Advanced Financial Accounting I

Chapter Four
Accounting for Insurance Contracts
(IFRS 17)
 Components of the chapter

Insurance Contract Aggregation

Initial Recognition of Insurance Contracts

Initial Measurement of Insurance Contracts

Estimated Future Cash Flows

Discount Rates Used

Risk Adjustment for Non-Financial Risk

Contractual Service Margin

Subsequent Measurement of Insurance Contracts

Modification of Insurance Contracts

Derecognition of Insurance Contracts

Presentation of Insurance Contract Information

 Definitions of terms
• What mean contracts??

• ‘Contract’ is an agreement between two or more parties that creates

enforceable rights and obligations.

• It can be written, oral or implied by the entity’s customary business

practices.
 What mean Insurance contracts ??

• “acceptance of significant insurance risk” (IFRS 17) .

• “presence of significant insurance risk transferred from the holder of the contract to

the issuer” (IFRS 4).

• “a contract under which one party (the insurer) accepts significant insurance risk

from another party (the policy holder) by agreeing to compensate the policyholder if

a specified uncertain future event (the insured event) adversely affects the

policyholder.”
 What mean Insurance contracts ??
• A contract is not an insurance contract if it exposes the issuer only to
financial risk but not to significant insurance risk. However, contracts
that expose the issuer to both financial risk and significant insurance
risk are insurance contracts.
• For example, a life insurance contract with a guaranteed minimum rate
of return (financial risk) and a promised death benefit that may
significantly exceed the policyholder’s account balance (insurance
risk) is an insurance contract.
 Definitions of terms…………
• Insurer. The party that has an obligation under an insurance contract
to compensate a policyholder if an insured event occurs.

• Policyholder. A party that has a right to compensation under an

insurance contract if an insured event occurs.

• Insured event. An uncertain future event that is covered by an

insurance contract and creates insurance risk.
 Definitions of terms…………
Financial risk. The risk of a possible future change in one or more of
a specified interest rate, financial instrument price, commodity price,
foreign exchange rate, index of prices or rates, credit rating or credit
index or other variable, provided in the case of a nonfinancial variable
that the variable is not specific to a party to the contract.

Insurance risk: Risk, other than financial risk, transferred from the
holders of a contract to the issuer.
Insurance Vs financial risk
 Definitions of terms…………
• Financial guarantee contract. A contract that requires the issuer to
make specified payments to reimburse the holder for a loss it incurs
because a specified debtor fails to make payment when due in
accordance with the original or modified terms of a debt instrument.

• Guaranteed benefits. Payments or other benefits to which a particular

policyholder has an unconditional right that is not subject to the
contractual discretion of the issuer.
 Definitions of terms…………
• Guaranteed element. An obligation to pay guaranteed benefits,
included in a contract that contains a discretionary participation
feature.
• Insurance asset. An insurer’s net contractual rights under an
insurance contract.
• Insurance liability. An insurer’s net contractual obligations under an
insurance contract.
 Definitions of terms…………
• Reinsurance contract. An insurance contract issued by one insurer
(the reinsurer) to compensate another insurer (the cedant) for losses on
one or more contracts issued by the cedant.
• Cedant. The policyholder under a reinsurance contract.
• Reinsurer The party that has an obligation under a reinsurance
contract to compensate a cedant if an insured event occurs.
• Portfolio of contracts: Insurance contracts that are subject to similar
risks and that are managed together.
 Definitions of terms…………
• Onerous contracts: A group of contracts becomes onerous if its
estimated cash outflows exceed its estimated cash inflows.
• Discount rates: Discount rates reflect the characteristics of the cash
flows arising from the group of insurance contracts (for example, the
timing, currency and liquidity of the cash flows). They are based on
current observable interest rates, with adjustments being made to these
observable rates to align them with the characteristics of the group of
insurance contracts.
• Risk adjustment: The risk adjustment is an explicit adjustment to
reflect the uncertainty in timing and in amount of future cash flows
 Definitions of terms…………
• Contractual service margin (CSM) The contractual service margin
represents the profit that the company expects to earn as it provides
insurance coverage.
• This profit is recognized in profit or loss over the coverage period as
the company provides the insurance coverage.

