QFIP-148: IFRS 17 Insurance Contracts – Effects Analysis

Question 1

IFRS Phase 1

Answer 1

Phase 1 (completed 2004): IFRS 4 Insurance Contracts

• Enhanced disclosure of amount, timing, and uncertainty of future cash flows
• Allowed insurers to continue using various accounting practices while the standard for insurance contracts was being reassessed

Question 2

IFRS Phase 2

Answer 2

Phase 2 (completed in 2017)

• Established IFRS 17, which supersedes IFRS 4
• IFRS 17 is required for insurers effective Jan. 1, 2021 but can be applied earlier if insurer already applies IFRS 9 and IFRS 15

Question 3

Considerations by the Board (IASB) in evaluating the likely effects of IFRS 17

Answer 3

• How relevant activities will be reported in financial statements
• Comparability of financial information across time and different companies
• Ability of users of financial statements to assess the amount, timing, and uncertainty of a company’s future cash flows
• Impact on economic decision-making
• Compliance costs
• Costs of analysis for users of financial statements

Question 4

IFRS 17 Effects Analysis

Answer 4

Describes the likely costs and benefits of IFRS 17

Question 5

Limitations of the IASB’s effects analysis

Answer 5

• May not cover all forms of insurance in existence
• IFRS 4 allowed a wide variety of formats; therefore aggregation is difficult to compare before/after IFRS 17 across different jurisdictions

Question 6

The impact of IFRS 17 will vary by company

Answer 6

• Will depend on the type and nature of the company’s products
  
  • Little change for short-term insurance contracts, but significant changes for long-term contracts
• Extent that IFRS 4 accounting practices were different
  
  • IFRS 4 allowed a wide range of practices—some were more similar to IFRS 17 than others
  • This is a key theme in the sections where they talk about IFRS 17 impacts. It really comes down to what the insurer was doing under IFRS 4 before IFRS 17 went into effect.

Question 7

Describe the 3 types of contracts in scope of IFRS 17.

Answer 7

1. Insurance contracts issued by any company
   
   • Contracts that transfer significant insurance risk from the policyholder to the insurer
   • Includes term, WL, UL, etc. (variable and non-variable)
2. Reinsurance contracts held
   
   • Includes ceded and assumed contracts
3. Investment contracts with discretionary participation features
   
   • ONLY if the company also issues insurance contracts
     
     • Otherwise these fall under IFRS 9
   • Have similar economic characteristics to insurance contracts
     
     • Long duration, recurring premiums, timing of return contractually determined by insurer
     • Commonly linked to the same pool of assets
     • Includes fixed and variable deferred annuities
4. Scope exclusions: product warranties, financial guarantee contracts, and fixed-fee service contracts (e.g. roadside assistance programs)

Question 8

List at least 5 general improvements in IFRS 17 over IFRS 4.

Answer 8

More transparent/comparable across contracts, insurers, and industries

1. Current value approach: contracts always measured with current assumptions
2. All insurance liabilities must reflect time value of money
3. Discount rate reflects characteristics of insurance cash flows
4. Insurance services vs. financial profit sources shown separately
5. More consistent with non-insurance industries
6. Provides information on current and future profitability
7. Facilitates better understanding of risk for decision making
8. Less reliance on non-GAAP measures (EV, etc.)

Question 9

General Improvements of IFRS 17 over IFRS 4

Answer 9

IFRS 17 addresses many inadequacies in the existing wide range of insurance accounting practices

• More timely and transparent => should increase long-term financial stability
  
  • Insurance risks are particularly complex, long-term, and not traded in markets
• Provides information about current and future profitability
• Increased financial statement comparability => more consistent across companies and regions
  
  • IFRS 4 allowed a wide range of practices and reporting formats
• Improved capital allocation and better economic decisions => increases investors’ understanding of insurance risks
• Will provide additional metrics for performance measurement

Question 10

Describe the separation of components required before applying IFRS 17.

Answer 10

Separate distinct components that are not highly interrelated with the insurance
component

• Embedded derivatives not highly interrelated with insurance component IFRS 9
• Distinct deposit and investment components IFRS 9
• Distinct goods and non-insurance services IFRS 15

Distinct means:

1. Not highly interrelated with the insurance component
2. Could be sold separately

Measure the remaining insurance components under IFRS 17

• Would include highly interrelated embedded derivatives like GMDBs
• Would include non-distinct components

Question 11

Describe how contracts are grouped when applying IFRS 17.

Answer 11

• *Portfolio of contracts** – contracts subject to similar risks and managed together
• *IFRS 17 can be applied to groups of contracts within a portfolio**
• *Each portfolio of contracts must be divided into these groups:** (basically based on profitabilty)

1. Onerous at initial recognition (Initial FCF > 0)
2. Contracts with no significant possibility of becoming onerous in the future
3. Remaining contracts that don’t fit into group 1 or 2

Contracts within a given group must be issued no more than 1 year apart

Question 12

Describe the key components of initial measurement under the IFRS 17 general
accounting model.

