Applying the General Measurement Model in IFRS 17 Insurance Contracts to a portfolio of insurance contracts
In this article, we explain, using a detailed example, how the ‘building blocks’ of the IFRS 17 General Measurement Model interact in the measurement of a portfolio of insurance contracts. This is the first in a series of articles where we will examine in more detail the accounting implications of each of the three measurement models available under IFRS 17, and follows on from our September 2021 edition of Accounting Alert, where we looked at the ‘building blocks of the General Measurement Model, and where we noted the existence of two alternative measurement models, i.e. the Premium Allocation Approach and the Variable Fee Approach, which may be used in certain circumstances.
The General Measurement Model we explain in this article is used for measuring most insurance contracts under IFRS 17.
This month, we explain, using a detailed example, how the ‘building blocks’ of the General Measurement Model interact in the measurement of a portfolio of insurance contracts.Building blocks of the General Measurement Model
As discussed in the September 2021 edition, the General Model comprises the following building blocks (identified in paragraph 32 of IFRS 17):
- Fulfilment cash flows, including:
- The insurer’s best estimates of the future cash inflows and cash outflows that relate directly to the fulfilment of the portfolio of contracts, including cash flows relating to any onerous contract liabilities
- An adjustment to reflect the time value of money and the financial risks related to the future cash flows, to the extent that the financial risks are not included in the estimates of the future cash flows, and
- A risk adjustment for non-financial risk
- A contractual service margin - represents the estimated unearned profit the entity will recognise as and when it provides insurance contract services to the policyholder in the future.
Let’s now look at a worked example to understand how these building blocks interact in the measurement of a portfolio of insurance contracts.
Example 1
BDO Pet Insurance Ltd has written 100 three-year insurance policies to commence on 1 July 2021. The policies insure the holder for up to 50% of any eligible veterinarian bills they incur in respect to their pets during the coverage period.
Each holder of a policy is required to pay an annual $90 premium, payable on the first day of each year of the coverage period. For the purposes of measuring the insurance contracts under IFRS 17, and based on past experience with similar types of insurance policies, BDO Pet Insurance Ltd adopts the following assumptions:
- Expected annual cash outflows flows are $7,000 per annum (comprising claims and administration costs)
- All insurance claims that are incurred during a year will be paid at the end of that year
- No policies will lapse during the coverage period and no extension periods are offered under the policy
- Discount rate of 5% per annum
- BDO Pet Insurance Ltd is not exposed to any material financial risk in respect to the insurance policies
- The risk adjustment for non-financial risk is measured at 5% of the present value of the expected cash outflows, and
- BDO Pet Insurance Ltd incurs no initial acquisition costs in respect to the insurance policies.
Based on the foregoing information, BDO Pet Insurance Ltd measures the portfolio of pet insurance policies on initial recognition as follows:
Table 1
| $ | Note | |
| Estimate of the present value of future cash inflows | (25,735) | |
| Estimate of the present value of future cash outflows | 19,063 | |
| Estimate of the present value of future (net) cash flows | (6,672) | |
| Risk adjustment for non-financial risk | 953 | |
| Fulfilment cash flows | (5,719) | (a) |
| Contractual service margin | 5,719 | (b) |
| Insurance contract (asset)/liability on initial recognition | 0 | (b) |
(a) Paragraph 32 of IFRS 17 requires that the fulfilment cash flows comprise estimates of future cash flows (inflows and outflows), adjusted to reflect the time value
of money and any financial risks related to those future cash flows and a risk adjustment for non-financial risk.
As discussed in the September 2021 edition of Accounting Alert non-financial risks include:
- Claim development risks (excluding direct inflation index linked risks), and
- Expense risks (the risk of unexpected changes in costs associated with administering the contract) that are associated with the insurance contracts but are not financial in nature.
Non-financial risk can also include lapse and persistency risks, which are the risks the policyholder will exercise any renewal, surrender, conversion or other option available to them under the policy that changes the amount, timing, nature or uncertainty of the amounts they will receive under the policy. However, in this example it is assumed that no policies will lapse during the coverage period and that no extension periods are offered under the policy.
