IFRS 17 - APPROCCIO SEMPLIFICATO (PREMIUM ALLOCATION APPROACH)

IFRS 17 – VALUTARE L’IMPATTO, PROGETTARE E PIANIFICARE LA FASE DI IMPLEMENTAZIONE E GESTIRE LA

TRANSIZIONE

ROMA, 19 OTTOBRE 2017

PREMIUM ALLOCATION APPROACH: WHERE DOES IT FIT?

CORE REQUIREMENTS
Modifications to achieve IFRS 17's fundamental objectives

Insurance contracts Investment contracts

Reinsurance contracts
with direct with discretionary
held
participation features participation features

PAA
SIMPLIFIED ACCOUNTING
for contracts with short coverage periods

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LIABILITIES FOR INSURANCE CONTRACTS
Fulfilment cash flows relating to future
service that will be provided under
Liability for remaining coverage
the contract in future periods and the
TOTAL CARRYING contractual service margin
AMOUNT
of a group of
insurance contract
Fulfilment cash flows related to past
Liability for incurred claims service for claims and expenses
already incurred

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LIABILITIES FOR INSURANCE CONTRACTS: SUMMARY OF MEASUREMENT
UNDER IFRS 17
Premium allocation Premium allocation
IFRS17 - General approach approach
measurement model (undiscouted incurred
claims)
Contractual service
coverage (unexpired risk)
Liability for remanining

margin

Risk adjustment Premium (less Premium (less

. acquisition costs) acquisition costs)
Discounting unearned unearned

Estimate of fulfilment
cash folws

Risk adjustment Risk adjustment Risk adjustment

incurred claims
(expired risk)
Liability for

Discounting Discounting
Estimate of fulfilment
Estimate of fulfillment Estimate of fulfilment cash flows
cash flows cash flow

Present value of future cash flows

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ELIGIBILITY CRITERIA FOR PAA

A group of insurance contracts is eligible for the premium allocation approach if, and only if, at the
inception of the group:

1. each contract in the group has a coverage period of one year or less(*)

OR
2. measurement of the liability for remaining coverage for the group using the premium allocation
approach is reasonably expected to produce a measurement of the liability for remaining coverage
which is not materially different from the one that would be produced applying the requirements in
general model.

(*) Included all the premiums within the

contract boundary

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ELIGIBILITY CRITERIA FOR PAA DECISION TREE
Criterion 1
Is the COVERAGE PERIOD for
the contracts in the group
<= ONE YEAR ?

ALL ANNUAL
YES NO
insurance contracts

Criterion 2
Is the PAA a REASONABLE POSSIBLE for property damage
APPROXIMATION to the type multi-year policies (2-3 y):
general measurement model? NEED DEMONSTRATION of
approximation and limited
NO variability

YES STRONGER DEMONSTRATION for

the following LOB: construction,
energy, enginering, long duration
property damage (multi-year)

GENERAL
PAA MEASUREMENT
MODEL

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ELIGIBILITY CRITERIA FOR PAA

Criterion 1
(General presumption for coverage period < = 1
year)

The Board views the premium allocation approach

as a simplification of the general requirements.
To simplify its application, the Board also decided to
provide guidance that an entity could assume,
without further investigation, that the approach
provides a reasonable approximation of the general
requirements of IFRS 17 if the coverage period of
each contract in the group is one year or less.

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ELIGIBILITY CRITERIA FOR PAA
Determining coverage period

Coverage period

Period to settle claims

<= 1 year > 1 year

Entity has the substantive: Consider the contract

1) obligation to provide boundary....the entity has the
coverage or pratical ability to reassess risks
2) right to collect premiums and reset premiums

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ELIGIBILITY CRITERIA FOR PAA

Criterion 2
(Variability of cash flows)

The last criterion reported above is not met if, at the inception of the group, an entity expects significant
variability in fulfilment cash flows that would affect the measurement of the liability for remaining coverage
during the period before a claim is incurred.