• It is a component of the carrying amount of the asset or liability for a

group of insurance contracts representing the unearned profit the
entity will recognize as it provides services under the insurance
contracts in the group.
 CSM………..

CSM is determined as the risk adjusted present value of the cash

inflows and outflows.
As such, at inception it captures the expected profitability of the
contract over its entire expected life.

• If expected to be loss making, CSM is ‘negative’ and recognized in profit or loss

(onerous contract).
• If expected to be profit making, CSM is ‘positive’ and recognized as a liability
(unearned profit).
 Scope of insurance contract
•An entity shall apply IFRS 17 Insurance Contracts to: [IFRS
17:3]
1. Insurance contracts, including reinsurance contracts, it
issues;
2. Reinsurance contracts it holds; and
3. Investment contracts with discretionary participation
features it issues, provided the entity also issues
insurance contracts.
Excludes from scope of Insurance contract
• IFRS 17 does not apply to the following contracts.

1. Warranties issued directly by a manufacturer, dealer or retailer in

connection with a sale of its goods or services to customer.
(IFRS 15 – IAS 37 Provisions, Contingent Liabilities and Contingent Assets).
2. Employers’ assets and liabilities under employee benefit plans.
( IAS 19 Employee Benefits – IFRS 2 Share-based Payment).
3. Retirement benefit obligations reported by defined benefit
retirement plans. (IAS 26 Accounting and Reporting by Retirement Benefit
Plans).
Excludes from scope of Insurance contract
3. Contractual rights or contractual obligations that are contingent on
the future use of, or right to use, a non-financial item.
(IFRS 15 – IFRS 16 Leases – IAS 38 Intangible Assets).
4. Residual value guarantees provided by a manufacturer, dealer or
retailer, and a lessee’s residual value guarantee embedded in a lease.
(IFRS 15 – IFRS 16).
5. Financial guarantee contracts – unless the issuer meets certain
requirements and makes an irrevocable election to apply IFRS 17 to
the contract.
(IAS 32, IFRS 7 and IFRS 9)
Excludes from scope of Insurance contract
6. Contingent consideration payable or receivable in a business
combination. (IFRS 3 Business Combinations).

7. Insurance contracts in which the entity is the policyholder, unless

these contracts are reinsurance contracts held by the entity.
(IAS 37 & IAS 16).
 Insurance Contract Aggregation

Aggregating contracts into groups

• The aggregation of contracts into groups is required on initial

recognition for all contracts in the scope of IFRS 17.

• The grouping of individual contracts under IFRS 17 is performed in a

way that limits the offsetting of profitable contracts against onerous
ones, having regard to how insurers manage and evaluate the
performance of their business.
 The level of aggregation
• An entity’s rights and obligations arise from individual contracts with policyholders.
• However, a fundamental aspect of much insurance activity is that the entity issues a
large number of similar contracts knowing that some will result in claims and others
will not.
• The large number of contracts reduces the risk that the outcome across all the
contracts will differ from that expected by the entity.
• This aspect of insurance activity, combined with the requirements of IFRS 17 that
require different timing of recognition of gains and losses (for example losses on
onerous contracts are recognized earlier than gains on profitable contracts).
• Meaning that the level of aggregation at which contracts are recognized and
measured is an important factor in the representation of an entity’s financial
performance.
 Aggregation
• An entity shall identify portfolios of insurance contracts.
• A portfolio comprises contracts subject to similar risks and managed
together.
• Contracts within a product line would be expected to have similar risks and
hence would be expected to be in the same portfolio if they are managed
together.
• Contracts in different product lines (for example single premium fixed
annuities compared with regular term life assurance) would not be expected
to have similar risks and hence would be expected to be in different
portfolios.
An entity divides each portfolio into a minimum of:

1. a group of contracts that are onerous on initial recognition, if there

are any
2. a group of contracts that, on initial recognition, have no significant
possibility of becoming onerous subsequently, if there are any; and
3. a group of any remaining contracts in the portfolio.

