Level of Aggregation

Unit of measurement that gives us an idea of profitability, volatility, granularity, and complexity of coverage.

Step 1
A portfolio of contracts is identified. They must share similar risks and be managed together. For instance, contracts with the same LOB may be in the same portfolio. This aggregation of insurance contracts is done when contracts are issued and they are not subsequently revised.

If the contracts in the portfolio have multiple LOBs, the portfolio can be considered at the contract level or LOB level if the contract’s components and risks are separable.

Step 2
The portfolio is further split into the following cohorts (the contracts cannot be issued more than a year apart and the maximum permitted length of the cohort is one year. A cohort can however be based on an issuing period that is less than one year”

a) A group of contracts that is onerous at initial recognition
b) A group of contracts that have no significant possibility of being onerous at initial recognition
c) A group of remaining contracts

For cohort (a) loss is realised in P/L at inception, otherwise, CSM is recognised and released gradually. The CSM of all these insurance contracts is determined in aggregate and not at the individual contract level. Consequently, the starting date and the end date of the cohort affect the pattern of CSM release over time.

As the contracts cannot be more than a year apart, new groups will be established every year. However, for the transition process, contracts in the cohort can be more than a year apart.

Grouping for reinsurance contracts held

The aggregation level for reinsurance contracts is distinct from other (re)insurance contracts.
Reinsurance contracts are not considered onerous because they are not undertaken for profit. The results of a group of reinsurance contracts are recognised as a net cost of purchasing or a net gain.

The contracts are thus grouped as follows:
a) A group of contracts with net gain at initial recognition
b) A group of contracts with no significant chances of making a net gain at initial recognition
c) A group of remaining contracts.

The initial recognition date of these contracts is also affected by whether they are proportional or not. The next blog will cover the recognition date and contract boundaries. Now we’ll look at the implications of aggregation level.

For a reinsurance contract held, the CSM can be positive or negative (Except in cases covered under paragraph 65A- where reinsurance purchase relates to events that have already occurred). When the group relates to an underlying insurance contracts group that was onerous at initial recognition, the CSM of reinsurance contracts held is adjusted to include the loss recovery in the same period as the expected loss.

How is it grouped?

IFRS 4 grouping was LOB or product portfolio based, whereas IFRS 17 grouping is granular. It keeps profitable and unprofitable contracts separate. Hence, the volatility under IFRS 17 will be much higher.

1) It can be assessed at a higher level than individual contracts if we has sufficient information.

2) If not, it examines each contract individually for onerousness, using

•  internal reporting data
•  the contract’s sensitivity to changes in assumptions about future performance; contracts with low levels of profitability will be more sensitive. This is done using the likelihood of changes in assumptions.

3) If contracts with different policyholders (and thus different contract prices) end up in different groups due to regulatory constraints, IFRS 17 does not require them to be recognised separately. However, this exemption only applies when specific constraint is imposed by the law. Non-regulatory characteristics that cause differences will be considered.

4) The contracts can be grouped across reporting periods if one of the recognition criteria is met. These will be considered open groups only for up to one year.

5) The contracts can be further disaggregated. It need not belong to only one of the above groups. For instance, the conracts can be divided further on the basis on the level of onerousness or profitability; or currency; or coverage.

Why would businesses price onerous contracts?

Companies usually keep a profit margin, but there may be reasons why onerous contracts are considered, for instance
1) To gain market share for a new product- a lower price would deter competitors
2) Premiums charged are regulated
3) Competition in the market

Can the group composition change?

No, the group composition shall not be reassessed.
This means that if a contract turns onerous post aggregation, it cannot be shifted to another cohort.
The contract is estimated based on internal information and the likelihood of changes in estimates. So, an actuary would require accurate and vast amounts of data to estimate these values.

Benefits of Grouping contracts

1) Cost Effective- the new requirements are applied to a group rather to each and every contract
2) Consistent measurement of contracts increases comparability across asset and geographic classes.
3) Grouped contracts allow for timely loss recognition and profit allocation. It gives you an idea of how profitable contracts are over time.
4) It also helps make onerous contracts visible.

However, to benefit from the grouping of contracts, companies will require an actuarial evaluation system that can apply the aggregation methodologies specified in IFRS 17. In laymen’s terms, the actuaries will have to start talking to the accountants!

For the right insurance solutions contact Deinon Insurance Brokers LLC via our website https://deinon.ae/treaty-structured-solutions/ or write to us at treaty-solutions@deinon.ae. Stay tuned for our next blog in the series on “Recognition date and contract boundaries”