between IFRS17 and current CIA practice for measurement of liabilities relating to LRC (5)

Answer 14

Criteria:
- IFRS17: allows PAA for short-term contracts without testing whether PAA reasonably approximates GMA
- Current: allows (UEP - DAC) to be used only if it’s a reasonable approximation to the explicit valuation approach

DAC Deferral:
- IFRS17: entity may choose deferral or direct expense for short-term contracts
- Current: no deferral in explicit valuation, but deferral if (UEP-DAC) is held

DAC Amount:
- IFRS17: allows deferral of DAC that is directly attributable to the portfolio of insurance contracts
- Current: allowable deferral is different

Discounting of LRC:
- IFRS17: requires discounting if the contract has a significant financing component (unless the time between the service provided and related premium due date is less than 1 year)
- Current: requires discounting & taking into account effect of financial risk

Discounting of LIC:
- IFRS17: ignore discounting and financial risk for LIC if: PAA is used & LIC cash flows are received ≤ 1 year within incurred date of claims
- Current: requires discounting

Question 15

Identify examples in Canadian P&C where PAA can & can’t be used to measure LRC

Answer 15

PAA ok:
- Auto outside QC (since the policy term is generally ≤ 1 year)
- Auto in QC (if PAA is a reasonable approximation to GMA)

PAA probably not ok:
- Warranty
- Mortgage default
(both may have terms > 1 year, or high year-to-year variability in claims)

Question 16

Briefly describe 2 measurement considerations for contract liabilities for IFRS 17

Answer 16

Level of aggregation:
- Must identify portfolios of contracts (contracts in a portfolio have similar risks and are managed together)
- Each portfolio is further subdivided into groups (a group is the unit of account for measurement of CSM)

Contract Boundary:
- must identify contract boundary for each contract (this is normally the term of the policy)
- Cash flow estimates include only cash flows related to claims incurred within the boundary

Question 17

Do expenses need to be allocated to groups in IFRS17

Answer 17

Yes

Question 18

Do assumptions (other than expenses) related to measurements of liabilities need to be allocated to group in IFRS 17

Answer 18

No - they can be allocated at whatever level is most appropriate for estimating cash flows

Question 19

Identify differences between IFRS 17 and current CIA practice regarding contract boundary (7)

Answer 19

Bias Towards Conservatism
- IFRS 17 is less conservative (in the sense that renewal that are written at a loss would be considered as a liability under IFRS 4 but not under IFRS 17)

Consideration of rights & obligations of both parties:
- IFRS 17 considers rights & obligations for both entity & policyholder (IFRS 4 considers only the entity)

Coverages within contracts:
- IFRS17 treatment of coverages may be different

Constraints on repricing:
- IFRS17 doesn’t consider the intent of the entity (whether to reprice) in setting contract boundary. Only considers the rights & obligations of the parties to the contract

Extension of term of liability for DAC:
- This concept doesn’t exist under IFRS17 (acquisition costs are considered directly in measurement of liabilities)

Segregated funds with material guarantees:
- This concept doesn’t exist under IFRS17 (contract boundary would be the full duration of the segregated fund contract when the entity has not right to adjust the contract)

Segregated funds supported by hedging strategy:
- Under IFRS17, existence of hedging is irrelevant to the determination of the contract boundary (whereas CIA standards permit term of liability to be extended under certain conditions)

Question 20

Identify examples where IFRS contract boundary may be different from policy term under current practice (4)

Answer 20

Cancellable contracts:
- Under IFRS17: contract boundary = cancel date (under current practice, policy terms extends beyond cancel date if that would increase the liability)

Title Insurance: (covers defects in the title to land or buildings)
- Under IFRS17: contract boundary = period of ownership of land/building (coverage is triggered by discovery of defect)
- Under current practice, policy term = term of contract since coverage is triggered by the defect itself, not its discovery)

Onerous Contracts:
- IFRS 17 must recognize liability of an onerous contract when signed (so even prior to effective date of contract)
- Under current practice, the entity can wait until effective date to recognize liabilities

Reinsurance held:
- IFRS 17 requires reinsurance contracts held to be measured as separate contracts
- Current practice determines policy term for underlying direct contract only

Question 21

How does IFRS17 define “estimate of future cash flow”

Answer 21

Estimate of future cash flows
= probability-weighted mean of the full range of possible outcomes (use all credible information available at the reporting date without undue cost or effort)

Question 22

Identify differences between IFRS17 and prior CIA practice regarding probability-weighted cash flows (5)

Answer 22

Assumptions that include implicit MfADs:
- IFRS17 requires separate disclosure of risk adjustment for non-financial risk
- Under current practice, the difference between “best estimate” of cash flows and “best estimate with PfAD” is not always quantified

Cash flows that vary with assumptions related to financial risk:
- IFRS17 includes financial risk in the PV of future cash flows
- Under current practice, MfAD for interest rate risk is separate from the best estimate of PV for cash flows

Policyholder options: (selection of limits and other coverage options can affect cash flows)
- IFRS accounts for policyholder behaviour
- Under current practice, the effect on cash flows is blurred

Ongoing Expenses:
- IFRS17 includes only expenses relating directly to the fulfilment of the contract
- Under current standard, requires liability to include provision for ongoing policy-related expenses

Future Income Taxes:
- IFRS17 excludes income taxes from estimates of future cash flows
- Under current CIA standard, require consideration of all future income taxes

Question 23

What is the purpose of discounting?

