IFRS 17 –

General Measurement Model

26th April 2019

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Disclaimer

The views expressed in this presentation are

those of the presenter(s) and not necessarily
of the Society of Actuaries in Ireland
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Agenda

• Introduction
– Previously covered
– TRG updates
– IASB updates
• Overview – Policy Liabilities under IFRS 17
• Present Value of Future Cashflows
• Risk Adjustment
• Contractual Service Margin
• Profit Emergence
• Conclusion
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Abbreviations
AoC Analysis of change IASB International Accounting Standards Board
Modified retrospective application (on
BBA Building Block Approach MRA
transition)
BEL Best estimate liability OCI Other comprehensive income
BoP Beginning of period PAA Premium Allocation Approach
CoA Chart of accounts RA Risk Adjustment
CoC Cost of capital RM Risk margin under Solvency II
CSM Contractual Service Margin SII Solvency II
European Financial Reporting Advisory
EFRAG TRG Transition Resource Group
Group
EoP End of period UoA Unit of account
GMM General Measurement Model (GMM) VFA Variable Fee Approach
FCF Fulfilment cash flows YE Year-end
Full retrospective application (on
FRA
transition)
FVA Fair value approach (on transition)
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Background to the Standard

IASB’s project on insurance contracts

Exposure
Insurance Revised Original Revised
Discussion Draft of
project Standard Effective Effective
paper revised
started due date date
Mar Jan Jul proposals May
2004 2005 2010 2017

1997 May Jun June Jan Jan

IFRS 2007 Exposure
2013 2019 2021 2022
IFRS 4 standards IFRS 17
Draft of issued
issued adopted in proposals
Europe
• IFRS 9 – some insurers will use deferral option until 1 January 2022 based on
IFRS 4 amendments
• IFRS 15 is effective 1 January 2018, IFRS 16 is effective 1 January 2019
• Investment contracts without discretionary participation features (e.g. unit
linked investments) are in scope of IFRS 9 / IAS 39
• IFRS 17 delayed by a year to 1 January 2022, revised standard due late Q2
2019.
• FASB decided to only make targeted amendments to US GAAP
 6

Previously Covered
• Scope
• Contract classification
– IFRS 17 defines insurance contracts as contracts under which significant insurance risk is
transferred.

• Unbundling
– distinct components?

• Aggregation
– profitable vs onerous contracts, Companies will need to set a definition of ‘similar risks’
and ‘managed together’ and complete a profitability analysis.

• Measurement models
– GMM, PAA, VFA.

• Reinsurance
– inward (“issued”) vs outward (“held”) reinsurance.

• Transition
– Full retrospective, modified retrospective or fair value approach.

• Presentation and disclosures

– amounts, judgements and risks.
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TRG Discussion Topics

• February 2018: • September 2018:
– Separation of insurance components of a single – Insurance risk consequent to an incurred claim
insurance contract; – Determining discount rates using a top-down
– Boundary of contracts with annual repricing approach
mechanisms – Commissions and reinstatement premiums in
– Boundary of reinsurance contracts held reinsurance contracts issued
– Insurance acquisition cash flows paid and future – Premium experience adjustments related to current or
renewals past service
– Determining the quantity of benefits for identifying – Cash flows that are outside the contract boundary at
coverage units initial recognition
– Insurance acquisition cash flows when using fair value – Recovery of insurance acquisition cash flows
transition – Premium waivers
– Group insurance policies
– Industry pools managed by an association
– Annual cohorts for contracts that share in the return of
a specified pool of underlying items.

• May 2018 • April 2019

– Combination of insurance contracts – Investment components within an insurance contract
– Determining the risk adjustment for non-financial risk – Policyholder dividends
in a group of entities
– Changes in the risk adjustment for non-financial risk
– Cash flows within the contract boundary due to time value of money and financial risk
– Boundary of reinsurance contracts held with repricing – Definition of insurance contracts with direct
mechanisms participation features— mortality cover
– Determining the quantity of benefits for identifying – Consideration of reinsurance in the risk adjustment for
coverage units non-financial risk
– Changes in fulfilment cash flows as a result of inflation.
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IASB – Areas considered for revision No change proposed

Change proposed

1. Scope: Loans and other forms of credit that 10. Measurement: Business combinations - 18. Defined terms: Insurance contract with
transfer insurance risk classification of contracts direct participation features

2. Level of aggregation 11. Measurement: Business combinations - contracts 19. Interim financial statements: Treatment of
acquired during the settlement period accounting estimates

3. Measurement: Acquisition cash flows for 12. Measurement: Reinsurance contracts held - initial 20. Effective date: Date of initial application of
renewals outside the contract boundary recognition when underlying insurance contracts are IFRS 17
onerous

4. Measurement: Use of locked-in discount 13. Measurement: Reinsurance contracts held - 21. Effective date: Comparative information
rates to adjust the contractual service margin ineligibility for the variable fee approach

5. Measurement: Subjectivity - Discount rates 14. Measurement: Reinsurance contracts held - 22. Effective date: Temporary exemption from
and risk adjustment expected cash flows arising from underlying insurance applying IFRS 9
contracts not yet issued

