IFRS 17: insurance contracts

An insurer takes your premium today and may pay a claim in ten years, or never. When has it earned its money? Old rules let insurers answer that in many different ways, so two insurers with the same business could report very different profits. International Financial Reporting Standard (IFRS) 17 fixes this.

It says the insurer earns revenue as it provides cover, measures what it owes using current estimates. Shows profit that is not yet earned as a liability called the contractual service margin.

This topic covers the objective and scope of IFRS 17, the definition of an insurance contract, separating components, grouping of contracts, recognition, the three measurement models, modification and derecognition, presentation, disclosure and transition. The previous topics covered first-time adoption. The next topics cover the standard for subsidiaries without public accountability and management commentary. The latest Pathfinder diets have no IFRS 17 question, but it is examinable.

Key terms in plain English

Syllabus check

IFRS 17 is examinable under syllabus area C. This topic covers:

• objective, scope, definition, separation of components, aggregation and recognition;
• the three measurement models, modification, derecognition, presentation, disclosure and transition.

CAMA 2020 and insurance contracts

The Companies and Allied Matters Act 2020 (CAMA 2020) requires statements that follow IFRS and give a true and fair view.

Objective and scope

IFRS 17 was issued in May 2017 to replace the interim standard IFRS 4. It has applied to annual periods beginning on or after 1 January 2023 (early application was allowed if IFRS 9 was also applied). Its aims are comparability, better information (current estimates, discounting and risk) and a faithful picture of the insurance business. Revenue follows the delivery of cover and not the receipt of premiums.

Inside the scope

• Insurance contracts issued (including reinsurance contracts issued).
• Reinsurance contracts held.
• Investment contracts with discretionary participation features, if the entity also issues insurance contracts.

Outside the scope

• Insurance contracts where the entity is the policyholder (other than reinsurance held).
• Manufacturers’ warranties given with the sale of goods, employers’ benefits, and financial guarantee contracts unless the issuer has said it treats them as insurance.

The standard applies to the contract, whoever issues it. A non-insurer that issues contracts that meet the definition applies IFRS 17 to them.

The definition and its elements

• Significant insurance risk: there must be a scenario with a loss on a present value basis. It is judged at the contract level, using the chance and size of loss.
• Insured event: a specified uncertain future event (death, accident, illness, fire, theft). The uncertainty can be about whether, when or how much.
• Insurance risk and financial risk: financial risk is the risk of changes in interest rates, prices, exchange rates and similar variables. A contract with only financial risk is not insurance and follows IFRS 9.

Separating components

• Embedded derivatives are separated and measured under IFRS 9 if they are not closely related to the host contract, would be a derivative on their own. The whole contract is not at fair value through profit or loss.
• Distinct investment components (not highly interrelated with the insurance and sold or able to be sold separately) are separated and follow IFRS 9. A non-distinct investment component stays inside IFRS 17 but is excluded from insurance revenue and insurance service expenses.
• Distinct goods or services other than insurance cover are separated and follow IFRS 15.

Level of aggregation

1. Portfolios: contracts with similar risks that are managed together (for example all motor contracts).
2. Groups by profitability at least three: onerous at initial recognition; no significant possibility of becoming onerous; the remaining contracts.
3. Annual cohorts: contracts issued more than one year apart are not in the same group.

The CSM is tracked for each group. Losses on onerous groups are recognised at once.

Recognition

A group is recognised at the earliest of:

• the start of the coverage period
• the date the first payment from a policyholder is due (or received, if there is no due date)
• for an onerous group, the date it becomes onerous

The general measurement model

The GMM is the default. A group is measured as the liability for remaining coverage and the liability for incurred claims.