(b) Paragraph 38 of IFRS 17 requires an entity to measure the contractual service margin on initial recognition of a portfolio of insurance contracts at an amount that
results in no income or expense arising from the initial recognition of the fulfilment cash flows. The contractual service margin is a component of the insurance
contract asset or liability that represents the estimated unearned profit the entity will recognise as and when it provides insurance contract services to the
policyholder in the future.
If BDO Pet Insurance Ltd’s assumptions at the commencement of the insurance contracts hold for the term of the insurance contracts, the entity would measure the insurance contracts for each of the three years as follows.
Table 2
| Year ended 30 June 2022 | Estimates of the present value of future cash flows ($) | Risk adjustment for non-financial risk ($) | Contractual service margin ($) | Insurance contract (asset)/ liability ($) | Notes |
| Opening balance – (asset)/liability | 0 | 0 | 0 | 0 | |
| Changes related to future service: new insurance contracts | (6,672) | 953 | 5,719 | 0 | |
| Cash inflows | 9,000 | 0 | 0 | 9,000 | |
| Insurance finance expenses | 953 | 48 | 286 | 1,287 | |
| Insurance finance income | (837) | 0 | 0 | (837) | (a) |
| Changes related to current service | 0 | (398) | (2,001) | (2,399) | (b) |
| Cash outflows | (7,000) | 0 | 0 | (7,000) | |
| Closing balance – (asset)/liability | (4,556) | 603 | 4,004 | 51 |
Table 3
| Year ended 30 June 2023 | Estimates of the present value of future cash flows ($) | Risk adjustment for non-financial risk ($) | Contractual service margin ($) | Insurance contract (asset)/ liability ($) | Notes |
| Opening balance – (asset)/liability | (4,556) | 603 | 4,004 | 51 | |
| Changes related to future service: new insurance contracts | 0 | 0 | 0 | 0 | |
| Cash inflows | 9,000 | 0 | 0 | 9,000 | |
| Insurance finance expenses | 651 | 30 | 200 | 881 | |
| Insurance finance income | (429) | 0 | 0 | (429) | |
| Changes related to current service | 0 | (380) | (2,102) | (2,482) | (b) |
| Cash outflows | (7,000) | 0 | 0 | (7,000) | |
| Closing balance – (asset)/liability | (2,334) | 253 | 2,102 | 21 |
Table 4
| Year ended 30 June 2024 | Estimates of the present value of future cash flows ($) | Risk adjustment for non-financial risk ($) | Contractual service margin ($) | Insurance contract (asset)/ liability ($) | Notes |
| Opening balance – (asset)/liability | (2,334) | 253 | 2,102 | 21 | |
| Changes related to future service: new insurance contracts | 0 | 0 | 0 | 0 | |
| Cash inflows | 9,000 | 0 | 0 | 9,000 | |
| Insurance finance expenses | 334 | 13 | 105 | 452 | |
| Insurance finance income | 0 | 0 | 0 | 0 | (a) |
| Changes related to current service | 0 | (266) | (2,207) | (2,473) | (b) |
| Cash outflows | (7,000) | 0 | 0 | (7,000) | |
| Closing balance – (asset)/liability | 0 | 0 | 0 | 0 |
From the example above it should be noted that:
(a) When an insurance contract gives rise to future cash inflows in the form of annual premiums, the entity issuing insurance contracts will recognise interest
income as the premium receivable unwinds, and
(b) When actual experience matches an entity’s assumptions in respect to the insurance contracts it issues, there are no changes related to current services
impacting the estimates of the present value of the future cash flows. However, the risk adjustment for non-financial risk and contractual service margin
will both ‘unwind’ over the coverage period, consistent with the notion that BDO Pet Insurance Ltd is being released from insurance risk while providing
insurance services.
Next month
In next month’s edition of Accounting Alert, we will modify some of the assumptions used in Example 1 above, and demonstrate the impact the differences between assumed and actual experience can have on measurement of insurance contracts under IFRS 17.
For more on the above, please contact your local BDO representative.
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