1. IFRS 17 Insurance Contracts – the final standard is here!
IABA annual meeting 2018
IFRS 17 Insurance Contracts – the final standard is here!
Introduction on the final standard and what it means to actuaries
July 27, 2018

2. Agenda Background Overview General Model Premium Allocation Approach
Impacts to financial reporting
Transition

3. 1 – Background
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4. Background IASB’s project on insurance contracts
Insurance project started
1997
Mar
2004
IFRS 4 issued
Jan
2005
IFRS standards adopted in Europe
Discussion paper
May
2007
Jul
2010
Exposure Draft of proposals
Jun
2013
Exposure Draft of revised proposals
2017
IFRS 17 issued
2021
Effective date
The International Accounting Standards Board (IASB) develops International Financial Reporting Standards (IFRS) – IFRS 17 covers insurance contracts and replaces IFRS 4
The IASB Board is represented by large countries around the globe, including the US
Most countries around the world, except for the US, follow IFRS either directly or with minor adjustments. US follows US GAAP (and US Stat)
IASB and FASB (developer of US GAAP) have different perspectives

5. Background IFRS 17 key points
What is IFRS 17?
A comprehensive standard to account for insurance contracts applicable to companies that prepare financial statements under IFRS. It replaces IFRS 4, which was not a comprehensive standard
Why was IFRS 17 developed?
To bring consistency to financial reporting around the globe for companies reporting under IFRS 17, and to better compare those insurance companies to those operating in other sectors of industry
What is the most fundamental element of change that IFRS 17 brings?
Closer alignment of the accounting to the underlying economics of insurance

6. Background IFRS 17 improvements
Existing issues
How IFRS 17 improves accounting
Variety of treatments depending on type of contract and company
Consistent accounting for all insurance contracts by all companies
Estimates for long-duration contracts not updated
Estimates updated to reflect current market-based information
Discount rate based on estimates does not reflect economic risks
Discount rate reflects characteristics of the cash flows of the contract
Lack of discounting for measurement of some contracts
Keep this slide – it’s from the IASB
Measurement of insurance contract reflects time value where significant
Little information on economic value of embedded options and guarantees
Measurement reflects information about full range of possible outcomes
The information presented on the slide was prepared by IFRS Foundation.

7. Background Overview of the guidance
IFRS 17 is the proposed new international accounting standard for insurance contracts which replaces the existing IFRS 4 standard. The new standard provides a single global accounting standard for insurance contracts.
What is changing?
Balance Sheet
IFRS 17 requires a current measurement model, where estimates are re-measured in each reporting period.
The measurement is based on the building blocks of discounted, probability-weighted cash flows, a risk adjustment, and a contractual service margin (‘CSM’) representing the unearned profit of the contract.
Income Statement
Requirements in IFRS 17 align the presentation of revenue with other industries. Investment components are excluded from revenue.
Under IFRS 17, entities have an accounting policy choice to recognize the impact of changes in discount rates in profit or loss or in other comprehensive income (‘OCI’) to reduce some volatility in profit or loss.
Disclosures
IFRS 17 disclosures will be more detailed than required under current reporting frameworks.
Disclosures will provide additional insight into key judgements and profit emergence.
Disclosures are designed to allow greater comparability across entities.

8. 2 – Overview
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9. Measurement Overview of measurement models
General model
Premium allocation approach (PAA)
Variable fee
approach
Why is it needed?
Default model for all insurance contracts
To simplify for short term contracts with little variability
To deal with participating business where payments to policyholders are linked to underlying items like assets
Types of contract
Long-term and whole life insurance, protection business
Certain annuities
US style universal life
Reinsurance written
Certain general insurance contracts
General insurance
Short-term life and certain group contracts
Unit-linked contracts, US variable annuities and equity index-linked contracts
Continental European 90/10 contract
UK with profits contracts
Mandatory?
Mandatory
Optional
Mandatory

10. Background Measurement models
Undiscounted reserves for past claims (including IBNR)
Current IFRS/GAAP
General Model
PAA
Discounting
Risk adjustment
Expected value of future cash flows
Contractual Service Margin
UPR less DAC
Premium (less acquisition costs) unearned
Expired risk
Unexpired risk
Qualifying for the PAA
Automatically available for contracts with coverage period twelve months or less.
Unlikely that all contracts will automatically qualify for PAA model.
Mixed measurement models within a reportable segment may make results difficult to interpret.
Drivers of profit
Changes to yield curves will require better asset liability matching to manage income statement volatility.
No prescribed method for measuring the risk adjustment but entity required to disclose methodology and confidence level and expected to be consistent year on year.
* Size of blocks are for illustrative purposes only

