Odomirok.24-IFRS
Reading: Financial Reporting Through the Lens of a Property/Casualty Actuary
Author: Kathleen C. Odomirok, FCAS, MAAA, Liam M. McFarlane, FCIA, FCAS, Gareth L. Kennedy, ACAS, MAAA, Justin J. Brenden, FCAS, MAAA, EY
Study Tips
International Financial Reporting Standards (IFRS) are global reporting standards from the International Accounting Standards Board (IASB). This is a very complex topic and the overview given in the source text barely scratches the surface. You will not be able to gain an understanding of IFRS from this brief treatment. All you can do is memorize a few selected items just in case they are asked on the exam:
- definition of insurance contract
- the concept of level of aggregation
- methods for measuring the liabilities of insurance contracts
- the basic formula: insurance contract liability = LRC + LIC
I think the likelihood of an exam question on this topic is low.
Estimated study time: 30 minutes (not including subsequent review time)
BattleTable
- this reading has not been tested on any exam from the year 2012 to Fall 2019 when the exams stopped being published.
reference part (a) part (b) part (c) part (d) no prior questions
Full BattleQuiz You must be logged in or this will not work.
In Plain English!
General Information
In broad terms, IFRS 17 establishes principles for the recognition, measurement, presentation and disclosure of insurance contracts. Let's take a step back however and see how IFRS relates to the current GAAP standard in the United States.
The first thing you have to know about accounting standards is:
- FASB develops and issues GAAP standards
- IASB develops and issues IFRS standards
Recall:
- FASB = Financial Accounting Standards Board
- IASB = International Accounting Standards Board
FASB & IASB are cooperating to create financial reporting standards to:
- increase transparency & consistency among insurers operating in different countries
- align standards with company economics (versus regulatory prudence)
An important first step in this cooperation is the IFRS definition of insurance contract:
- a contract under which one party (the insurer) accepts significant insurance risk from another party (the policyholder) by agreeing to compensate the policyholder if a specified uncertain future event (the insured event) adversely affects the policyholder
Recall that in the U.S. insurance risk requires both underwriting risk and timing risk. Note however that IFRS does not require timing risk. ← IFRS does require timing risk.
IFRS 17
IFRS 17 establishes principles for the recognition, measurement, presentation and disclosure of insurance contracts. The treatment of IFRS 17 in chapter 24 of Odomirok is very brief but here are few items that are discussed:
| Level of Aggregation |
- an insurer can aggregate its portfolio of insurance contracts into different groups
- there are 3 broad levels of aggregation used for defining groups and these levels are based on the concept of "onerous contracts"
- the term "onerous contracts" is a key concept in IFRS but it is not defined in Odomirok (for this reason, it would not be a good exam question)
After the insurer aggregates their contracts into groups, the next step is to measure the liabilities associated with these groups. There are a few different ways of doing this.
| Measurement Models: General Model (this is the default approach in IFRS) |
- Balance Sheet liability = FCF + CSM
- → FCF
- = Fulfillment Cash Flow
- = [ Present Value of (premium - losses - benefits - expenses) ] + [ adjustment for timing and risk of these cash flows ]
- → CSM
- = Contractual Service Margin
- = (expected profit for providing future insurance coverage)
- calculating the discount rate used in the PV calculation is a complex topic that is not discussed in any detail in the source text
- → as a general rule however, use current discount rates (versus historical rates in effect at contract inception)
- The VFA or Variable Fee Approach is based on the General Model but with additional features to account for contracts with direct participating features.
| Measurement Models: Premium Allocation Approach |
- a simplified version of the General Model but one of these eligibility requirements assessed at contract inception must be met:
- - can be used for short-term contracts (policy term ≤ 1 year)
- - can be used for longer-duration contracts IF PAA is a reasonable approximation to GMA over the life of the contract
- - applies only to LRC component of insurance contract liabilities (see below)
Question: define the term Liability for Incurred Claims or LIC
- insurer’s obligation to pay claims for events that have already occurred
Question: define the term Liability for Remaining Coverage or LRC
- insurer’s obligation to provide insurance coverage for events that have not yet occurred (basically just the premium liabilities)
| Extra background information on IFRS 17 |
- Here's a link to the official IFRS 17 website. It isn't specifically part of the syllabus but I found it helpful. Take a quick look now then you can come back later to review:
- Under the IFRS accounting model, we have the following relationship on the balance sheet:
- → insurance contract liability = LRC + LIC
- And the CSM (Contractual Service Margin) is part of LRC.
Full BattleQuiz You must be logged in or this will not work.