6. Measurement: Risk adjustment in a group 15. Presentation in the statement of financial position: 23. Transition: Optionality
of entities Separate presentation of groups of assets and groups
of liabilities

7. Measurement: Contractual service margin - 16. Presentation in the statement of financial position: 24. Transition: Modified retrospective
coverage units in the general model Premiums receivable approach: further modifications

8. Measurement: Contractual service margin - 17. Presentation in the statement(s) of financial 25. Transition: Fair value approach: OCI on
limited applicability of risk mitigation performance: OCI option for insurance finance income related financial assets
exception or expenses

9. Measurement: Premium allocation

approach - premiums received
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Agenda

• Introduction
• Overview – Policy Liabilities under IFRS 17
– Measurement Models - which model when?
– IFRS 17 General Measurement Model
• Present Value of Future Cashflows
• Risk Adjustment
• Contractual Service Margin
• Profit Emergence
• Conclusion
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Which Model When

IFRS 17 Measurement Models

Modifications to the General Measurement Model

General Measurement
Model Variable Fee Approach Premium Allocation Approach
(mandatory) (optional)
(Ins. Contracts with Direct Participation Features) (Liability for remaining coverage)

• Default approach MUST be used, if at inception* of

contract **: MAY be used, if at inception of
group:
• Used at transition (i) Policyholder contractually
& live/production participates in clearly identified (i) not differ materially to GMM
pool of underlying items;
or
• Both life & &
general insurance (ii) Policyholder receives (ii) coverage period of group is
substantial share of the returns max one year. (Many GI
• (aka “BBA”, on the underlying items; contracts; possibly annual
& renewable life contracts.)
Building Blocks
Approach) (ii) Changes in policyholder (Note other preferences may also
benefits substantially vary with impact on decision here.)
the change in underlying items.
* For transition business this varies
** Approach not necessarily seriatim
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Which Model When – Likely Product Types

IFRS 17 Measurement Models

Modifications to the General Measurement Model

General Measurement
Model Variable Fee Approach Premium Allocation Approach
(mandatory) (optional)
(Ins. Contracts with Direct Participation Features) (Liability for remaining coverage)
Long term business
“Life” examples • Unit linked (UL) • Short term general insurance
• Variable annuity (VA) & equity business
• Whole of life
index-linked contracts • Short term life and certain
• Term assurance
• Continental European 90/10 group contracts
• Protection
contracts
• Annuities
• UK with profits contracts
• Reinsurance written
• Unitised with profits
“Non-Life” examples
• Multi-year motor Judgements re possible breaches of VFA Judgements re possible breaches of PAA
requirements: requirements:
• Warranty cover • For VA, guarantee aspects. • For annual renewable business,
• Certain types of Loss whether guarantee at renewal date
• For UL, if death benefit sufficient to
Portfolio Transfers / justify insurance contract treatment.
Adverse Development
Cover • European “formulaic with profits”
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General Measurement Model Overview

• General Measurement Model (GMM) determines the insurance contract liability via
component building blocks.
Insurance Contract
Liability
• Expected PV of Fulfilment Cash
cashflows: premiums,
Flows (FCF)
claims, benefits,
expenses etc Present value of
future cash flows
(PVCF)

• Expected profit,
Risk adjustment (RA) earned as services
provided.
• Adjusted for changes
in non-financial
• Entity specific variables
assessment of • Locked-in discount rate
uncertainty re amount • If negative, “Loss
and timing Component”

Contractual Service
Margin (CSM)

• We’ll go through each of these in more detail in the following sections.

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Agenda

• Introduction
• Overview – Policy Liabilities under IFRS 17
• Present Value of Future Cashflows
– Overview
– Which cashflows?
– Contract Boundaries
– Discount rates
• Risk Adjustment
• Contractual Service Margin
• Profit Emergence
• Conclusion
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Present Value of Future Cashflows - Overview

Insurance Contract
Liability Expected Future Cashflows:
• Based on current estimates
Fulfilment Cash • Probability weighted
Flows (FCF)
• Unbiased
Present value of • Stochastic modelling where required for
future cash flows
(PVCF) financial options and guarantees

Risk adjustment (RA) Time Value of Money

• Adjustment to convert the expected future
cashflows into current values

Expected Future Cashflows should:

Be within the boundary of the contract
Relate directly to the fulfilment of the contract
Contractual Service
Margin (CSM) Include cashflows over which the entity has
discretion
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Which Cashflows?
Examples of cashflows to include:
• Claims and benefits paid to policyholders, plus associated costs
• Surrender and participating benefits
• Cashflows resulting from options and guarantees
• Costs of selling, underwriting and initiating that can be directly attributable to a
portfolio level
• Transaction-based taxes and levies
• Policy administration and maintenance costs
• Some overhead-type costs such as claims software, etc.
• Adjustment to convert the expected future cashflows into current values

Cashflows excluded:
• Investment returns
• Payments to and from reinsurers
• Cashflows that may arise from future contracts
• Acquisition costs not directly related to obtaining the portfolio of contracts
• Cashflows arising from abnormal amounts of wasted labour
• General overhead
• Income tax payments and receipts
• Cashflows from unbundled components
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Attributable Acquisition Expenses

• All directly attributable acquisition expenses that can be allocated to the individual insurance
contracts (or group) are included in the CSM calculations.
• Includes also costs that cannot be attributed directly to individual insurance contracts (or group) but
are in the portfolio – should be allocated on a rational and consistent basis
• Asset / liability set up for costs paid/received before group’s coverage period begins

EXAMPLES
• Examples: External Commissions, Sales bonuses, Salary of sales team, Overhead of sales department
• Acquisition costs that are not considered directly attributable to a portfolio of contracts would be
expensed when they are incurred in profit or loss.