11. Measurement Level of aggregation – portfolios & groups of contracts
A portfolio: insurance contracts subject to similar risks and managed together
Entity divides each portfolio of contracts into groups based on profitability and initial recognition date.
Car insurance
Portfolio 1
Group A
Group B
Group C
Group D
Group health
Portfolio 2
Group
Surety
Portfolio 3
Group AA
Group BB
Group CC
Breeze through this
Minimum requirement

12. 3 – General model
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13. General model Liability components of the general model
Key components
Discount future cash flows using rates to reflect the characteristics of the liabilities in terms of timing, currency, and liquidity.
Discounting
Reflect compensation entity requires for uncertainty inherent in the cash flows. Quantifies the value difference between certain and uncertain liability.
Risk adjustment
Contractual service margin to prevent gain on policy inception. Unearned profits recognized over coverage period.
Contractual service margin
Expected value (explicit, unbiased, probability weighted estimate) of the future cash flows that will arise as the insurer “fulfils” the insurance contract.
Probability weighted expected future cash flows

14. General model Overview
Discounting
Risk adjustment
Contractual service margin
Best estimate of fulfilment cash flows
Expired and unexpired risk
Default model for all insurance contracts
Based on discounted best estimate of future cash flows (in and out)
Explicit margins:
CSM to prevent gain on policy inception
Risk adjustment
Day 1 loss recognized in income statement
Cash flow approach for all liabilities:
LIC: past claims (including IBNR)
LFRC: future cover

15. General model Best estimate of fulfilment cash flows
Discounting
Risk adjustment
Contractual service margin
Best estimate of fulfilment cash flows
Expired and unexpired risk
Consistent with observable market prices
Current value
Probability-weighted mean of range of possible outcomes
Entity perspective for other cash flow estimates
Incorporates all available information in unbiased way
Include both intrinsic value and time value of options, forwards and guarantees

16. General model Discount
Discounting
Risk adjustment
Contractual service margin
Best estimate of fulfilment cash flows
Expired and unexpired risk
Discount rates should:
Reflect the time value of money, the characteristics of the cash flows and the liquidity characteristics of the insurance contracts;
Be consistent with observable current market prices for financial instruments with cash flows whose characteristics are consistent with those of the insurance contracts, in terms of, for example, timing, currency and liquidity; and
Exclude the effect of factors that influence such observable market prices but do not affect the future cash flows of the insurance contracts.
Options
Method not specified
OCI option for I/S
Discounting is not required if cash flows are expected to be received/paid within one year from the date the claims are incurred

17. General model Risk adjustment
Discounting
Risk adjustment
Contractual service margin
Best estimate of fulfilment cash flows
Expired and unexpired risk
Reflects compensation that entity requires for bearing uncertainty for non-financial risks
Measures compensation to make entity indifferent between:
Range of possible outcomes
Fixed cash flows with same expected value
Key characteristics
Explicit
Company perspective (not exit value or FV)
Consider risk arising from contract only
Non-hedgeable risks only
Fulfilment value (vs. transfer value)
Consider diversification
* Entities will be required to disclose the confidence level

18. General model Contractual service margin
Discounting
Risk adjustment
Contractual service margin
Best estimate of fulfilment cash flows
Expired and unexpired risk
Represents unearned profit over the coverage period
Amortized
Over coverage period in systematic way reflecting provision of coverage/service
Service is provided on basis of passage of time (stand ready obligation) and based on the coverage units reflecting expected duration and quantity of benefits
CSM cannot be negative * – once CSM is reduced to zero, expected losses arising will be immediately recognized in P/L
Previously recognized losses can be reversed arising from favorable changes in estimates
Adjusted for changes in risk and estimates of the fulfilment cash flows related to future services
Locked in rates should be used for accretion of interest and calculation of changes in cash flows that offset the CSM
* CSM can be negative for ceded reinsurance held.

