IFRS 17 - Actuarial Science - Part 1
IFRS 17 Insurance Contracts is a new accounting
standard that entities are expected to apply for reporting periods beginning on
or after 1 January 2023 (though earlier application is permitted).
An accounting standard is a common set of principles,
standards, and procedures that define the basis of financial accounting
policies and practices.
It supersedes IFRS 4 Insurance Contracts as
it was an interim standard for Insurance Contracts and lacked
comparability, transparency, usefulness and qualify of information for insurers
and key stakeholders. IFRS17 aims to increase the usefulness, comparability,
transparency and quality of insurers financial statements.
CSM (Contractual Service Margin)
A fundamental concept introduced by IFRS 17 is the contractual
service margin (CSM). The CSM, in most instances, represents the
unearned profit that an entity expects to earn as it provides services.
IFRS17 is a principles-based standard, so entities must
apply significant judgement when determining the inputs, assumptions and
techniques they use to determine the CSM at each reporting period.
RA (Risk Adjustment)
This is the adjustment for the compensation a company
requires for bearing Non-Financial Risk. Non-financial risks include Mortality,
Surrender/ Lapses, Expense, Trends, etc. The insurer needs to make a separate
adjustment by setting an amount aside for RA to account for Non Financial
Risks.
Let’s understand how CSM is calculated with the help
of an example…
PV of
Cash In-Flows (at time 0) |
PV of
Cash Outflows (at time 0) |
Risk
Adjustment (at time 0) |
100 |
60 |
20 |
CSM = PV of Cash Inflows – PV of Cash Outflows -
Risk Adjustment
In the above example, we have more Inflows and less outgo’s, which means that at time zero the insurer recognizes and unearned profit of 20 units (i.e., 100 - 60 - 20 = 20). The insurer will amortize CSM over the total duration of the contract and will release it in the form of profits into its Profit and Loss statement, as it provides services. The release of CSM is determined using the method called Coverage Units.
𝐒𝐮𝐛𝐬𝐜𝐫𝐢𝐛𝐞 𝐭𝐨 𝐦𝐲 𝐘𝐨𝐮𝐓𝐮𝐛𝐞 𝐂𝐡𝐚𝐧𝐧𝐞𝐥 𝐭𝐨 𝐥𝐞𝐚𝐫𝐧 𝐏𝐲𝐭𝐡𝐨𝐧 𝐚𝐧𝐝 𝐒𝐐𝐋 𝐟𝐨𝐫 𝐀𝐜𝐭𝐮𝐚𝐫𝐢𝐞𝐬
Release of CSM
A
key feature of IFRS17 is that it allows profits to be recognized as and when
they are earned, i.e. some amount of profit is released out of the CSM every
year over the total duration of the contract. This ensures that profits are
distributed all over the duration of contact rather than just being recognized
at time 0, with losses in further years.
This
could be explained with the help of an example. Below is a contract with 5 year
duration and a CSM of 100 recognized at time 0:
Term |
CSM |
Release Pattern |
CSM Released |
Remaining CSM after Release |
1 |
100 |
20% |
(20) |
80 |
2 |
80 |
25% |
(20) |
60 |
3 |
60 |
33% |
(20) |
40 |
4 |
40 |
50% |
(20) |
20 |
5 |
20 |
100% |
(20) |
- |
In
the above example we used a straight-line method to release the same of amount
of CSM i.e., 20 units over the 5 year duration of the contract. In real world the
release pattern could be different and may not necessarily be straight line.
IFRS17
describes coverage units as a method to determine the release of CSM.
The
insurers need to identify the amount of coverage provided by each contract in
the portfolio (called coverage units). E.g. taking in-force policies as a proxy
to determine the amount of coverage provided over the total duration of the contract.
We
have covered CSM in our 1st Blog. The upcoming blogs would be
covering further topics of IFRS17.
Article written by: Omang Gaba
𝐒𝐮𝐛𝐬𝐜𝐫𝐢𝐛𝐞 𝐭𝐨 𝐦𝐲 𝐘𝐨𝐮𝐓𝐮𝐛𝐞 𝐂𝐡𝐚𝐧𝐧𝐞𝐥 𝐭𝐨 𝐥𝐞𝐚𝐫𝐧 𝐏𝐲𝐭𝐡𝐨𝐧 𝐚𝐧𝐝 𝐒𝐐𝐋 𝐟𝐨𝐫 𝐀𝐜𝐭𝐮𝐚𝐫𝐢𝐞𝐬
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