WHEN RECOVERABILITY TESTING DOES NOT APPLY

• Generally no recoverability testing before initial recognition of group
• Implicit recovery testing through CSM calculation, if CSM < 0 then loss is recognised in P&L.

WHEN RECOVERABILITY TESTING DOES APPLY

• Recent development from January 2019 IASB – if acquisition costs incurred relate to cash flows
outside contract boundary (e.g. future renewals), maintain asset for costs related to future renewals.
• Need to assess recoverability of asset each period until associated renewals recognised.
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Contract Boundaries

Is the cash flow in the boundary of an insurance contract?

No Policyholder obliged to pay related premiums? Yes

OR

Practical ability to reprice risks of the particular policyholder to

Yes
reflect the risks?
OUT

No

IN
Practical ability to reprice portfolio of contracts to reflect the risks? No

Yes

No Premiums reflect risks beyond the coverage period? Yes

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Contract Boundaries – IFRS 17 Vs SII

IFRS 17 contract boundary:
• No longer has substantive rights to receive premiums or obligations to
provide services since the risks of the policyholder or portfolio in setting the
price or level of benefit can be reassessed.

Solvency II Contract boundary:

• No longer required to provide coverage or can amend terms to ‘fully reflect
risk’ at portfolio level (unless individual life underwriting took place).

Definition could differ between each regime…

The view from EIOPA:
“Even though Solvency II uses slightly different wording than IFRS 17 to express the
objective, one cannot expect material differences to the resulting contract
boundaries, other than in circumstances where the insurer has the legal right to
reprice the premium for the re-assessed risk, but can reasonably justify the insurer
does not have the practical ability to reprice.”
EIOPA’s analysis of IFRS 17 Insurance Contracts, October 2018
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Discounting

Market Consistency:
• IFRS 17 requires insurers to use fair value and market-consistent approaches to
liability valuations as the basis for reporting their accounts.
• Careful consideration required in constructing the discount rates.
• Two approaches:
– “Top-Down”
– “Bottom-Up”
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Discounting – “Bottom-Up”

• Foundation is a fully liquid yield curve

• No explicit definition of the basis for deriving a risk free curve
• If using EIOPA what is the UFR?
• Credit Adjustment may be required
• E.g. if underlying instruments carry some level of risk
• Estimating the liquidity adjustment likely to be challenging
• Unlike the Solvency II Volatility Adjustment & Matching Adjustment
this must be set by reference to the liabilities rather than the assets.
• Other approaches:
• Bid-ask spreads?
• Pricing hypothetical liquidity swaps?
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Discounting – “Top-Down”

• Starting point may appear more straightforward

• However, a flat discount curve is unlikely to be suitable
• Adjust for credit losses
• No prescribed method – potential approaches:
• Historical defaults
• Distribution-based derivation of losses
• Credit Default Swap
• Solvency II Fundamental Spread
• Mismatch Risk
• Discount rate must reflect the
characteristics of the liability not the
asset.
• Adjustment to allow for mismatches
between cashflows of the assets and
those of the liabilities.
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Discounting

Likely to be differences between the results of each approach!

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Agenda

• Overview – Policy Liabilities under IFRS 17

• Present Value of Future Cashflows
• Risk Adjustment
– Concept & Background
– Risk Adjustment v Risk Margin
– Risks covered
– Calculation Methods: CoC / VaR / TVaR / PAD
• Contractual Service Margin
• Profit Emergence
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Risk Adjustment – Concept

Insurance Contract
Liability

Fulfilment Cash
Flows (FCF)
The risk adjustment is the compensation that the
entity requires for bearing the uncertainty about
Present value of
future cash flows the amount and timing of the cash flows that arises
(PVCF) from non-financial risk.

Risk adjustment (RA) • Range of possible outcomes versus a fixed

cashflow with same NPV are equal

• Entity’s internal view of non-financial risk

Contractual Service
Margin (CSM)
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Risks Covered
Risks Covered Risks Not Covered
Claim occurrence, amount, Financial risk
timing and development

Lapse, surrender, premium

persistency and other Asset-liability mismatch risk
policyholder actions

Expense risk associated with Price or credit risk on underlying

costs of servicing the contract assets

External developments and

trends, to the extent that they General operational risk
affect insurance cash flows

Claim and expense inflation risk,

excluding direct inflation index Risk from cyber attack
linked risk
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Risk Margin vs. Risk Adjustment

