C. IFRS 17 Notes PDF

General glossary ================ +-----------------------------------+-----------------------------------+ | **Abbreviation** | **Definition** | +===================================+===================================+ | FCT - Fulfillment Cash Flows | The p...

General glossary ================ +-----------------------------------+-----------------------------------+ | **Abbreviation** | **Definition** | +===================================+===================================+ | FCT - Fulfillment Cash Flows | The present value of an | | | insurer\'s liabilities, including | | | discounting and risk adjustments | +-----------------------------------+-----------------------------------+ | RA - Risk Adjustment (for | Claims development | | non-financial risk) | | | | (Note, that discount rates and/or | | | cashflows will be adjusting for | | | financial risk) | +-----------------------------------+-----------------------------------+ | LIC - Liability for Incurred | Insurer's obligation to pay | | Claims | claims for events that have | | | already occurred (earned | | | business) | +-----------------------------------+-----------------------------------+ | LRC - Liability for Remaining | Insurer's obligation to provide | | Coverage | insurance coverage for events | | | that have not yet occurred | +-----------------------------------+-----------------------------------+ | LC - Loss Component | Expected net outflow of an | | | onerous group | +-----------------------------------+-----------------------------------+ | CSM - Contractual Service Margin | Unearned profit from a group of | | | insurance contracts | +-----------------------------------+-----------------------------------+ | AIC - Asset for Incurred Claims | Usually reinsurance | +-----------------------------------+-----------------------------------+ | ARC - Asset for Remaining | Usually reinsurance | | Coverage | | +-----------------------------------+-----------------------------------+ Relation to CCIR.Instructions paper: +-----------------------------------+-----------------------------------+ | **Statement of Profit or Loss** | **Formula** | +===================================+===================================+ | Insurance Service Result (ISR) | +TIR - Total Insurance Revenue | | | | | | \- ISE - Insurance Service | | | Expense | | | | | | \+ NRE - Net expenses from | | | reinsurance contracts held | | | | | | = ISR | +-----------------------------------+-----------------------------------+ | Net Investment Result (NIR) | \+ IR - Investment Return | | | | | | \+ Net fin income/expenses from: | | | | | | a\. Insurance contracts | | | excluding segregated funds | | | | | | b\. Segregated funds | | | | | | c\. Reinsurance contracts held | | | | | | \+ Movement in investment | | | contract liabilities | | | | | | = NIR | +-----------------------------------+-----------------------------------+ | Other Income and Expenses (OIE) | \+ Other Income | | | | | | \+ Share of NI (Loss) of Equity | | | Accounted Investees | | | | | | \+ General and Operating Expenses | | | | | | = OIE | +-----------------------------------+-----------------------------------+ | Net Income (Loss) For the Year | \+ ISR - Insurance Service Result | | (NI) | | | | \+ NIR - Net Investment Result | | | | | | \+ OIE - Other Income and | | | Expenses | | | | | | \+ Discounted Operations | | | | | | \- Taxes | | | | | | = NI | +-----------------------------------+-----------------------------------+ | **Investment Return** | | +-----------------------------------+-----------------------------------+ | Investment Return (IR) | \+ NII - Net Investment Income | | | | | | \- Provision for Credit Loss | | | | | | = IR | +-----------------------------------+-----------------------------------+ CIA.IFRS17 (comparison) ======================= [Educational Note: Comparison of IFRS 17 to Current CIA Standards of Practice](https://www.casact.org/sites/default/files/2023-05/6C_CIA_Educatitional_Note_Comparision_of_IFRS_17_to_CurrentCIA.pdf) Section 1: Introduction ----------------------- R Recognition --- -------------- M Measurement P Presentation D Disclosure Q\) Principals that IFRS 17 establishes\ A) Section 2: IFRS 17 Overview --------------------------- \*\*Important question Q\) Briefly describe the 3 building blocks of the measurement of insurance contract liabilities under IFRS 17\ A) **P**resent **v**alue of future cash flows Similar to PV(liabilities) without PfADs (but includes a provision for financial risk, unlike current CIA practice) -------------------------------------------- --------------------------------------------------------------------------------------------------------------------- **Risk** adjustment for non-financial risk Similar to PfADs for non-economic risk Contractual service margin (**CSM**) Represents unearned profit from a group of insurance contracts (so no front-ending profits) Define liability for incurred claims (LIC): insurers obligation to pay claims for events that have already occurred Define liability for remaining coverage (LRC): insurer's obligation to provide insurance coverage for events that have not yet occurred (just like premium liabilities) Define fulfilment cash flows (FCF): =PV(future cash flows) + (risk adjustment for non-financial risk) Q\) When is a CSM amount established and what is the amount?