The objective is to identify contracts that fit into these groups at an

individual contract level
Example of aggregation for life insurance entity
 Initial recognition of Insurance contract
• An entity should recognize the obligations and associated benefits arising from a
group of insurance contracts from the time at which it accepts risk.
• There are several criteria to determine when an entity recognizes a group of
insurance contracts.
• When to recognize a group of contracts??
• An entity recognizes a group of insurance contracts that it issues from the earliest of:
1. the beginning of the coverage period of the group of contracts;
2. the date when the first payment from a policyholder in the group becomes due; and
3. for a group of onerous contracts, when the group becomes onerous if facts and
circumstances indicate that there is such a group.
 If there is no due date specified in the contract, then it is considered to be the date
when the first payment is received from the policyholder.
 Recognition……
• A group of contracts initially recognized in a reporting period only
includes contracts that individually meet one of these three recognition
criteria by the reporting date.
• New contracts are added to the group in subsequent reporting periods in
which any new contracts are recognized.

• Why the recognition date is important?

1. To determine the CSM: On initial recognition

2. To determine the discount rate on initial recognition
Example: Recognition of an insurance contract
• Entity X is bound by the terms of an insurance contract at 1 June 2023.
The coverage period of the insurance contract starts on 1 January 2024,
which is also the premium due date. This example assumes that the group
comprises only this contract.
• Recognition: On 1 June 2023 and at each reporting date between 1 June
2023 and 31 December 2023 – i.e. the pre-coverage period. Entity X
assesses whether any facts or circumstances indicate that the group is
onerous. If it is, then X recognizes the group on the date when the group
becomes onerous. If it is not, then X recognizes the group on 1 January
2024.
 Measurement of insurance contract
• Measurement of an insurance contract incorporates all available
information, in a way consistent with observable market information.
Types of Measurement model
1. General Measurement Model (GMM) - default model for all
insurance contract.
2. Variable fee approach (VFA) - (modification) model for direct
participating business (DPF).
3. Premium Allocation Approach (PAA) - (simplification) simplified
measurement for short term contracts.
 General Measurement Model (GMM)
• Under IFRS 17, insurance contracts are aggregated into groups.
• When measuring a group of insurance contracts, IFRS 17 identifies two
key components of the liability:
1. the of fulfillment cash flows and.
2. the CSM.

• For profitable groups of contracts, the CSM has an equal and opposite
value on initial recognition to the fulfillment cash flows, plus any cash
flows arising from the group at or before that date.
 Initial measurement
• The liability (or asset) recognized for a group of insurance contracts is measured,
on initial recognition and subsequently, as the sum of four constitutes:
1. the fulfilment cash flows, which are a risk-adjusted, explicit, unbiased and
probability-weighted estimate of the present value of expected cash flows that
will arise as the entity fulfils the contracts.
2. An adjustment to reflect the time value of money (discounting) and the
financial risks related to the expected cash flows (to the extent that they are not
already included in the estimates of expected cash flows).
 Initial measurement
3. An explicit risk adjustment for non-financial risk: to reflect the
compensation that the entity requires for bearing the uncertainty
about the amount and timing of cash flows that arise from non-
financial risk

4. The Contractual service margin (CSM), which is the amount that

represents the unearned profit that the entity will recognize in profit
or loss as services are provided.
 Measurement exhibit.