HIGHLIGHT VARIABILITY ASSESSMENT

IFRS 17 states two examples of situations where variability in the fulfilment cash flows increases:
• there are embedded derivatives that have not been separated and that impact the fulfilment cash flows
of the contracts; and
• insurance contracts with longer coverage periods.

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ELIGIBILITY CRITERIA FOR PAA

NO GUIDANCE IN IFRS FOR APPROXIMATION & VARIABILITY

IFRS 17 does not provide guidance to assess of variability and evaluate reasonable reasonable approximation
of the general measurement model.

Management will play important role (applying judgment) in assessing whether the fulfilment cash flows of
contracts with a coverage period greater than one year vary significantly.

Considerations should be made with reference to the length of the coverage period and to the existence of
embedded derivatives.

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ELIGIBILITY CRITERIA FOR PAA

This assessment could be performed (at the inception and for a model contract representative of the
group of insurance contracts) by:

• creating a sensitivity analysis to compare groups of insurance contracts' liability for remaining coverage
under the general measurement model and the PAA;
• establishing a measurement of the margin;
• defining an internal range for acceptable and reasonable approximation of results under the PAA and the
general measurement model.

Furthermore

Entities should also consider:

• how often to refresh the analysis for the purpose of new business. In a situation of great unstability of
current interest rates, it will be necessary to refresh the analysis with higher frequency;
• documenting this assessment;
• designing internal controls over the process.

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ELIGIBILITY FOR PAA

However

PAA does not mean complete dismissal of General Measurement Model

because

entities should ensure that their accounting systems are ready to use the General Measurement Model if a
group of contracts is or becomes onerous.

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ELIGIBILITY FOR PAA

HIGHLIGHTS: CONSIDERATION OF ELIGIBILITY ASSESSMENT

General Insurance (Coverage period < = 1 year)

Contracts with a coverage period of one year or less automatically meet the PAA eligibility criteria, even if
the claims settlement period is greater than the coverage period.

Example: Personal car insurance contracts for one year (typical MTPL), even if bodily injury claims
are expected to be settled over a number of years.

General Insurance (Coverage period > 1 year)

A group of contracts with a coverage period longer than one year meet the PAA eligibility criteria based on
an assessment of the expected variability of cash flows.

Many general insurance contracts as property and casualty contracts will meet the PAA eligibility
criteria, mainly based on their short duration and because they usually do not include embedded
derivatives.
Many insurers will probably seek to apply the PAA for these types of contracts because, in many
jurisdictions. a similar unearned premium approach is currently applied.

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ELIGIBILITY FOR PAA

Life Insurance
Whole-life insurance contracts or annuity contracts:
are not expected to meet the PAA eligibility criteria, mainly due to the length of the period they
cover.
One-year term life insurance contracts:
will automatically meet the PAA eligibility criteria;
however, contract boundaries require considerations.

Many life contracts will probably not meet the PAA

eligibility criteria, because their coverage periods are
significantly greater than one year.
Therefore…

life insurance products will probably be accounted

for under the general measurement model, even if
some of them meet the PAA eligibility criteria,
mainly because it is expected that the contracts
will be handled using similar processes and systems.

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LIABILITY FOR REMAINING COVERAGE: INITIAL RECOGNITION

+ Premiums received

Unless the entity chooses -

under 17.59 (a) - to recognise

- Acquisition cash flows insurance acquisition cash flows

as expenses as they are
incurred.
.

=
Liability for remaining
coverage

minus any insurance acquisition cash flows at that date

Acquisition cash flows plus or minus any amount arising from the derecognition at
that date of the asset or liability recognised for insurance
acquisition cash flows applying par. 27

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LIABILITY FOR REMAINING COVERAGE: SUBSEQUENT MEASUREMENT
PAA consider the liability for remaining coverage is measured at each subsequent reporting date as follows:

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(ii, iii) INSURANCE ACQUISITION CASH FLOWS

Under the PAA, the accounting policy for recognising insurance cash flows is a simplification of the general
measurement model consider by IFRS 17, 33.