\ A) When: FCF \< 0 (negative FCF is profit)\ Amount: CMD = -FCF (CSM offsets the negative FCF amount and is released into income as services provided) Q) What is meant by the front-ending of profits\ A) 2 valuation methods under IFRS 17: +-----------------------------------+-----------------------------------+ | GMA (General measurement | This is the default approach | | approach) | | +===================================+===================================+ | PAA (Premium allocation approach) | A simplified version of GMA 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 | +-----------------------------------+-----------------------------------+ [We have the following relationship on the balance sheet:] Insurance contract liability = LRC + LIC\ \*and the CSM is part of LRC Section 3: Classification of contracts -------------------------------------- Q\) Define an insurance contract according to IFRS 17\ A) a [contract] under which one party (the issuer) [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 \*Things to note - Significant insurance risk: Pr \> 0% that insurer loss \> premiums received - Insurance risk must exist before an insurance contract is created - Thus, lapse risk, persistency risk, and contract expense risks arising from a contract are not insurance risks because they only existed *after* a contract is created - Specified uncertain event has 3 aspects of uncertainty - Size - Timing - Probability **Reinsurance contracts...** - [Issued] by the reinsurer are just normal direct written contracts from the perspective of the reinsurer - [Held] by the ceding entity are separate from the underlying direct written contract - Lapse risk and expense risk in a direct written contract are not considered insurance risks because the risk is created by the contract itself (lapse/expense cannot be an insured event). - However, the transfer of lapse or expense risk from one entity to another would meet the definition of insurance risk from the perspective of the entity assuming the risk - This means it is possible for a reinsurance contract issued to be within the scope of IFRS 17 while the corresponding contract that transfers risk to the reinsurer is not Section 4: Separation of contract components -------------------------------------------- Q\) Identify examples of components within an insurance contract under IFRS 17\ A) - Insurance components (non-financial risk that is the "normal" part of any insurance contract) - Service components (e.g., claims adjudication with reinsurance protection) - Investment components (amounts included in premiums that are returned customers, regardless of the occurrence of an event) - Embedded derivative (not on syllabus) Section 5: Measurement approach for LRC --------------------------------------- Q\) Identify exception to using the GMA approach for insurance contracts (lacks detail in source so unlikely exam question)\ A) - Contracts satisfying IFRS 17.53 may use PAA (premium allocation approach) - Contracts with direct participation features may use VFA (variable free approach) - Reinsurance contracts held may use either GMA or PAA (but never VFA) Eligibility is assessed at inception of contract and PAA only applies to the LRC portion of the insurance contract liability (the LIC portion is valued using GMA, which does not have a CSM component). Q\) What is the formula for LRC under PAA?\ A) LRC = UEP -- DAC (do NOT subtract premiums receivable) Q\) Difference between IFRS 17 and previous method regarding measurement of liabilities relating to LRC (liability for remaining claims)...