IFRS 17 is an International Financial Reporting Standard issued in May 2017 by the International Accounting Standards Board, which will be brought into effect from January 1, 2023. Introduced to serve as a replacement for IFRS 4, it totally overhauls accounting for insurance contracts and presents new requirements for data and processes which bear an effect on different teams across the organisation. Therefore, IFRS 17 establishes a set of risk management and general principles for recognising, presenting, measuring, and disclosing insurance contracts that fall within the scope of the standard.

The Scope of IFRS 17

IFRS 17 once effective shall be applicable to the following:

1. Insurance and reinsurance contracts issued by the entity;
2. Reinsurance contracts held by the entity;
3. Investment contracts having discretionary participation features (DPF) issued by the insurer, given that insurance contracts are also issued by the entity.

For the uninitiated, an insurance contract is essentially a contract in which one party, i.e. the issuer, accepts significant insurance risk from another party, i.e. the policyholder. Under this contract, the issuer agrees to provide compensation to the policyholder in case there arises a specified uncertain circumstance in the future (the insured event) that has an adverse impact on the policyholder. Insurance companies often have a huge portfolio of contracts that have to be assessed and managed for net liabilities. The calculation of insurance contract liabilities according to the general model of IFRS 17 will be the expected present value of future insurance cash flows along with a provision for non-financial risk.

Some of the contracts match the definition of an insurance contract but have the provision of services for a fixed fee as their main purpose. These issued contracts also come under the scope of the standard, unless they are applied to IFRS 15 (Revenue from Contracts with Customers) and as long as the below conditions are satisfied:

• The entity does not reflect the risk assessment linked to an individual customer in setting the contract price with that customer;
• The contract offers compensation to the customer by way of a service, as opposed to giving them cash payments;
• The insurance risk that the contract transfers stems majorly from the customer’s usage of services and not from uncertainty over the cost of those services.

The Importance of Level of Aggregation

Entities are required to identify portfolios of insurance contracts as per the guidelines of IFRS 17. IFRS 17 will enhance the quality of reporting by making the insurance sector more worthy of investment and also foster improved communication between insurance companies and their investors. Thus, the level of aggregation – which enables the grouping and management of contracts based on commonality of risks – that it requires is a gateway to a thoroughly transparent accounting process. The insurance business being rather unpredictable makes insurers and investors vulnerable to numerous risks. For appropriate risk management, it is vital that the financial statements of insurers consider insurance risks and the likely fluctuations in those risks in a clear and timely manner, as their financial health also affects the global economy.

Factors That Are Impacted by Level of Aggregation

Level of Aggregation is one of the important aspects of IFRS 17 as it impacts the following aspects:

• How Contractual Service Margin (CSM) is allocated to insurance revenue, and also how onerous contracts are identified.

CSM here represents the unearned profit of the portfolio of insurance contracts that the entity will recognise as it offers services in the future. A contract is considered onerous if the total of the fulfilment cash flows (FCF), any acquisition cash flows recognised earlier, and any cash flows emerging from the contract at that date is a net outflow.

• How the entity’s financial performance is presented overall for financial risk

Objectives of IFRS 17’s Requirement for Level of Aggregation

In majority of the situations, IFRS accounting standards recognise and measure the financials according to individual contracts. However, the structure of business of insurance companies is so complex in nature, that measurement of financials on the basis of individual contracts is not feasible. This is the prime reason behind the introduction of IFRS 17 guidelines, as it helps in contract aggregation to calculate and adjust the CSM.

The purposes that IFRS 17’s requirement for the level of aggregation intends to achieve are as under:

• Identifying onerous contracts at the initial stage, instead of hiding them by offsetting the losses against contracts that are profitable.
• Allowing for comparison of profit recognition across different industries and also between insurance and other industries.
• Identifying and closing open portfolios in a timely manner.
• Systematically allocating CSM throughout the coverage period to generate impactful profit trends.

According to IFRS 17, following are the three criteria on the basis of which insurers must aggregate insurance contracts into groups – product portfolio, degree of profitability, and year of issue.

Level of Aggregation on the Basis of Annual Cohorts

• One of the key requirements of IFRS 17 is dividing a portfolio of insurance contracts into ‘time buckets’ or ‘annual cohorts.’ Because of this, the group may not comprise contracts which have been issued more than a year apart. This issuing period on which a cohort can be based could be less than a year.
• The requirement of annual cohort for grouping is related to the timing of recognition of profit or loss in the insurance contract, i.e. the CSM. The amount of CSM that is released during every reporting period is on the basis of an average CSM for one coverage unit of the group. This depicts the ratio of service offered within the coverage period to the total service that is projected in the future until the group’s last contract becomes mature.

This concludes our first blog in the IFRS 17 series. Stay tuned to the next blog in this series – ‘An Insight Into Recognition Date and Contract Boundaries Under IFRS 17.’ Contact Deinon Insurance Brokers LLC at the email address treaty-solutions@deinon.ae for availing expert treaty and structured solutions.