E.1 IFRS 17 effect analysis

Question 1

scope of IFRS 17

Answer 1

IFRS 17 applies to 3 contract types:

1. Insurance contracts issued
   - must transfer significant risk
2. reins contracts held
3. investment contracts with discretionary participation features issued
   - only if the company also issues insurance contracts

exclusions:

• product warranties
• financial gt contracts
• fixed fee services

Question 2

separation of non insurance components

Answer 2

IFRS 17 requires separation of non insurance components if both are true:

1. a separate contract with the same features as the non insurance component would be within the scope of another IFRS
2. if the non insurance component is distinct
   - not highly interrelated with the insurance component
   - a contract with equivalent terms could be sold separately in the same market

examples:
- embedded derivatives
- distinct deposits
- distinct goods

Question 3

IFRS 17 GA model

Answer 3

IFRS 17 can be applied to groups of contracts within a portfolio, divided into these groups:

1. contracts that were onerous at initial recognition; estimated cf outflow > estimated cf inflow
2. contracts with no significant possibility of becoming onerous in the future
3. remaining contracts that dont fit into groups 1 or 2

all insurance contracts are initially measured as the total of:

1. fulfillment CFs = best estimate +risk adj of future CFs
   - risk adj = explicit adj to reflect the uncertainty in timing and in amount of future cash flows
   - discount rates reflect the characteristics of the contracts CDs
   - based on current observable IRs
2. Contractual service margin = expected profit from providing insurance coverage
   - CSM = 0 for onerous contracts and their losses are recognized immediately

• Future CFs are measured under current assumptions, updated each reporting period
• changes in part or current CFs should be recognized immediately

Question 4

modifications to the GA model (Variable fee approach)

Answer 4

• VFA is a modification of the general accounting model for insurance contracts with direct participation features
• identical to GA model at inception

differences after inception:

• VFA allows the CSM to be optionally adjusted/updated to offset changes in the variable fee
• an insurer may choose to not adjust the CSM and instead allow the effect to flow through P & L
• direct participation feature = an obligation to pay PHs the FV of the underlying items less a variable fee for service

an insurance contract has a direct participation feature if it has all of the following:

1. PH participates in a share of clearly identified pool of underlying items
2. Company expects to pay a substantial share of the FV returns on underlying items
3. Payments to PH will vary with the change in FV of underlying items

Question 5

statement of comprehensive income

Answer 5

Comprehensive income is broken into 2 items:

1. Insurance service results = insurance revenue - insurance service expenses
   - “UW results”
2. Insurance finance income or expenses
   - “Net investment results”
   - II on assets
   - net result = finance income - finance expenses

Question 6

Disclosures required by IFRS 17

Answer 6

1. Explanation of recognized amounts
   - reconciliation of opening and closing balances
2. significant judgments
3. Nature and extent of risks arising from insurance contracts
4. Effect of the insurers regulatory framework

Question 7

Improved requirements introduced by IFRS 17

Answer 7

1. use of current estimates - based on the most up to date info available
2. Appropriate discount rates - that reflect the characteristics of the liability CFs
3. Explicit current risk adjustment
4. current value of financial options and gts - always included in FCFs and consistent with observable market prices
5. Grouping contracts at initial recognition in a way that reflects profitability
6. making onerous contracts visible in a timely way - recognizing loss immediately at issue
7. consistent recognition of profit as it is earned for insurance services
8. consistent treatment of acquisition costs - include directly attributable acquisition costs in the FCFs
9. Revenue recognition comparable to other industries - report on an earned basis
10. understandable claims and other expenses - insurance expenses are only items that reflect insurance service expenses
11. consistent accounting policies across all insurers
12. consistent accounting for non insurance components
13. single approach for all insurance components
14. More useful information - requires insurance accounting policies that provide useful info to users of financial statements

Question 8

Improved financial reporting info introduced by IFRS 17

Answer 8

• ifrs 17 provides more transparent and timely info
• requires insurers to reflect the time value of money in liability (discounting)
• ifrs 17 requires updated assumptions every reporting date
• ifrs 17 requires discount rates that reflect the characteristics of the CFs
• requires a company to calculate and disclose an explicit risk adjustment
• improve transparency about the sources of profit: must recognize profits as it delivers insurance services. show risk adjustments and CSM separately
• require reconciliation of change in the CSM each period
• ifrs 17 will reduce the non-GAAP disclosures that companies make; such as EV

Question 9

IFRS 17 vs (MC) EV

Answer 9

similarities:
- both reflect current estimates of CFs

differences:

• discount rates; MCEV uses rfr, IFRS 17 uses a DR based on characteristics of ins CF
• MCEV presents an explicit TVOG item
• IFRS 17 captures the time value and intrinsic value of FOGs in the insurance liability
• MCEV quantifies the total expected future profit at inception
• IFRS 17 establishes a liability for unearned profit that is systematically released

Question 10

how IFRS 17 affects the balance sheet

Answer 10

Short term contracts, IFRS impact depends on:

1. length of settlement periods
2. size of claims
3. previous discount rate used
4. size of the previous risk adjustment applied

For long term contracts:

1. Current or historical assumptions
   - If a discount rate was used that is higher than the current rate then IFRS 17 liability will be higher
2. risk margins - depends on how large the pre-ifrs 17 risk margin was
3. FOGs
   - insurers that did not fully reflect FOGs will see an increase in liability; else will probably see little impact
   - mostly impacts products with min gtd rates
4. acquisition costs:
   - ifrs 17 requires a company to include directly attributable acquisition costs in FCFs
   - if a company previously recognized acquisition costs as incurred they will see the insurance liability decrease under ifrs 17
5. any ifrs 17 impact that will cause liability to increase will cause equity to decrease (and vice versa)
   2a. pre-ifrs practices will lead to an increase in reported equity after ifrs 17:
   - acquisition costs are expensed as incurred
   - discount rates < market rates
   risk margins > ifrs 17 risk adj
   2b. pre-ifrs practices ill lead to a decrease reported equity:
   - profits are recognized at contract inception
   - aggregation of onerous and profitable contracts
   - discount rates based on assets backing the insurance contract liabilities
   - value of FOGs not fully included in the measurement of insurance contract liabilities
   - discount rates > market rates
   - risk margins < ifrs 17 risk margins

Question 11

how IFRS 17 affects the statement of comprehensive income

Answer 11

1. presentation of premiums
   - premiums are no longer counted as revenue or expenses
   - insurance revenue = amount the company expects to receive for the services provided
2. presentation of insurance finance expenses
   - the net investment result is shown separately form the insurance result
3. recognition of CSM and risk adjustment
   - risk adjustment will reflect the company’s own assessment of risk
4. total amounts recognized in P&L
   - ifrs 17 will reduce the volatility of the amount of recognized in P&L
   - onerous contract losses are recognized immediately in P&L