\ A) +-----------------------+-----------------------+-----------------------+ | **Category** | **IFRS 17** | **Prior method | | | | (CIA)** | +=======================+=======================+=======================+ | Criteria | allows PAA for | allows (UEP -- DAC) | | | short-term | to be used [only | | | contracts [without]{. | if] it\'s | | | underline} testing | a reasonable | | | whether PAA | approximation to the | | | reasonably | explicit valuation | | | approximates GMA | approach | +-----------------------+-----------------------+-----------------------+ | DAC deferral | entity may choose | no deferral in | | | deferral or direct | explicit valuation, | | | expense for | but deferral if (UEP | | | short-term contracts | -- DAC) is held | +-----------------------+-----------------------+-----------------------+ | DAC amount | allows deferral of | allowable deferral is | | | DAC that is directly | different | | | attributable to the | | | | portfolio of | | | | insurance contracts | | +-----------------------+-----------------------+-----------------------+ | Discounting of LRC | requires | requires discounting | | | discounting *(i.e. | | | | reflecting the time | | | | value of money)* if | | | | the contract has a | | | | significant financing | | | | component *(unless | | | | the time between the | | | | service provided and | | | | related premium due | | | | date is less than 1 | | | | year)* | | +-----------------------+-----------------------+-----------------------+ | Discounting of LIC | ignore discounting | requires discounting | | | and financial risk | | | | for LIC if: | | | | | | | |    - PAA is used for | | | | LRC | | | | | | | |    - LIC cash flows | | | | are received ≤ 1 year | | | | within incurred date | | | | of claims | | +-----------------------+-----------------------+-----------------------+ Summary: IFRS 17 seems to give the entity more choice in several areas: *methods (GMA or PAA), treatment of DAC, whether to discount.* That may make IFRS 17 harder to apply than the current rule-based approach, but it may provide a more customized and accurate way to measure liabilities. On the other hand, the job of the regulator might become more difficult and cross-company comparisons may not be as meaningful. Greater choice also gives companies more opportunity to manipulate their financial statements. However, properly trained regulators should be able to identify this. Q\) Identify examples in Canadian P&C where PAA can and can't be used for LRC\ A) Yes -- Auto outside of Quebec (since policy term is generally \ 1 year, or high year-to-year variability in claims) Section 6: Measurement considerations ------------------------------------- Q\) Briefly describe 2 measurement considerations for contract liabilities in IFRS 17\ A) +-----------------------------------+-----------------------------------+ | Level of aggregation | - Must identify portfolios of | | | contracts (contracts in a | | | portfolio have similar risks | | | and are managed together) | | | | | | - Each portfolio is further | | | subdivided into groups (a | | | group is the unit of account | | | for measurement of CSM) | | | | | | \*Need to put risks into | | | homogeneous classes but make sure | | | the groups are still credible and | | | not too granular | +===================================+===================================+ | Contract boundary | - Must identify contract | | | boundary for each contract | | | AKA the term of the policy | | | | | | - Cash flow estimates include | | | only cash flows related to | | | claims incurred within the | | | boundary | +-----------------------------------+-----------------------------------+ Section 7: Probability weighted cash flows ------------------------------------------ Estimate of future cash flows = probability weighted mean of the full range of possible outcomes Q\) Identify differences between IFRS 17 and current CIA practice regarding probability-weighted cash flows... (MfADs PET)\ A) +-----------------------+-----------------------+-----------------------+ | **Category** | **IFRS 17** | **Prior method | | | | (CIA)** | +=======================+=======================+=======================+ | MfADs (for | Requires [separate | The difference | | non-financial risk) | disclosure]{.underlin | between \"best | | | e} of | estimate\" of cash | | | risk adjustment for | flow and \"best | | | non-financial risk | estimate with PfAD\" | | | | is not always | | | | quantified | | | | | | | | \*[brief forum | | | | discussion & | | | | example](https://batt | | | | leactsmain.ca/vanilla | | | | forum/discussion/453/ | | | | non-financial-risk)  | +-----------------------+-----------------------+-----------------------+ | MfADs (for financial | IFRS | MfAD for interest | | risk) | 17 [includes]{.underl | rate risk is separate | | | ine} financial | from the best | | | risk in the present | estimate of PV for | | | value of future cash | cash flows | | | flows | | +-----------------------+-----------------------+-----------------------+ | Policyholder options | IFRS accounts for | The effect on cash | | (selection of limits | policyholder behavior | flows is blurred | | and other coverage | | | | options can affect | | | | cash flows) | | | +-----------------------+-----------------------+-----------------------+ | Expenses | IFRS 17 includes only | This is not a | | | expenses [directly]{. | requirement | | | underline} attributab | | | | le | | | | to the portfolio | | +-----------------------+-----------------------+-----------------------+ | Taxes | IFRS | Taxes are included | | | 17 [excludes]{.underl | | | | ine} taxes | | | | from cash flow | | | | estimates | | +-----------------------+-----------------------+-----------------------+ Section 8: Discounting ---------------------- The purpose of discounting is to account for the time value of money. Q\) Under pre IFRS 17, what 3 things do you need for the discounting calculation?