19. Liability for Remaining Coverage = $0 at Day 1
Initial recognition
Liability for Remaining Coverage = $0 at Day 1
Day 1 Calculation of CSM
Nominal Future Cash flows
Discount
Discounted
Future
Cash Flows
(1)
Premiums
$2,000 $0
(2)
Losses
($1,000)
$20
($980)
(3) = (1) + (2)
Future Cash Flows
$1,000
$1,020
(4) = 20% x (2)
Risk Adjustment (20%)
($196)
(5) = (3) + (4)
Fulfillment Cash Flows
$824
(6) = -(5)
CSM
($824)
(7) = (5) + (6)
Liability for Remaining Coverage

20. 4 – Premium allocation approach
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21. Premium allocation approach Overview
Expected to apply to most property/casualty contracts and annual health contracts
Simplification that may be applied when the entity reasonably expects that it would produce a measurement of the liability for remaining coverage for the group that would not materially differ from the general model or when the coverage period on the product is one year or less
Similar to current US GAAP unearned premium approach, but:
Use of “mean” rather than “best estimate” for incurred claims
Discounting of incurred claims is generally required at a rate reflective of the underlying liabilities-a risk-free rate with an adjustment for liquidity
Inclusion of “risk adjustment” to reflect uncertainty in amount/timing of unpaid claims
Revenue pattern based on the passage of time or expected timing of incurred insurance service expenses, if the expected pattern of release from risk differs
Other key differences include (1) gross presentation as regards reinsurance in income statement (e.g., revenue is not “netted” for ceded reinsurance), (2) exclude “investment components” from revenue and claims incurred expense, (3) ceding commissions netted against reinsurance premiums, (4) present DAC net against LFRC, (5) more granular level of onerous contract testing (akin to UPR deficiency test)
Discounted liability for incurred claims
Liability for remaining coverage
DAC
Onerous + =
Insurance liability

22. Premium allocation approach Eligibility criteria
An entity may simplify the measurement of a group of insurance contracts using the premium allocation approach if, and only if, at the inception of the group:
the entity reasonably expects that such simplification would produce a measurement of the liability for remaining coverage for the group that would not differ materially from the one that would be produced applying the General Model; or
the coverage period of each contract in the group (including coverage arising from all premiums within the contract boundary determined at that date) is one year or less.
Criterion (a) above is not met if at the inception of the group an entity expects significant variability in the fulfilment of cash flows that would affect the measurement of the liability for remaining coverage during the period before a claim is incurred.
What is the unit of account?
What are the coverage units?
What is materiality?

23. Premium allocation approach Eligibility … tougher than it looks …
At inception, would the PAA differ materially from the BBA (LFRC only)?
Is the coverage period one year or less?
Is significant variability in the fulfilment cash flows expected (which may affect the measurement of the liability for remaining coverage during the period
before a claim is incurred)?
PAA is automatically applicable
More challenging to construct an argument that PAA is applicable
Yes No ?
May be possible to construct an argument that PAA is applicable
Factors to consider
Contract boundaries under IFRS 17 (different to current standard and Solvency II)
Variability in your expectation of the present value of future cash flows
All (re)insurance contracts with coverage period of one year or less
Property damage type multi-year policies of 2 to 3 years, some reinsurance contracts (e.g. risk attaching)
Construction, energy, engineering, A&H, D&O, credit, surety, warranty and seasonally impacted property damage type multi-year policies
Decision tree
Possible impact on lines of business
No definition of “material” or “significant”

24. Premium allocation approach PAA vs. US GAAP: profit emergence example
Assumptions:
Example is for one unit of account – e.g. Accident Year 2017 Auto Liability
Premium totaling $1,000 is earned in first year
Initial expected/unbiased mean loss ratio on policy = 80%; additional $100 of claims are incurred during year 2. Thus, total profit = $100.
20% of claims are paid in the year they are incurred; remainder paid in the subsequent year after being incurred.
Flat 5.5% discount rate applied.
Risk adjustment equals 30% of outstanding liability for incurred claims at each reporting period; the risk adjustment is released as claims are paid.

25. Premium allocation approach PAA vs. US GAAP: profit emergence example
Total
100
Under PAA, profit emergence is delayed vs US GAAP due to the presence of the risk adjustment.
Under PAA, profit is smoother than US GAAP due to the release of risk adjustment offsetting an increase to incurred claims in this particular example.