Answer 12

Fulfillment CFs = PV(Outflows) - PV(Inflows)

• Outflows = claims, expenses, directly attributable acquisition costs, etc.
• Inflows = premiums and considerations paid by contractholder
• Calculate with and without risk adjustment
• Risk adjustment = explicit adjustment for uncertainty in timing/amount of FCFs
• Discount rates
  
  • Reflect the characteristics of the contract’s cash flows (timing, currency, liquidity)
  • Based on current observable interest rates with adjustments

CSM = extra liability that eliminates day 1 gain

• Initial CSM = -FCFs so that FCF + CSM = 0
  
  • If Initial FCF > 0, set CSM = 0 (“onerous”)
• CSM = expected future profit
• Recognize CSM in P&L as insurance coverage is provided

Question 13

Describe subsequent measurement under the IFRS 17 general accounting model.

Answer 13

• *Carrying Amount = Fulfillment Cash Flows + CSM** (reserve + deferred profit liab)
• *FCFs are always measured with current assumptions**
• Changes in FCFs related to current or past coverage: recognize immediately in P&L
• Changes in FCFs related to future coverage:
  
  • If the CSM > 0, adjust the CSM to offset so there is no P&L effect
  • Otherwise recognize immediately in P&L
• Recognize FCF discount rate changes in either P&L or OCI
  
  • Most insurers will be consistent with IFRS 9 asset classification

Recognize the CSM in P&L over the coverage period of the group

• Accrete interest on the CSM using the original discount rate

If experience = expectations, profit = CSM recognized + Risk Adj expired

Question 14

Describe the meaning of “insurance contracts with direct participation features” under IFRS 17

Answer 14

• *Direct participation feature** – obligation to pay policyholders the FV of underlying items - variable fee
• *Variable fee** = consideration company receives for providing investment-related services
• Based on a share in the underlying items
• Reflects investment performance of underlying items and CFs needed to fulfill the contracts

An insurance contract has a direct participation feature if:

1. Policyholder participates in a share of a clearly identified pool of underlying items
2. Company expects to pay a substantial share of the FV returns on underlying items
3. Payments will vary with the change in FV of underlying items

If ALL of the above are true, the contract qualifies for the variable fee approach (VFA)

Question 15

Describe the IFRS 17 accounting model for insurance contracts with direct
participation features.

Answer 15

VFA = modification of GAM for insurance contracts with direct participation features

• Gives insurers more flexibility to reduce P&L volatility due to variable fee changes
• *At inception: VFA is identical to GAM**
• *Subsequent measurement: identical to GAM except that insurer may adjust CSM to offset changes in the variable fee**

1. Allows CSM to reflect interest rate and other financial variable changes
   
   • Under the GAM, discount rate changes never impact the CSM
2. If choose not to adjust, changes in the variable fee affect P&L
   
   • Good choice for insurers already hedging variable fee in P&L

Question 16

Describe the IFRS 17 accounting model for reinsurance contracts held.

Answer 16

Use the general accounting model with the following modifications:

1. Recognition date for a group of reinsurance contracts:
   
   • Proportionate reinsurance recognition date = later of:
     
     • Beginning of the coverage period of the group
     • Initial recognition of the underlying insurance contracts
   • Non-proportionate: beginning of the coverage period
2. Ceding company must reflect nonperformance risk of reinsurer
3. At inception of the reinsurance agreement, any initial net gain or loss is recognized as a CSM
   
   • Key difference with GAM: a group of reinsurance contracts can have a negative CSM
   • Keeps the CSM consistent before and after reinsurance

Question 17

Describe the 2 key components in the IFRS 17 statement of comprehensive income.

Answer 17

1. Insurance service result = insurance revenue - insurance service expenses
   
   • Insurance revenue = consideration company expects to receive for services provided under the contracts
     
     • Includes release of FCFs for current and past coverage (including risk adjustment)
     • Includes release of CSM for insurance services provided
     • Excludes deposit components (premiums, etc.)
   • Insurance service expenses = costs incurred in providing services in the period
2. Net financial result = insurance finance income - insurance finance expenses
   
   • Finance income = investment income on assets
   • Finance expenses = interest on FCFs, CSM, etc.
     
     • CSM uses locked-in original DR
     • FCF interest depends on whether DR changes are presented in P&L or OCI

Question 18

List and describe at least 4 required disclosures under IFRS 17.

