IFRS 17 Part-1

Let's dive deep into this International Financial Reporting Standards for Insurance Contracts

Sat Dec 2, 2023

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 quality 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.

CSM = PV of Cash Inflows – PV of Cash Outflows - Risk Adjustment

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 RA is similar to the Solvency II risk margin. 

RA can be calculated via VaR (Value at Risk) or CTE (Conditional Tail expectation) or CoC (Cost of capital) method. IFRS 17 does not specify the confidence level at which the RA should be set – this is at the choice of the insurer.

Let’s understand how this works with the help of an example…

In the above example, we have more Inflows and less outgo’s, which means that at time zero the insurer has a profit of 20 (i.e., 100 - 60 - 20 = 20). This amount is essentially the unearned profit is known as the CSM (contractual service margin). The insurer will release CSM in the form of profits into its Profit and Loss statement over the years, as it provides services. The release pattern of CSM is determined using the Coverage Units.

Coverage Units

The CSM will be recognized at time 0 as an unearned profit and will be released over the time using a release pattern. The released amount of CSM would be recognized as profit over the years in P&L accounts.

This could be explained with the help of the following example, let's consider the CSM is $100.

In the above example we used a straight-line method to release CSM over the 5 year term.

IFRS17 describes coverage units as a method to determine the release of CSM. This could be determined to reflect the quantity of benefits and the effective duration of the product. 

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Kamal Sardana
Qualified Actuary from IFoA with expertise in US GAAP, Solvency II and Python.

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