Solvency II Risk Margin IFRS 17 Risk Adjustment

Market plus regulatory Entity plus financial statements

Prescribed calibration at 99.5% confidence

No prescribed calibration but must be disclosed
internal

Based on the Solvency II cost of capital method No prescribed method

The cost of capital rate used is prescribed by

The cost of capital rate used is not prescribed
EIOPA

Group diversification may be permitted for solo

No group diversification for solo entity
entity

Separately for primary insurance and reinsurance

Net of reinsurance basis
contracts held

Only insurance risks, lapse risk and expense

All the NH risks
risks
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Cost of Capital Approach (1/2)

𝑛
Cost of 𝐶𝑜𝐶𝑡 ∙ 𝐶𝑎𝑝𝑖𝑡𝑎𝑙𝑡
𝐑𝐢𝐬𝐤 𝐀𝐝𝐣𝐮𝐬𝐭𝐦𝐞𝐧𝐭 =
Capital (1 + 𝑑𝑡 )𝑡
𝑖=1

𝐶𝑜𝐶𝑡 : Cost of capital at time t

𝑑𝑡 : discount rate at time t
𝐶𝑎𝑝𝑖𝑡𝑎𝑙𝑡 : Capital from non-financial risk at time t
 28

Cost of Capital Approach (1/2)

• Leverages Solvency II calculations

• Flexibility
Pros
• Simplicity
• Simple to understand

• Judgement needed

• Result sensitive

Cons • Choice of risks

• Need future capital figures

• Company’s confidence level

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Value-At-Risk (“VaR”) / Tail-VaR (“TVaR”) (1/2)

Value at • Value at Risk (VAR) calculates the expected loss on a portfolio at a

Risk specified confidence level.

Tail Value at • Tail VaR (TVaR) calculates the average expected loss on a portfolio
Risk given the loss has occurred above a specified confidence interval.

Three potential approaches to calculate VaR :

Calculation (1) Historical returns
Approaches (2) Assume standard normal distribution
(3) Monte Carlo simulation
 30

VaR / TVaR Approach (2/2)

• Need to choose confidence interval (for both)

VaR • Easy to communicate (for both)
• Need to calculate the statistical distributions of the liabilities

• Highly sensitive in the tail

TVaR • Data points in tail may be limited
• Stochastic modelling
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Provision for Adverse Deviation Approach (PAD)

Approach 𝑹𝒊𝒔𝒌 𝑨𝒅𝒋𝒖𝒔𝒕𝒎𝒆𝒏𝒕 = 𝑭𝑪𝑭 𝑷𝒂𝒅𝒅𝒆𝒅 − 𝑭𝑪𝑭 (𝑩𝒆𝒔𝒕 𝑬𝒔𝒕𝒊𝒎𝒂𝒕𝒆)

• Similar to IFRS 4 reporting

Pros
• Easy to understand and leverages off current architecture

• Need appropriate confidence level

Cons • Need statistical distributions for the risks
• Lot of runs
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Agenda

• Introduction
• Overview – Policy Liabilities under IFRS 17
• Present Value of Future Cashflows
• Risk Adjustment
• Contractual Service Margin
– Concept
– Initial Recognition & Subsequent Measurement
– Loss Component
• Profit Emergence
• Conclusion
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Contractual Service Margin – Concept

Insurance Contract
Liability

Fulfilment Cash
Flows (FCF) New concept under IFRS 17 – profit deferral
mechanism measured at a “group” level
Present value of
future cash flows
(PVCF) • Offsets initial risk adjusted profits (excluding
non-attributable expenses)
Risk adjustment (RA)

• Reduced over time to provide steady release of

profits into P&L in line with service provided

• Absorbs changes for group profitability related

to future service (e.g. basis changes)
Contractual Service
Margin (CSM) • Cannot offset losses*, those hit P&L but
recorded and tracked by a Loss Component
*Except for Reinsurance Held

Loss Component
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CSM – Not a seriatim calculation

• CSM calculated for a “Group”
Group of Insurance Contracts
Portfolio Annual
(Similar risk & Profitability
managed (3 types) cohorts
together) (or shorter)

• Cash flows and risk adjustment measured for contracts in a group

and combined to give risk adjusted profit for group

CSM generated for group

Total profit for group
• CSM generated for the group to offset
risk adjusted profit

Key point: CSM is not a policy level

concept. Calculated and measured for

Contract 2
a group of contracts, not for a single
Contract 1

contract.
 Systems development implications

Contract 3
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CSM – Initial Recognition

• CSM on initial recognition offsets risk-adjusted profits for the group.

+€100
• Expected cashflows @ best estimate assumptions.
 Total inflows of 100, outflows of 50.
Claims / Other Cash Flows Out

 Excluding time value of money.