Answer 23

To account for the time value of money

Question 24

Under Pre-IFRS17 practice, what 3 things do you need for the discounting calculation

Answer 24

Assuming you have the nominal value of the liabilities, you need:
- Discount rate
- Discount rate MfAD
- Payment pattern

Question 25

Under IFRS17, how is the discount rate selected when cash flows do not vary with returns on underlying items

Answer 25

Discount rate is based on a liquidity-adjusted risk-free discount rate curve (or yield curve)

Question 26

Briefly describe the approaches for coming up with the discount rate curve under IFRS 17

Answer 26

Bottom-up approach:
- Adjust the risk-free yield-curve by adding an illiquidity premium that reflects the liabilities
- Under current practice, there’s no requirement to identify an illiquidity premium

Top-down approach:
- Use the investment return on a reference portfolio of assets that’s “similar” to the liabilities
- This reference portfolio does not have to be based on assets held by the company (ex: use the 10-yr spot rate on a Canadian bond for a 10-yr liability cash flow)
- Then remove asset characteristics not relevant to the liability (ex: remove credit and market risk)

• Under current practice, the rate would be tied more closely to assets held by the company

Question 27

What are two judgments/estimates considered in the Bottom-up approach?

Answer 27

• Should the risk-free discount curve be based on government bond rates or swap rates?
• How would the illiquidity premium be estimated?

Question 28

What are two judgments/estimates considered in the Top-down approach?

Answer 28

• How would rates be estimated beyond the obsevable period?
• How would the reference portfolio be selected?

Question 29

Briefly describe how financial risk is incorporated into discounting under IFRS17

Answer 29

You can build financial risk into the
- Discount rate
- OR the cash flows
- OR a combination of both

Under current practice, there is an explicit provision for reinvestment risk (no such provision under IFRS 17)

Question 30

What is the replicating portfolio technique under IFRS17

Answer 30

The value of the liability is set equal to the fair value of an asset portfolio whose cash flows exactly match (in all scenarios) the liability cash flows

Question 31

What are two different ways in which cash flows are affected by financial risk?

Answer 31

• Cash flows can vary based on returns on underlying items (usually assets)
• Cash flows can vary with assumptions related to financial risk, such as expense cash flows varying with inflation. Other examples are lapse rates that vary with future interest rates and minimum guaranteed credited rates.

Question 32

Briefly describe how the discount rate is selected when cash flows do vary with returns on underlying items

Answer 32

Use the replicating portfolio technique: the value of the liability is set equal to the fair value of an asset portfolio whose cash flows exactly match (in all scenarios) the liability cash flows

Question 33

Briefly describe how are cash flows handled when they vary with assumptions related to financial risk

Answer 33

• Either through adjustments to the discount rate or adjustments to the cash flows themselves
• In either case, must be consistent with observable market prices
• IFRS17 suggests using of stochastic and risk-neutral measurement techniques and considering the costs of options and guarantees

Question 34

Regarding non-financial risk, how is the “measurement objective” different under IFRS17 vs pre-IFRS17 practice

Answer 34

IFRS17:
- represents compensation required by entity to bear uncertainty about the amount and timing of the cash flows that arises from non-financial risk

Current practice:
- represents amount required to provide for the effect of uncertainty

Note: this means that two different companies could value an identical portfolio of liabilities differently simply because 1 company wants a higher elvel of compensation for accepting risk.

Question 35

IFRS17 guideline regarding facilitating compensation among entities

Answer 35

IFRS17 requires entities to disclose the confidence level to which the risk adjustment for non-financial risk corresponds (this is a new requirement)

Question 36

Considerations for using PfADs to determine risk adjustment for non-financial risk

Answer 36

• Is the current level of PfAD consistent with the compensation the entity requires for bearing uncertainty?
• Are the diversification benefits included in current PfADs consistent with those that would be reflected in IFRS17?
• Are any adjustments needed for pass-through features?

Question 37

Definition of risk adjustment for non-financial risk on a reinsurance contract held

Answer 37

The RA for non-financial risk on a reinsurance contract held represents the amount of risk transferred from the entity to the reinsurer.

• Therefore, unlike other contracts, the RA for non-financial risk on a reinsurance contract held reduces the liability (or increases the asset)

Question 38

Risk adjustment for non-financial risk: effect of pass-through features

Answer 38

If using CIA PfADs to determine IFRS17 risk adjustment for non-financial risk, adjustment would be required if the entity ignores (some or all) pass-through features in determining the compensation it requires for bearing uncertainty.

• Note: this is because CIA MfADs may be too low if they accounted for the lowered risk brought on by pass-through features