Answer 18

1. Explanation of recognized amounts
   
   • Reconciliations between the opening and closing liabilities, CSM, and PVs
   • Show insurance vs. reinsurance and profitable vs. onerous groups separately
2. Explanation of when remaining CSM will be recognized
3. Analysis of insurance revenue, finance income/expense, NB issued
4. Significant judgments
   
   • Methods/processes/inputs used to measure insurance contracts
   • Any changes in the above methods/processes with explanation
   • Yield curve(s) used
   • Confidence level associated with risk adjustment
5. Nature and extent of risks arising from insurance contracts
   
   • Sensitivity analysis for insurance risk and for each type of market risk
   • Various disclosures (exposures, concentrations, credit quality, liquidity)
6. Effect of the insurer’s regulatory framework

Question 19

Review the improved requirements introduced by IFRS 17 on the other side of this card. Be able to explain more detail behind each

Answer 19

Question 20

List 4 ways that IFRS 17 provides more transparent and timely financial information as compared to IFRS 4.

Answer 20

1. More informed economic decisions
2. Long-term financial stability
3. Easier to understand information
4. More meaningful comparisons across contracts, insurers, and other industries

Question 21

Describe the following:

• Common discount rate practices under IFRS 4
• IFRS 17 discount rate approaches allowed
• How policyholders react to falling interest rates

Answer 21

• Under IFRS 4, many insurers use a locked-in interest rate
  
  • Understates liability in a falling rate environment
  • Makes earnings look better than they really are
  • Made Japanese insurers insolvent in the 1990s
• Under IFRS 4, many insurers base DR on asset returns
  
  • Example: DR = Expected Asset Return - Margin
  • Obscures economic mismatches
  • Understates the liability since asset returns include extra premiums
• IFRS 17 allows top-down or bottom-up approach
  
  • Top-down: deduct credit and other irrelevant risk premiums from asset returns
  • Bottom-up: add liability-specific liquidity premium to risk-free rates
• How policyholders react to falling interest rates:
  
  • Hold contract longer than expected (lower lapses)
  • Increasing premium payments on existing contracts
  • Buy fewer new contracts

Question 22

How does IFRS 17 improve transparency about sources of profit?

Answer 22

• Separates insurance result and financial result
• Info on current and future profit recognition (CSM)
• Risk adjustment and CSM shown separately
• Reconciles CSM change each period
  
  • Amount recognized in P&L
    
    • Increases from NB written
    • Changes in CSM to offset FCF assumption changes
• Less need for non-GAAP measures like EV

Question 23

Compare similarities and differences between embedded value and IFRS 17.

Answer 23

Question 24

Describe key impacts on insurers’ balance sheets as a result of implementing IFRS 17.

Answer 24

• Liability will increase if:
  
  • Pre-IFRS 17 DR was higher (likely)
  • Pre-IFRS 17 risk adjustment was lower (depends on insurer)
  • FOGs not fully reflected Pre-IFRS 17 (depends on insurer)
• Liability will fall if insurer previously expensed acquisition costs as incurred
  
  • Acquisition costs lower CSM, which lowers liability

Question 25

Describe how IFRS 17 will change the presentation of the following items:

• Aggregation of contracts in an asset and liability position
• Intangible assets and liabilities
• Policy loans

Answer 25

• No more netting of contracts in an asset and liability position
  
  • Must present in separate groups
• No more intangible assets and liabilities
  
  • No DAC, VOBA, URL, UPL
  • No premiums receivable or claims payable
• Policy loans no longer reported as separate financial asset
  
  • Must include in contract measurement and disclose in notes

Question 26

Review the IFRS 17 effects on reported balance sheet equity on the back of this card. Be sure you can “reason” through why each is the way it is.

Answer 26

Question 27

Describe how IFRS 9 will impact accounting for financial instruments.

Answer 27

IFRS 9 = new standard for financial instruments (replaces IAS 39)

• Effective Jan. 1, 2018 (3 years before IFRS 17)
• IFRS 9 Asset Classifications
  
  • Amortized cost: simple debt instruments if plan to hold to maturity
  • FVOCI: simple debt instruments that may possibly sell
  • FVPL: other debt instruments and equities
• Some assets will be reclassified under IFRS 9
  
  • FV changes will move to/from P&L or OCI

Question 28

Describe the interaction between IFRS 9 and insurance contract accounting before and after IFRS 17 is implemented.

Answer 28

• Once both are implemented, accounting volatility should not be a problem
  
  • Changes in financial variables will have similar treatment in P&L and OCI
  • IFRS 17 + IFRS 9 will help highlight economic mismatches and aid ALM
• Solutions during 3-year gap before IFRS 17:
• Deferral approach for companies predominantly connected to insurance contracts
  
  • May defer IFRS 9 adoption until they adopt IFRS 17
• Overlay approach for any company who implements IFRS 9 before IFRS 17
  
  • Allows accounting differences between IFRS 9 and IAS 39 to go through OCI
  • Prevents IFRS 9 from impacting P&L