+€30
• Time value calculated @ current discount rates.
Adjustment
 The impact overall was positive 30.
Discounting

Risk
Premiums / Other Cash Flows In

 Could be positive / negative depending on the

Fulfilment Cash Flows

cashflow pattern.
Pre-Recognition

-€20
Cash Flows

• Risk adjustment calculated using one of the methods

-€50
described previously.
 The impact was negative 20.
-€30
• Other cashflows not included in the FCFs included as
CSM = €30

the pre-recognition cashflows:

 Attributable acquisition cash flows
 Other day 1 cash flows
• Risk adjusted profit for group = 30, so a CSM of 30 is
Expected Future Time Value generated to offset this.
Cash Flows of Money
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CSM – Subsequent Measurement

Accretion

Future Service
Interest

Changes for
New Business

Changes
Fx

Provided
Service
Opening CSM

Closing CSM
• Graphical illustration of subsequent measurement of CSM over a period.
• Will walk through each step in following slides
 37

CSM – Subsequent Measurement Example

€60
Opening CSM

• The opening CSM balance is the closing CSM balance from the previous reporting period.
 38

CSM – Subsequent Measurement Example

€30

€60 New Business

Opening CSM

• The CSM for new business recognised during the period is added.
• This is measured as described previously.
• Only occurs when group is still forming an annual cohort.
 39

CSM – Subsequent Measurement Example

€20

Accretion
Interest
€30

€60 New Business

Opening CSM

• Interest is accreted on the CSM balance based on the “locked-in” rate at initial recognition
• As new business is still being added, the locked in rate for the group is still being established.
• Once rates are locked in, they do not change.
• Need to track appropriate locked-in rate for each group identified
 40

Locking in discount rate

• Interest is accreted on the CSM at locked in rates for the group. These are the IFRS 17 rates for the group at the
time it is formed.
• Once a group is closed, the rates are fixed and are not updated.
• As the group is forming, the rates can be rebalanced to reflect appropriate weighted average rates for the group
(per paragraphs 28 & B73).
• Simple example for an annual group forming with 100 identical policies issued each quarter. Here the current
market rates as assumed to be flat, and the blended rates are weighted by the number of policies.
• General formula:
( # BoP policies x previous blended rate +
# New policies * current rate)
100 Policies

100 Policies

100 Policies

100 Policies
/ # EoP Policies

• Quarter 1: (100 x 4%) / (100)

= 4.00%
Quarter 1 Quarter 2 Quarter 3 Quarter 4
• Quarter 2: (100 x 4% + 100 x 5%) / (200)
Market rates over
= 4.50%
4.00% 5.00% 5.25% 4.75%
Quarter: • Quarter 3: (200 x 4.5% + 100 x 5.25%) / (300)
= 4.75%
Blended Rate for
CSM:
4.00% 4.50% 4.75% 4.75% • Quarter 4: (300 x 4.75% + 100 x 4.75%) / (400)
= 4.75%

• In practice this will be more complex. Rates will likely be a term structure and there are different approaches to
blending the different rates together.
 41

CSM – Subsequent Measurement Example

€20

Accretion

Future Service
Changes include:

Interest

Changes for
- Experience Variance for future service
€30
- Basis changes for non-financial assumptions

New Business
-€30

€60
Opening CSM

• The CSM is adjusted for changes in the fulfilment cashflows that relate to future service
• The impact of these changes is measured at locked in rates – need to value FCFs on locked in rate
for CSM.
• Not included here are changes due to financial risk or changes for past/current service
 42

CSM – Subsequent Measurement Example

€20

Accretion

Future Service
Interest

Changes for
€30

New Business

Changes
-€30

Fx
€60

-€20
Opening CSM

• Update for the effect of any currency exchange differences on the CSM
 43

CSM – Subsequent Measurement Example

€20
CSM after all changes = 60

Accretion

Future Service
Interest

Changes for
Sum assured in period = 1 unit
€30 PV expected future sums assured = 3 units
Amortisation = 60 * (1/3) = 20

New Business

Changes
-€30

Fx
€60

Provided
Service
-€20
Opening CSM

-€20

• The total CSM after all changes is aggregated. This balance is then amortised for services provided
in the period. The amount amortised is released into the P&L as profits recognised.
• Different methods can be used to recognised service provided, e.g.:
• Sum assured in period vs. all future expected sums assured
• Policy count in period vs. all future expected policy counts
• Can be discounted or undiscounted
• More on coverage units later
 44

CSM – Subsequent Measurement Example

€20

Accretion

Future Service
Interest

Changes for
€30

New Business

Changes
-€30

Fx
€60

Provided
Service
-€20
Opening CSM

Closing CSM = €40

-€20

• Closing CSM balance combines all of the component movements.

• This represents the remaining risk-adjusted profits on the group which relates to future service
• This will be released as profit in the future as the service is provided.
 45

CSM – Subsequent Measurement Summary

General Measurement Model Comments

Per Paragraph 44 of the IFRS 17 standard, the starting point for the re-measuring the
Opening CSM Balance
CSM is to take the closing CSM balance from the previous period.
Subsequent measurement of CSM

New Business The CSM is adjusted for the impact of new business added to the group in the
period, measured using the initial recognition approach detailed previously.

CSM is increased for interest at rates locked in from initial recognition. Note that the
Interest accretion at locked
rates will not be locked into until the (annual) cohort is fully formed (Paragraphs 28 &
in inception rates
B73).

Changes in fulfilment cash flows related to future service adjust the CSM, for
Changes in fulfilment cash example if there is a basis change which updates future expected claims this will go
flows for future service into the CSM rather than directly into the P&L. Does not include changes in financial
risk and changes are valued at locked in rates.

Exchange Rate Movements The CSM is updated for the effect of any currency exchange differences.

Apply Zero Floor The CSM is floored to zero, it cannot be an asset to offset future loses (except for
Reinsurance Contracts Held).