• Fulfilment cash flows: (a) estimates of future cash flows (premiums, claims, claim handling and administration costs) that are current, explicit and unbiased; (b) an adjustment for the time value of money and financial risk, using discount rates that reflect the cash flows and current market conditions; (c) a risk adjustment for non-financial risk, by a technique such as confidence level, conditional tail expectation or cost of capital.
• Contractual service margin: at initial recognition it makes the group’s measurement nil, so there is no gain on day one. If the group is onerous, the CSM is nil and the loss is recognised at once.
• Subsequently: the CSM is released to profit or loss as services are provided, in line with the cover given (coverage units). Changes in estimates that relate to future service adjust the CSM. Changes that relate to current or past service go to profit or loss at once. If a future-service adverse change exceeds the CSM, the excess is a loss.
• Liability for incurred claims: claims already incurred, including those reported but not settled and those incurred but not reported, at the current estimate of the fulfilment cash flows.

A convention point: the standard counts fulfilment cash flows as a net outflow (a liability). If premiums exceed claims, costs and the risk adjustment, the fulfilment cash flows are a net inflow, shown as a negative liability, and the CSM offsets it. Some books show the same amounts with the opposite sign. State your convention.

The premium allocation approach

An optional simplification when the coverage period of each contract is one year or less, or when the result would not differ materially from the GMM.

• At the start: LRC = premiums received less insurance acquisition cash flows. The LIC is nil.
• Later: LRC = brought forward + premiums received − acquisition cash flows paid + amortisation of those cash flows − insurance revenue recognised (and the investment component, if any).
• No CSM is calculated. Revenue follows the passage of time (straight-line) unless the pattern of risk differs. At each date the group is tested for being onerous. The LIC is measured as under the GMM.

The variable fee approach

Mandatory for contracts with direct participation features:

• the policyholder shares in a clearly identified pool of underlying items
• the insurer expects to pay a substantial share of the fair value returns
• a substantial proportion of the change in amounts paid is expected to vary with the fair value of the underlying items

Examples: unit-linked and with-profits contracts.

The insurer’s obligation is the fair value of the underlying items, and its fee is its share of that value less amounts it must pay regardless of returns. Changes in its share of the underlying items adjust the CSM and not profit or loss at once.

Modification and derecognition

• A substantive modification (one that would have changed the grouping or terms as for a new contract) leads to derecognition of the old contract and recognition of a new one.
• A modification that is not substantive adjusts the existing contract, with the effect in the CSM or profit or loss.
• A contract is derecognised when it is extinguished (discharged, cancelled or expired) or substantively modified. Any remaining CSM and fulfilment cash flows are removed.

Presentation and disclosure

• Statement of financial position: insurance contract assets and liabilities and reinsurance contract assets and liabilities are shown separately, with no offset unless legally enforceable and intended.
• Profit or loss: insurance revenue (consideration for cover and services, excluding investment components); insurance service expenses (incurred claims and directly attributable costs); and insurance finance income or expenses (the unwinding of the discount and changes in rates), where part may be taken to other comprehensive income by policy choice. The insurance service result is separate from the finance result, so underwriting is shown apart from market movements.
• Disclosure: reconciliations of the opening and closing balances, by remaining coverage and incurred claims, for each model; significant judgements (inputs, risk adjustment technique and confidence level, whether VFA or PAA is used); and the nature and extent of risks, with sensitivity analysis, credit, liquidity and market risk and claims development.

Transition and amendments

IFRS 17 is applied retrospectively unless impracticable. Where that is impracticable, a modified retrospective approach or a fair value approach may be used to find the CSM at transition. The amendments of June 2020 deferred the effective date to 1 January 2023, simplified some requirements (such as acquisition cash flows and the scope of VFA) and added transition reliefs.

The rules in more depth

Why there is no day-one profit

The insurer has only promised cover. It has not yet provided it. Profit is earned as the cover is given, so it waits in the CSM.

Why losses are recognised at once

An expected loss on contracts already signed is a present obligation. Waiting would hide it.

Why future and past service changes differ

A change in the cost of cover still to come changes the expected profit of the group, so it moves the CSM. A change in the cost of claims already incurred is a result of the past and goes to profit or loss.