Acquisition insurance cash flows are cash flows arising from the costs of selling, underwriting and starting a
group of insurance contracts that are:
• directly attributable to the portfolio of insurance contracts to which the group belongs
• not directly attributable to individual contracts or groups of insurance contracts within the
portfolio.

PRACTICAL EXPEDIENT (17.59.a)

If the coverage period of each contract in the group of initial recognition is one year or less, then an entity
may choose to recognise insurance acquisition cash flows as an expense when they are incurred.

HIGHLIGHTS
Companies that already have a policy of expensing acquisition cash flows over the coverage period could be
able to continue to do so as their systems and processes may not need significant adjustment.

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(ii, iii) INSURANCE ACQUISITION CASH FLOWS

However…
Companies will still have to assess whether the costs previously deferred meet the definition of insurance
acquisition cash flows under IFRS 17.

Furthermore…
Companies may consider recognising those costs as they are incurred.

Acquisition cost expensed when Acquisition cost P/L effects are

incurred (amount of acquisition cost expensed over the SIMILAR AND
not varying significantly during the coverage period CONSISTENT over
reporting period) reporting periods

VS Acquisition cost expensed when P/L effects VARY

incurred (amount of acquisition cost over reporting
varying significantly during the periods (disclosure
reporting period, concentration in and explanations
specific instant) required

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(iv) ADJUSTMENT TO A FINANCING COMPONENT

If insurance contracts in the group have a significant financing component, an entity shall adjust the carrying
amount of the liability for remaining coverage to reflect the time value of money and the effect of financial
risk using the discount rates specified in paragraph 36, as determined on initial recognition .

The entity is not required to adjust the carrying amount of the liability for remaining coverage to reflect the
time value of money and the effect of financial risk if, at initial recognition, the entity expects that the
time between providing each part of the coverage and the related premium due date is no more than a year.

IFRS 17 does not define standards to use in order to assess the existence of significant financing component.

However…

we can refer to IFRS 15.61 in order to identify main criteria in determining whether a financing component is
significant:
• expected length of time between when the entity transfers promised goods or services and when
customer pay for it;
• whether amount of consideration would differ significantly if customer paid in cash promptly;
• prevailing interest rates in relavant market.

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(v) INSURANCE REVENUE RECOGNISED

Recognition of insurance revenues for the period equals to the amount of premiums receipts allocated to
such period (IFRS 17.B126).

Allocation to each period of coverage is determined by the entity

• based on the passage of time (systematic allocation, pro-rata temporis)

BUT

• if the pattern of release of risk during the coverage period is expected to be significantly different from
passage of time, then the allocation of insurance revenues will be based on the expected timing of
incurred insurance service expenses.

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(v) INSURANCE REVENUE RECOGNISED

HIGHLIGHTS – RISK PATTERN ISSUES – Linear vs Non-linear

The risk pattern of many insurance contracts is tipically flattened over the coverage period (i.e. Motor TPL).

However for some insurance contracts a non-linear risk distribution over time could be observed; this may
happen for risk that are subject to seasonality and low frequency (i.e. cat risks).
Entities need to:
• adopt internal procedures to measure different risk patterns;
• demonstrate the patterns identified as different from “passage of time” by detailed analisys of past
experience (i.e. distribution of claims incurred over time);
• support future expectations.

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ONEROUS CONTRACT TEST
If FACTS and CIRCUMSTANCES indicate that a group of insurance contracts is ONEROUS, then a LOSS
calculation need to be performed.

The entity needs to determine the liability for remaining coverage under the general measurement
requirements, determining the fulfilment cash flows that relate to remaining coverage according to
paragraphs 33–37 and B36–B92). (*)
LOSS is EQUAL TO:
• carrying amount of the liability for remaining coverage under PAA
• minus liability for remaining coverage under the general measurement requirements.
If the liability under the general measurement requirements IS GREATER than the liability under PAA, then a
loss need to be accounted for in P&L, increasing the liability for remaining coverage.

(*) If, in the measurement of the liability for incurred claims under the PAA, the entity does not adjust the
liability for incurred claims for the time value of money and the effect of financial risk, it shall not
include in the fulfilment cash flows any such adjustment.

