IFRS 17: Insurance contracts
The general measurement model (fulfilment cash flows plus the contractual service margin), onerous contracts, and the premium allocation approach.
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What it is: How insurance companies account for the policies they sell. It replaced IFRS 4 from 1 January 2023.
The key idea: an insurer measures its contracts at the present value of expected future cash flows, plus a risk adjustment, plus any unearned profit (the contractual service margin, CSM). The profit is released as the cover is provided. If a group of contracts is expected to lose money, the loss is recognised immediately.
Example. Premiums worth 1,000; expected claims and costs worth 800; risk adjustment 50. Expected profit = 150, held as the CSM and released over the cover period.
Key words
- Insurance contract
- A contract under which one party (the insurer) accepts significant insurance risk from another (the policyholder) by agreeing to compensate them if a specified uncertain future event harms them.Example: A car insurance policy.
- Fulfilment cash flows
- The present value of estimated future cash flows (premiums in, claims and costs out), discounted for the time value of money, plus a risk adjustment for non-financial risk.Example: PV outflows 800 − PV premiums 1,000 + risk adjustment 50 = (150).
- Risk adjustment
- The compensation the insurer requires for bearing uncertainty about the amount and timing of cash flows from non-financial risk.Example: 50 added for the uncertainty in future claims.
- Contractual service margin (CSM)
- The unearned profit in a group of contracts, recognised in profit or loss as insurance services are provided.Example: CSM of 150 released over 3 years.
- Onerous contract
- A group of contracts expected to make a loss at initial recognition. The loss goes straight to profit or loss.Example: Expected outflows exceed premiums.
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Grouping
Contracts are grouped into portfolios (similar risks managed together), then split into: contracts onerous at initial recognition; those with no significant possibility of becoming onerous; and the rest. Contracts issued more than one year apart can’t be in the same group (annual cohorts).
General measurement model
| Building block | What it is |
|---|---|
| 1. Estimates of future cash flows | Premiums, claims, benefits and expenses within the contract boundary |
| 2. Discounting | Adjust for the time value of money and financial risk |
| 3. Risk adjustment | For non-financial risk |
| = Fulfilment cash flows | |
| 4. Contractual service margin | Unearned profit. If the fulfilment cash flows are a net inflow, the CSM equals it, so no profit on day one. If a net outflow, there is no CSM and the loss goes to P/L. |
The CSM is released to profit or loss as insurance contract services are provided (based on coverage units). Changes in estimates about future service adjust the CSM rather than profit.
Other approaches
- Premium allocation approach (PAA): a simplification, allowed mainly when the coverage period is one year or less (or it gives a similar result). Similar to recognising premiums over the cover period as unearned premium.
- Variable fee approach: for contracts with direct participation features (the policyholder shares in a pool of investments).
Presentation
Insurance revenue shows the services provided in the period; it excludes investment components (amounts repaid to the policyholder whatever happens). Insurance service result and insurance finance income or expenses are shown separately.
Worked example
An insurer issues a group of 3-year contracts. At initial recognition (all present values):
| Profitable group | Onerous group | |
|---|---|---|
| PV of premiums (inflows) | (1,000) | (1,000) |
| PV of claims and expenses (outflows) | 800 | 1,100 |
| Risk adjustment | 50 | 50 |
| Fulfilment cash flows | (150) net inflow | 150 net outflow |
| Contractual service margin | 150 | nil |
| Liability at initial recognition | 0 | 150 |
| Profit or loss on day one | nil | 150 loss |
For the profitable group, the CSM of 150 is released as cover is given, roughly 50 a year if coverage is even (ignoring interest accretion on the CSM). For the onerous group, the 150 loss is recognised immediately.
Practice questions
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