Amortisation of CSM into The CSM is amortised to reflect the services provided in the period. This is for
P&L insurance services provided, but as per the January 2019 IASB meeting will now
include “investment return” services (paper AP2E).

Closing CSM Balance

 46

Loss Component
• CSM only for deferral of future risk adjusted profits.
• If losses identified, they are immediately recognised in P&L.
• These losses are tracked as a “loss component”. Group can only have a CSM or a Loss
Component at any one point in time, but can move between both regularly.

• On initial recognition: Group FCFs + pre-recognition cashflows

When is are negative. This would likely form an “onerous group”
Loss • On subsequent measurement: Group had CSM, but due to
Component adjustments, e.g. a significant negative basis change, now
generated? viewed as loss making. This could be for an “onerous” or “non-
onerous” group.

Important Point: Loss component not necessarily negative equity impact. The risk
adjustment also represents unearned profit (compensation for risk) and when released
without any adverse experience, may exceed the loss component.
 47

Loss Component - Examples

Loss Component on Initial Recognition Loss Component on Subsequent Measurement
€20
+€70

Accretion
Interest
Claims / Other Cash Flows Out

€30

New Business
Premiums / Other Cash Flows In

+€30

Changes for Future Service

Adjustment €60
Discounting

Risk

Opening CSM
-€20
Pre-Recognition Cash Flows

-€50

Component
Component

= €30
Loss
Loss

-€140
-€50

Subsequent measurement: A group here had expected future

Initial recognition: Present value of cash outflows and risk profits at the start of the period. However a change related to
adjustment exceed inflows – the loss amount is recognised in future service had a large negative impact (e.g. basis update)
P&L and loss component established and tracked. and eliminated the CSM. The excess hits the P&L and is tracked
as a loss component
 48

Tracking the Loss Component

• Once recognised, the loss component is tracked over time:
• To monitor potential subsequent positive developments and know if/when to (re-)establish a CSM
• Presentation of revenue and expenses in the P&L needs to be adjusted for any losses already recognised
• Loss component needs to be allocated in each period for presentation of revenue and expenses in the
financial statements.
• This can follow a similar method to CSM, or use other methods

In the next 2 time periods there are no changes. Claims

emerge, but these are partially reduced because a

generates a
Remainder
component of those claims has already been recognised in

= €40

CSM.
CSM
the loss component of 60. The write down of 10 in the loss

Positive Basis Change

component in each period reduces claims.

= +€80
Loss Component
Loss Component

Component.
Elimination
Loss Component

= €40

of Loss
When Loss
= €50

component first
= €60

recognised –
negative 60 hits
the P&L.

In period 3 there is a positive basis change.

This is used to eliminate any remaining loss
component first, and then generates a CSM.
 49

Agenda

• Introduction
• Overview – Policy Liabilities under IFRS 17
• Present Value of Future Cashflows
• Risk Adjustment
• Contractual Service Margin
• Profit Emergence
– Level of Aggregation Impact
– Coverage Units
• Conclusion
 50

Profit Emergence under IFRS 17

• Profit emergence under IFRS 17 comes from several sources including
• Release of risk adjustment – the “entity’s compensation for accepting risk”
• Release of CSM – the remaining risk-adjusted profit on the portfolio
• Experience variance “noise”

• For CSM, several factors affect profit emergence. The following slides focus on two of
those factors:
• The impact of selected level of aggregation
• The selection of appropriate coverage units
 51

CSM – Level of Aggregation impact

• The CSM is measured for a group of
insurance contracts. Group of Insurance Contracts
Portfolio Annual
• Once recognised the risk-adjusted (Similar risk & Profitability
managed cohorts (3 types)
profitability (excluding non-attributable (or shorter)
together)
expenses) in that group establishes a CSM
and is released into the P&L over the
period services are provided for the
group collectively.

• Different products in a group may have significantly different profitability per coverage unit
 The profit release profile may not look sensible.

• IFRS 17 permits an entity to create groups more granular than specified above (criteria in
Paragraph 21)
 Forming more groups may improve profit emergence, but it will also have systems and data
storage impacts as well.

• Simple examples on next slides to illustrate

 52

CSM – Level of Aggregation impact

• Simple example: two term products – 5 year and 10 year terms. Both profitable, and same sum
assured covered. 5 year product is 3 times more profitable than 10 year product on present value
basis.

Profitability - Grouped vs. Grouped: The profits for both products

are combined.
Ungrouped
• 10 periods of service are provided in
the first 5 years (5 periods on each of
the two products)
• 5 periods of service are provided in
P&L Profits

the second 5 years (5 periods for the

10-year product only)

Ungrouped: Here, the profits from the 5

1 2 3 4 5 6 7 8 9 10
year product are released over 5 years,
Year and the 10 year product over 10 years.
Ungrouped: 10-year Ungrouped: 5-year Grouped

Important Point: When grouped, some of the profits from the more profitable product are deferred
because the profit is viewed as applicable to the entire group as service earned for that group.
• This would have the opposite effect if the longer term product were the more profitable – next
slide
 53

CSM – Level of Aggregation impact

• Simple example: Same as previous slide, but now 10 year product is 3 times more profitable than 5
year product on a present value basis.