Note: Depending on the facts and circumstances, the size and direction of the components could vary.
If the total mentioned above is a net cash outflow, then
the group of contracts is onerous.
 1. Expected (mean) cash flows
• “expected value of cash flows” represents the mean of the (typically
unknown) probability distribution of cash flows.
• Expected cash flows: Current, explicit, unbiased and probability-
weighted estimates of expected cash flows within the boundary of
each contract in the group.
• “fulfilment cash flows” as including the risk adjustment for
nonfinancial risk and the effect of discounting..
• Fulfilment cash flows is a probability-weighted estimate of cash
inflows and outflows that will arise as the entity fulfils the contract.
Expected cash flows
Cash flows that are included in the estimates
The importance of the contract boundary

• The measurement of a group of insurance contracts includes all of the

expected cash flows within the boundary of each contract within the
group.

• The contract boundary distinguishes the expected cash flows that

relate to existing insurance contracts from those that relate to future
insurance contracts.
 Cash flows that are within the contract boundary

• Cash flows within the boundary of an insurance contract are those that
relate directly to the fulfilment of the contract, and include those over
which the entity has discretion, including the following.
Premiums and any other costs _ Premium adjustments
specifically chargeable to the – Instalment premiums
policyholder – Any additional cash flows that result from those premiums
Payments to, or on behalf of, a – Incurred claims that have not yet been paid
policyholder – Incurred claims that have not yet been reported
– Future claims
– Payments that vary depending on returns on underlying items
Costs of providing benefits in kind Replacement of stolen articles
Cash flows that are within the contract boundary
Payments in a fiduciary capacity to meet • Payment of death duties or inheritance tax
the policyholder’s tax obligations
Potential cash inflows from recoveries on • Salvage and subrogation
claims, as long as they have not been
recognized as a separate asset
• Premium taxes
Transaction-based taxes and levies that
arise directly from existing insurance• Value-added taxes and goods and services taxes – Fire service
contracts or are attributable to them levies
• Guarantee fund assessments
Claim handling costs – investigating, • Legal and loss adjusters’ fees
processing and resolving claims • Internal costs of investigating claims and processing claims
payments
Policy administration and maintenance  Costs of billing premiums
costs  Costs of handling policy changes (e.g. conversions)
 Recurring commissions expected to be paid to intermediaries
if the policyholder continues paying premiums within the
boundary of the insurance contract
 B. Cash flows that are outside the contract boundary

1. Cash flows related to the following items (which are accounted for
separately): -
A. investment returns;
B. components separated from the insurance contract;
C. reinsurance contracts held; and
D. income tax payments or receipts that the entity does not pay or
receive in a fiduciary capacity or are not specifically chargeable to
the policyholder under the terms of the contract.
2. Cash flows relating to costs that are not directly attributed to the portfolio
of insurance contracts (e.g. some product development and training costs)
Cash flows that are outside the contract
boundary….
3. Cash flows arising from abnormal amounts of wasted labor or other
resources used to fulfill the contract.
4. Cash flows between different components of the reporting entity that
do not change the amount that will be paid to policyholders (e.g.
policyholder funds and shareholder funds).
5. Cash flows that may arise from future insurance contracts (e.g. those
outside the boundary of existing insurance contracts).
 2. Discounting
• Discounting adjusts the estimates of expected cash flows to reflect the time
value of money and the financial risks associated with those cash flows (to
the extent that the financial risks are not already included in the cash flow
estimates).
• The discount rates applied to the estimates of expected cash flows:
• Reflect the time value of money, the characteristics of the cash flows and
the liquidity characteristics of the insurance contracts;
• Are consistent with observable current market prices; and
• Exclude the effects of factors that affect observable market prices used in
determining the discount rate, but do not affect the expected cash flows of
the insurance contract.
 3. Risk adjustment for non-financial risk
• Risk adjustment assessment of uncertainty about future cash
flows and cost to the entity.
• The estimate of the present value of the future cash flows is
adjusted to reflect the compensation that the entity requires
for bearing the uncertainty about the amount and timing of
future cash flows that arises from non-financial risk.
 Interpretation
• To determine the risk adjustment, an entity measures the compensation that
it would require to make it indifferent between fulfilling a liability from
each of Contracts 1 and 2, and a contract with a liability that is fixed at 50.
• Given the uncertainty in the amount of cash outflows, an entity would
generally require additional compensation for both Contracts 1 and 2.