Effect on analysis

Insurance revenue is no longer the premiums written. Analysts watch the CSM balance and its release as the guide to future profit.

Worked examples

1. It is a warranty provided by the manufacturer in connection with the sale of its goods, and it covers defects in the product sold.
2. IFRS 17 excludes it. XYZ applies International Accounting Standard (IAS) 37 (or IFRS 15 if the warranty is a separate performance obligation).
3. If XYZ sold separate extended cover that transferred significant insurance risk (for example accidental damage), that cover could be an insurance contract.

1. One portfolio, divided into three groups. All were issued on one date, so there is only one annual cohort.
2. The onerous group is recognised on 1 January 2027, when it is onerous, so that the loss is shown at once.
3. The other two groups are recognised on 15 January 2027, the earlier of the due date of the first premium and the start of cover.

1. Scenario A, not onerous:
   premiums 800 − claims 650 − costs 80 = 70
   less risk adjustment 40 = a net inflow of ₦30m.
2. CSM = ₦30m (so no profit on day one).
3. Liability at initial recognition = − 30 (fulfilment cash flows) + 30 (CSM) = nil.
4. Scenario B, onerous.
   (premiums ₦750m): 750 − 650 − 80 = 20
   less 40 = a net outflow of ₦20m.
5. CSM = nil. Liability = ₦20m. Loss in profit or loss at once = ₦20m.

1. If the future claims estimate rises by ₦10m, the CSM falls to ₦20m. No loss arises.
2. If it rises by ₦40m, the CSM falls to nil, and the extra ₦10m is a loss in profit or loss, because the CSM cannot be negative.
3. If the rise relates to claims already incurred, it goes to profit or loss and the CSM is not changed.

1. LRC at the start.
   1,200 − 120 = ₦1,080m.
2. Insurance revenue for three months.
   1,200 × 3/12 = ₦300m.
   Amortisation of acquisition cash flows = 120 × 3/12 = ₦30m.
3. LRC after three months.
   1,080 + 30 − 300 = ₦810m.
4. Profit or loss.
   insurance revenue 300; insurance service expenses 100 + 30 = 130; insurance service result = ₦170m.

How to score full marks

• Test the definition first (significant insurance risk and an insured event) and then the exclusions.
• Group before you measure: portfolio, profitability groups, annual cohorts.
• Give the recognition date with the earliest-of test.
• Show the build-up of fulfilment cash flows, the risk adjustment and the CSM, and say which sign convention you use.
• Say the loss is recognised at once for an onerous group.
• Choose the model (GMM, PAA, VFA) and give the reason.
• Present revenue, service expenses and finance items separately.

Common mistakes in the exam

• Applying IFRS 17 to a manufacturer’s warranty or to a contract where the entity is the policyholder.
• Recognising a profit at the start of a group that is not onerous.
• Making the CSM negative.
• Mixing groups issued more than a year apart.
• Using premiums received as revenue.
• Applying the PAA to contracts with cover over one year without a test.
• Putting changes in past service into the CSM.

Quick revision

• Scope: insurance contracts issued, reinsurance held, certain investment contracts. Not the policyholder’s own cover or warranties.
• Groups: onerous, no significant chance of becoming onerous, remaining; one-year cohorts.
• GMM: fulfilment cash flows plus CSM. No day-one gain; immediate loss if onerous.
• PAA: simplified for cover of one year or less. VFA: direct participation.
• Present insurance revenue, service expenses and finance income or expenses.
• CAMA 2020: ss. 377(1), 378, 379 to 381, 374(1), 385, 404(7).

Practice questions

These are original questions written in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one before you open the answer. Full model answers follow the written questions.

Recall check: multiple choice

The real ICAN paper has no multiple-choice section. These questions are for quick recall. The written questions that follow are closer to the exam.

Written questions

Model answers

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