Profitability - Grouped vs. Grouped: As before, profit is identified

Ungrouped for the group as a whole. Profitability
from different underlying products is
ignored & becomes overall profitability
of the group. In effect, there is a cross-
subsidy between different levels of
P&L Profits

profitability.

Ungrouped: As before, the profits from

1 2 3 4 5 6 7 8 9 10
the 5 year product are released over 5
Year years, and the 10 year product over 10
years.
Ungrouped: 10-year Ungrouped: 5-year Grouped

• This is a very simple example, more considerations in practice:

• Complexity of creating additional groups vs. overall impact on profit emergence
• Actual significance of difference in profitability
• Other ways to compensate, e.g. selection of appropriately complex coverage units to
recognise service, allowing for discounting in coverage units to reduce impact, etc.
 54

Coverage Units – Introduction

“Coverage units” establish the amount of the CSM recognised in P&L in the
period for a group.

• Recognise profit as it is earned i.e. “spread” CSM over time.

• The CSM amount is allocated equally to each coverage unit.

• How to allocate coverage units consistently?

- Consistency across heterogeneous contracts
- Consistency over time
 55

CU – Identification & Quantification

• “Service” is the insurer standing ready to pay claims.

• Challenge is the variety of benefit types, benefit amounts, remaining
Measure term, claim likelihood, profitability … etc within a group of contracts.
Key Aim?
“service”
• Judgement and estimates, applied systematically and rationally.
• Not expected average claims cost or claim likelihood!

Quantity of Benefits
• Amount that can be claimed 120
e.g. Sum Insured
by a policyholder. 100 €100
Quantity of
Benefit • Variability across periods 80 S = €550
e.g. if max benefit decreases
60
How? over time.
40

Expected • Term of remaining coverage, 20 €10

coverage adjusted for expected 0
duration decrements. 1 2 3 4 5 6 7 8 9 10
Year
 56

CU – Other Considerations

• Cashflows – unless demonstrate that reflective of service rather

than expected claims.
• Premiums – not allowed unless reasonable proxy for service in
Some period.
notable (For example not ok if: timing difference premium versus service;
Not Valid aspects premiums more reflect different probability of claims; premiums more
likely not reflect different profitability.)
appropriate • Entity’s asset performance influence (if no investment
component).
• Any approach where no allocation of CSM to a period where
entity is standing ready to meet claims.
 57

CU – Recognition of CSM in P&L

• At end each period (before any CSM allocation for the period),
Re- reassess the expected coverage units and duration.
Ongoing
assessment • Re-allocate CSM equally to each coverage unit (in current period
and future periods).

Recognise • For each period, recognise the amount of CSM (for the group) for
P&L
CSM coverage units allocated to that period.

• Explanation of when entity expects to recognise the CSM in the

Coverage future (either via time bands, or qualitative info)
Disclosure
units relevant
• General requirement to disclose significant judgements.
 58

CU – Simple Example

Details of product
• Sum insured decreases over time in known steps, cannot be increased.
• Fixed contract term.
• (e.g. Mortgage term assurance)

Analysis comments from TRG paper

Expected coverage duration Quantity of Benefits: Max claim possible /
120
Sum insured
• Should reflect term of coverage, and also €100
100
expected deaths and lapses.
S = €550
Quantity of benefits 80
• Decreasing sum insured – valid as it is the 60
maximum contractual cover and also the
expected amount that the policyholder 40
can validly claim if insured event occurs.
100/550=18% €10
20
• Note TRG felt that a constant cover (e.g. of CSM
representing a generic “death benefit”) is 0
not valid. 1 2 3 4 5 6 7 8 9 10
Year
 59

CU – Warranty Cover

Details of product
• 5 year warranty – new replacement if an item fails during 5 years.
• Claim timing skewed toward end of coverage period as item gets older.

Analysis comments from TRG paper However – extended warranty cover

Expected coverage duration Note if this were “extended” product
• 5 years, over which the cover is provided, adjusted warranty (i.e. after manufacturer’s
for any expected lapses. original warranty expired):
• (See note re an extended warranty cover.) • Expected coverage duration –
does not start until the
Quantity of benefits
manufacturer’s original warranty
• If price of the item is static (i.e. no inflation) - has expired. The policyholder
constant cover over period. cannot make a valid claim to the
• If inflation – need to allow for increasing price (i.e. entity until then.
increasing cover).
 60

CU – Health Cover (1/4)

Details of product
Health cover for 10 years, specified types of medical costs.
• Up to €1m total costs covered, over the life of the contract.
• The expected amount and expected number of claims increases with age.

Analysis comments from TRG paper

Expected coverage duration
• 10 years during which cover is provided,
adjusted for expected lapse, and any
expectations of the limit being reached
during the 10 years.
Quantity of benefits
(see next slides, with full details in
appendix slide)
 61

CU – Health Cover (2/4)

Details of product
Health cover for 10 years, specified types of medical costs.
• Up to €1m costs covered, over the life of the contract.
• The expected amount and expected number of claims increases with age.