• However, given the higher level of variability in the amount of cash

outflows in Contract 1, it would generally require greater compensation for
Contract 1 than for Contract 2.
Risk adjustment Estimation technique
 4. Contractual service margin
The final step in measuring a group of insurance contracts on initial recognition is to
determine the unearned profit.
The CSM represents the unearned profit of the group of insurance contracts that the entity
will recognize as it provides services in the future. This is measured on initial recognition
of a group of insurance contracts at an amount that, unless the group of contracts is
onerous, results in no income or expenses arising from.

A. The initial recognition of an amount for the FCF;

B. The derecognition at that date of any asset or liability recognized for insurance
acquisition cash flows; and
C. Any cash flows arising from the contracts in the group at that date.
Example 1—Measurement on initial recognition

• An entity issues 100 insurance contracts with a coverage period of

three years. The coverage period starts when the insurance contracts
are issued. It is assumed, for simplicity, that no contracts will lapse
before the end of the coverage period.
• The entity expects to receive premiums of Br. 900 immediately after
initial recognition; therefore, the estimate of the present value of the
future cash inflows is Br. 900.
 Example………..cont’d
• The entity estimates the annual cash outflows at the end of each year as follows:
1. In Example 1A, the annual future cash outflows are Br. 200 (total Br. 600). The entity
estimates the present value of the future cash flows to be Br. 545 using a discount rate
of 5% a year that reflects the characteristics of those cash flows determined.
2. In Example 1B, the annual future cash outflows are Br. 400 (total Br. 1,200). The
entity estimates the PV of the future cash flows to be Br. 1,089 using a discount rate of
5% a year that reflects the characteristics of those cash flows determined.
3. The entity estimates the risk adjustment for non-financial risk on initial recognition as
Br. 120.
4. In this example all other amounts are ignored, for simplicity.
 Example’s solutions
Example 1A Example 1B
Estimates of the PV of future cash inflows 900 900

Estimates of the PV of future cash outflows (545) (1,089)

Estimates of the NPV of future cash flows 355 (189)
Risk adjustment for non-financial risk (120) (120)
Fulfilment cash flows (a) 235 (309)
Contractual service margin (CSM) 235 (b) _ (c)
Insurance contract (asset) / liability on initial recognition (d) _ 309 (c)
Insurance service expenses _ 309 (c)
Loss recognized in the year _(b) (309)
a. fulfilment cash flows comprise estimates of future cash flows,
adjusted to reflect the time value of money and the financial risk
related to those future cash flows and a risk adjustment for non-
financial risk.

b. the entity measures the contractual service margin on initial

recognition of a group of insurance contracts at an amount that
results in no income or expenses arising from the initial recognition
of the fulfilment cash flows. Consequently, the contractual service
margin equals Br. 235.
c. The entity concludes that these insurance contracts on initial
recognition are onerous because the fulfilment cash flows on initial
recognition are a net outflow.

The entity will group those contracts separately from contracts that
are not onerous. The entity recognizes a loss in profit or loss for the
net outflow, resulting in the carrying amount of the liability for the
group being equal to the fulfillment cash flows, and the CSM of the
group is zero.

d. The entity measures the group of insurance contracts on initial

recognition at the total of the fulfillment cash flows and the
contractual service margin (0+309).
 Immediately after initial recognition, the entity receives the
premium of Br. 900 and the carrying amount of the group of
insurance contracts changes as follows:
Example 1A Example 1B