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ONEROUS CONTRACT TEST
HIGHLIGHTS - FACTS AND CIRCUMSTANCES (INDICATIONS OF LOSS)
Contracts may become onerous AT ANY TIME DURING THE COVERAGE PERIOD (initial recognition or
subsequently).

BUT
A systematic measurement of the liability according to general model is not required by IFRS 17.
Companies are required to evaluate if a group of contracts is becoming onerous.
IFRS 17 does not provide any guidance related to facts and circumstances to be considered.
Therefore entities need to:
• define policies to identify fact and circumstances (indications of loss);
• be able and ready to monitor such indications and the related changes.

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ONEROUS CONTRACT TEST
Which indicators are relevant for management to monitor?
• economic changes and regulatory modifications which cause (adverse) changes in the expected cash
flows;
• expected “claims to premiums” ratio;
• actual ratio and its historical trend over the coverage period;
• other expected profitability measures;
• changes to costs for fulfilment of contracts (both internal costs and external services used to provide
insurance coverage).

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LIABILITY FOR REMAINING COVERAGE: RECAP

So under IFRS 17 PAA:

The initial measurement does not explicitly identify the present value of future cash flows, the effects of
risk and the time value of money.

Consequently

the subsequent measurement does not involve an analysis of the variations in those components before a
claim is incurred because the rationale for applying the PAA is that there are unlikely to be significant
changes in them.

However…..

when facts and circumstances indicate that a group of contracts is onerous, the entity calculates the
liability for remaining coverage using the general measurement model's fulfilment cash flow
requirements, with certain simplifications if certain conditions are met.

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LIABILITY FOR INCURRED CLAIMS
PAA provides the liability for incurred claims to be measured according to the general measurement model
(paragraphs 33-37 and B36-B92).

PRACTICAL EXPEDIENT UNDER PAA - IFRS 17.59 (b)

If the entity expects future cash flows to be paid or received in ONE YEAR OR LESS from the date the claims
are incurred, the entity may choose not to discount those cash flows and not to adjust for the time value of
money.

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EXPECTATION FOR ADOPTION OF PAA
In issuing the standard, IASB expectations for Premiums allocation approach were that, compared to the core
model of IFRS 17, if conditions for eligibility of PAA are met (mainly “plain” of short term insurance
contracts):

 semplification to core requirements;  lower costs for insurers to implement PAA

 avoids the calculation of contractual service
margin;
 some practical expedients could be used;
 no need to update estimates;
 similar to the current approach required in
some jurisdictions (liabilities for unearnead
premium to major for unexpired risk).
approach
 no significant loss of information (in respecto
to the general model) for users of financial
statements;
 no significant issues of comparability for users
of financial statements.

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IMPLEMENTATION MATTERS

 Need to implement also the general measurement

model (required in case contracts become onerous)
 For any multi-year contracts, it could be appropriate
to determine, during the transition process to IFRS
17, whether the PAA will furnish any material
difference in terms of valuation to the general
measurement model;
 Defining the contract boundary is critical to analyzing
whether an insurer can use the PAA for some
contracts either due to having a coverage period of
one year or less, or because the PAA reasonably
approximates the general measurement model
results.
 Some life insurance contracts currently using long duration measurement models may qualify to be able
to use the PAA approach, which would simplify the modelling required.
 Contracts with longer coverage periods, such as engineering, construction or lenders mortgage insurance
will need to demonstrate they meet the second criteria. If not, they will have to use the general
measurement model instead. Non-life insurers in this scenario will need to develop more complex
modelling than they currently apply, requiring more data and the development of long-term assumptions.
Financial statements will include a mix of valuation techniques, complicating the way results are
analyzed and communicated.

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CONTATTI
Andrea Mezzadra
Partner – Audit & Assurance
andrea.mezzadra@bdo.it
D. +39 02 58201324
M. +39 348 3060784
BDO Italia S.p.A.
Viale Abruzzi, 94
20131 Milano
Tel. 02 58 20 10
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