26. Premium allocation approach Why is the PAA a useful simplification of the general model?
Liability for Remaining Coverage, for unexpired risk, is accounted for using an Unearned Premium Reserve
Under the General Model, an entity is required to establish an estimate of the expected value of future cash flows for both the expired and unexpired risk (and determine a CSM).
Under the PAA, estimating the expected value of future cash flows is required only for the Liability for Incurred Claims, unless the contract is deemed onerous (which would then require the measure of the unexpired risk using the General Model framework to quantify the loss amount that must be recognized).
Do not need to calculate a CSM
Do not need to determine the estimated lifetime profitability of the contract at issue date
No need to continue to solve for unlocked CSM at future valuation dates
Companies can leverage current reserve estimates, with applicable adjustments:
Unbiased mean, discounting, risk adjustment
System updates are still needed to quantify and track these adjustments through time

27. 5 – Impacts to financial reporting
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28. Presentation (PAA) Income statement
Revenue and expense are recognised as services delivered and incurred respectively
Interest expense is current or locked-in depending on accounting policy choice
Insurance components
Liability for Remaining Coverage (Unearned premiums less DAC)
Risk adjustment for unpaid claims
Discounted expected cash flows for unpaid claims
20XX
Insurance revenue* X
Insurance service expenses
(X)
Insurance service result
Investment income
Insurance finance expenses
Finance result
Profit or loss
Gains and losses on financial assets at FVOCI
Effect of discount rate changes on insurance liability (optional)
Total comprehensive income
~ ~
Non-distinct investment components
Insurance contract revenue* consists of the following:
Expected claims and benefits
Expected expenses
Amortization of CSM
Release of risk adjustment
Amortization of acquisition costs
Premiums due or written prohibited
If OCI option is chosen, difference between current and locked-in market variables
are presented in OCI

29. Disclosure requirements
Amounts
Detailed roll forward schedules and reconciliations
Reconciliation of sources of profit
Contracts written in the period
Relationship interest and investment return
Significant judgements
Processes to estimate inputs to methods
Effect of changes in methods and inputs
Confidence level for determining risk adjustment
Yield curve(s) used to discount cash flows
Nature and extent of risks
Nature and extent of risks
Insurance risk on gross/net basis
Concentrations of insurance risk and claims development
Quantitative disclosures about non-insurance risks

30. 6 – Transition
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31. Transition
Effective date is 1 January 2021, but at least one year of comparative numbers required
Transition is retrospective, so historic data is required.
Transition is aimed at determining the CSM on the transition date.
Impact of transition is recognized in opening equity
Approach:
Full retrospective approach
When historical data exists and hindsight is not required
Modified retrospective approach
When not all historical information is available but information about historical cash flows is available or can be constructed
Measurement at fair value
When no historical information about cash flows is available to determine the CSM
If impracticable

32. Transition
Required for annual reporting periods beginning on or after January 1, 2021 (applied to in-force policies starting January 1, 2020)
At transition, each group of insurance contracts (Unit of Account) should be reported as the sum of the fulfilment cash flows (including onerous contract liability if required), risk adjustment and CSM
Current CSM = initial CSM at inception and adjusting it to reflect the experience until the transition date at locked in rates
Capture the cumulative amount of insurance finance income or expenses recognised in other comprehensive income at transition
Full retrospective
Closest outcome to full without undue cost or effort
Allowed to adopt each simplification below only if there is insufficient data:
Grouping of contracts (e.g., more than one underwriting year)
Use of yield curves (e.g., discount rate specified as of Transition instead of at inception of contract)
Cash Flows estimated at inception = FCF at Transition, adjusted by CF known to have occurred since inception
Risk Adjustment estimated at inception = RA at Transition, adjusted by expected release based on other similar contracts
Approach to capture cumulative impact in other comprehensive income at transition
Modified retrospective
IFRS 13 market participant price to transfer the asset or liability = FV at Transition
Fulfilment CF and risk adjustment liabilities measured based on IFRS 17 measurement approach at Transition date
CSM balance or loss component at Transition is set as the difference of the above 2 items
Fair value could be derived by adjusting IFRS 17 fulfilment and risk adjustment liabilities to reflect a market participants viewpoint and include other non-attributed expenses that a market participant would expect to be covered by the premium
Not required to separate contracts into underwriting year
Fair value

33. Questions? Lela Patrik Adam Kallin FCAS, MAAA
PwC, Actuarial Services Director, Philadelphia
(267)
Adam Kallin
PwC, Actuarial Services Manager, Atlanta
(678)

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