Estimates of the PV of future cash inflows _ _

Estimates of the PV of future cash outflows 545 1,089
Estimates of the NPV of future cash flows 545 1,089
Risk adjustment for non-financial risk 120 120
Fulfilment cash flows 665 1,209
Contractual service margin (CSM) 235 _
Insurance contract (asset) / liability immediately after initial recognition 900 1,209
 Example 2—Subsequent measurement
• Example 2 uses the same fact pattern as Example 1A, In addition:
1) In Year 1 all events occur as expected and the entity does not change
any assumptions related to future periods;
2) In Year 1 the discount rate that reflects the characteristics of the cash
flows of the group remains at 5% a year at the end of each year (those
cash flows do not vary based on the returns on any underlying items);
3) Risk adjustment for non-financial risk is recognized in profit or loss
evenly in each year of coverage; and
4) Expenses are expected to be paid immediately after they are incurred
at the end of each year.
 Example 2 …….Cont’d
• At the end of Year 2 the incurred expenses differ from those expected for
that year. The entity also revises the fulfilment cash flows for Year 3 as
follows:
• (a) in Example 2A, there are favorable changes in fulfilment cash flows
and these changes increase the expected profitability of the group of
insurance contracts; and
• (b) in Example 2B, there are unfavorable changes in fulfilment cash flows
that exceed the remaining contractual service margin, creating an onerous
group of insurance contracts.
 Example 2 solution
Initial recognition Year 1 Year 2 Year 3

Estimates of the PV of future cash inflows (900) _ _ _

Estimates of the PV of future cash outflows 545 372 191 _

Estimates of the NPV of future cash flows (355) 372 191 _

Risk adjustment for non-financial risk 120 80 40 _

Fulfilment cash flows (235) 452 231 _

Contractual service margin (CSM) 235

Insurance contract (asset) / liability on initial recognition _

 Example 3
• Entity E issues a group of insurance contracts with a coverage period of four
years. The contracts have no participation features or investment
components. At inception, the total premiums from the group of 1,500 are
received and insurance acquisition cash flows of 100 are paid.
• Entity E expects claims and expenses of 800 to be incurred evenly over the
coverage period, and no contracts to lapse. Claims are settled as they are
incurred.
• The risk adjustment for non-financial risk on initial recognition is 80. For
simplicity, this example assumes that it is released evenly over the coverage
period and that the discount rate is negligible.
• Over the coverage period, all events happen as expected and E does not
change any assumptions related to future periods.
Entity E measures the insurance contract liability on initial
recognition and at the end of each year as follows.

Initial Year 1 Year 2 Year 3 Year 4

recognition

Estimates of the PV of cash inflows 1,500 _ _ _ _

Estimates of the PV of cash outflows, including acquisition (900) (600) (400) (200) _
cash flows (100)

Risk adjustment (80) (60) (40) (20) _

Fulfilment cash flows 520 (660) (440) (220) _
a = CSM = ((520 – (520 / 4) = 390)) (520) (390)a (260) (130) _
Insurance contract liability _ (1,050) (700) (350) _
 Derecognition and contract modifications
An insurance contract is derecognized

1. When it is extinguished or,

2. In some cases when its terms are modified.

 Derecognition
• An entity derecognizes an insurance contract when it is extinguished
– i.e. when the specified obligation in the contract expires or is
discharged or cancelled.
• This is the point when an entity is no longer exposed to risk nor
required to transfer economic resources to satisfy the contract.
• Insurance contracts are also derecognized when they are modified if
certain criteria are met
 Contract modifications
• A modification of an insurance contract amends the original terms and
conditions of the contract (for example, extending or shortening the
coverage period or increasing the benefits in return for higher
premiums).

• Contract modification could be a result of an agreement between the

parties to the contract or a change in regulation.

• The exercise of a right included in the contract is not a modification.

 Contract modifications…….Cont’d.
• If the terms of a contract are modified in a way that would have significantly
changed the accounting for the contract had the new terms always existed, then
the modification triggers derecognition of the original contract and recognition of
a new contract.

• All other contract modifications are accounted for as changes in estimates of

fulfilment cash flows
 Presentation in the statement of financial position

•An entity shall present separately in the statement of financial position

the carrying amount of groups of:

[Link] insurance contracts issued that are assets;

[Link] contracts issued that are liabilities;
[Link] contracts held that are assets; and
[Link] contracts held that are liabilities.
End of chapter 4

Thank you!!