Analysis comments from TRG paper Quantity of Benefits: Max claim possible
Quantity of benefits – either: €1m S = €10m
(a) Constant coverage, max possible
claim
• At outset, 10 CU in total, 1 for
each year.
€0.9m S = €9.1m
• And adjust to reflect claims as
they arise (so coverage level
reassessed down for all years 1
= 10%
after a claim, say €0.1m in year 10 1 2 3 4 5 6 7 8 9 10
1) of CSM * Year
1
(b) … = 10.9% 0.9
9.1 = 11.1%
of CSM ∗∗ 8.1
* Year 1, if no claims; ** Year 1 if a 0.1m claim.
# Year 2 P&L & Remaining CSM if 0.1m total claims. of CSM #
 62

CU – Health Cover (3/4)

Details of product
Health cover for 10 years, specified types of medical costs.
• Up to €1m costs covered, over the life of the contract.
• The expected amount and expected number of claims increases with age.

Analysis comments from TRG paper

Quantity of Benefits: Max claim possible
Quantity of benefits – either:
(a) … €1m
(b) Capture interaction via using S = €5.5m
expected claim in each year (say
€0.1k p.a.)
• Involves looking at the claim
likelihood (contrary to
general principle).
• However, here, claims in one 1 €0.1m
= 18% of CSM
5.5
period do affect the amount
of cover for future periods, 1 2 3 4 5 6 7 8 9 10
so do affect the level of
service in future periods. Year
 63

CU – Health Cover (4/4) – Appendix: Calc detail

Details of product
Health cover for 10 years, specified types of medical costs.
• Up to €1m costs covered, over the life of the contract.
• The expected amount and expected number of claims increases with age.

Analysis comments from Footnote re (a) – constant coverage

TRG paper • At outset, level €1m cover for each of 10 yrs. So total is
€1m*10=10m. Need to observe incurred claims in each year. If
Quantity of benefits – either: none in year 1, will allocate 1/10 (10%) of CSM in year 1.
(a) Constant coverage of • If a claim say in year 1 of €0.1m, then remaining cover is €0.9m
max possible claim and … so 1 year of €1m coverage and 9 yrs of €0.9m = €1+€8.1 =
€9.1m total cover. So allocate 1/9.1 of CSM in first year.
adjust coverage to
reflect claims as they Footnote re (b) – capture interaction via expected claims
arise • If expected claims pattern is €0.1 per annum, so total coverage
(b) Capture interaction via is €1m in year 1, €0.9m (yr 2), €0.8m (yr 3) etc. This sums to
using expected claim €5.5m total coverage. So allocate 1/5.5 of CSM to first year.
in each year • Note this does use expected claim amounts, (which appears
against the general principle) but only to establish level of
coverage in periods when the periods impact each other, rather
than directly using expected claims amount of establish the
amount of service.
 64

CU – Further Examples

Transition Resource Group papers provide several further examples and detailed
commentary. (Feb 2018, May 2018)

More complex/bespoke situations are also covered in the TRG examples.

• E.g. unlimited sum insured, unpredictable sum insured, contingent sum insured,
multiple benefits on a contract, interactions between benefits on a contract, coverage
pattern variations, deferral before coverage, VFA, reinsurance, etc.

Note TRG felt that facts and circumstances are important in forming a valid judgement.
 65

Agenda

• Introduction
• Overview – Policy Liabilities under IFRS 17
• Present Value of Future Cashflows
• Risk Adjustment
• Contractual Service Margin
• Profit Emergence
• Conclusion
 66

Summary – Present Value Future Cashflows

• Best estimate future cashflows.

Cashflows
• Relating directly to fulfilment of the contract.
included
• Within contract boundary.

• No longer has substantive rights to receive premiums or obligations to

Contract
provide services since the risks of the policyholder or portfolio in setting the
boundaries
price or level of benefit can be fully reassessed.

• IFRS 17 requires insurers to use fair value and market-consistent approaches to

Discounting liability valuations as the basis for reporting their accounts.
• Bottom-up or Top-down approach.
 67

Summary – Risk Adjustment

• The Risk Adjustment is calculated as the discounted value of future capital for
Cost of
non-financial risk at required confidence interval multiplied by the company’s
Capital
internal cost of capital.

• Value at Risk (VAR) calculates the expected loss on a portfolio at a specified

Value at
confidence level. This value less the discounted value of best estimate
Risk
cashflows gives the Risk Adjustment.

• Tail VaR (TVaR) calculates the average expected loss on a portfolio given the
Tail Value at
loss has occurred above a specified confidence interval. This value less the
Risk
discounted value of best estimate cashflows gives the Risk Adjustment.

Provision • Cashflows revalued using padded non-financial assumptions calibrated to

for Adverse reflect the company’s risks and chosen confidence level. The risk adjustment
Deviation is the difference between this and the best estimate.
 68

Summary – CSM

Initial • At initial recognition, the CSM is set to offset any profits on the group of
recognition contracts and represents the unearned profits on that group.

Subsequent • Movements will allow for new business, interest accretion, changes in
Measurement fulfilment cashflows, exchanges rate movements and amortisation.

Loss • No negative CSM.

component • Losses must be tracked as a loss component.

• Level of aggregation effect – CSM is for a group of contracts.

Profit
Emergence • “Coverage units” establish the amount of the CSM recognised in P&L in the
period for a group.
 69

Thank you.
Questions?