\ A) 1. Discount rate 2. Discount rate MfAD (margin for adverse deviations) 3. Payment pattern Q\) How is the discount rate selected under IFRS 17?\ A) +-----------------------------------+-----------------------------------+ | **Topic** | **Details** | +===================================+===================================+ | When cash flows **do not** vary | Discount rate is based on a | | with returns on underlying items | liquidity adjusted risk free | | | discount rate (yield) curve. | | | | | | \*Ways are listed below | +-----------------------------------+-----------------------------------+ | General concepts on reflecting | You can build financial risk into | | financial risk in the discount | the discount rate OR cash flows | | rate selection | OR both | +-----------------------------------+-----------------------------------+ | When cash flows **do** vary with | Choose a discount rate that makes | | returns on underlying items | the value of the liability cash | | | flows equal the fair market value | | | of the underlying assets | +-----------------------------------+-----------------------------------+ | When cash flows vary with | Either through adjustments to the | | assumptions related to financial | discount rate OR adjustments to | | risk | the cash flows themselves and | | | must adhere to market | | | consistency. IFRS 17 suggests | | | using stochastic and risk-neutral | | | measurement techniques and | | | considering the costs of options | | | and guarantees | +-----------------------------------+-----------------------------------+ \*Approaches for coming up with the discount rate curve under IFRS 17: +-----------------------------------+-----------------------------------+ | Bottom-up approach | Adjust the risk-free discount | | | curve by adding an illiquidity | | | premium that reflects the | | | liabilities | | | | | | - Under prior way there is no | | | requirement to identify an | | | illiquidity premium | +===================================+===================================+ | Top-down approach | Use the investment return on a | | | reference portfolio of assets | | | that's "similar" to liabilities, | | | this does not have to be based on | | | assets held by the company, then | | | remove asset characteristics not | | | relevant to the liability. | | | | | | Example: use the 10-year spot | | | rate on a Canadian bond for a 10 | | | year liability cash flow and then | | | remove credit and market risk | | | | | | - Under prior way the rate | | | would be tied more closely to | | | assets held by the company | +-----------------------------------+-----------------------------------+ Section 9: Risk adjustment for non-financial risk ------------------------------------------------- **Risk Adjustment formal description**: IFRS 17 requires the entity [to adjust the present value of future cash flows] to reflect "the compensation that the entity [requires] for bearing the uncertainty about the [amount and timing] of the cash flows that arises from non-financial risk" (IFRS 17.37). Q\) Regarding non-financial risk, how is the "measurement objective" different under IFRS 17 vs pre IFRS 17 practice?\ A) [IFRS 17]: cash flows reflect an insurer's compensation for assuming non-financial risk (amount and timing of claim payments)\ [Pre IFRS 17]: cash flows incorporate PfADs (similar to IFRS 17 but include both financial and non-financial risk) IFRS 17 vs pre IFRS in terms of treatment of non-financial risk... \*Most important CIA.IFRS 17-1 (reinsurance) =========================== [Educational Note: IFRS 17 -- Actuarial Considerations Related to Reinsurance Contracts Issued and Held](https://www.casact.org/sites/default/files/2023-05/6C_CIA_Educational_Note_IFRS_17_Actuarial_Considerations_Related_to_Reinsurance.pdf) Section 1: Introduction ----------------------- This reading is specifically about reinsurance contracts under IFRS 17. The reinsurer "issues" the contract and the primary insurer "holds" the contract. The reinsurance contracts held by the ceding entity are recognized and presented in the statement of financial position and in the statement of financial performance [separately] from the underlying insurance contracts. Section 2: Level of aggregation ------------------------------- Linked to "level of aggregation" (section 6 from IFRS17 paper), contracts are first aggregated into portfolios and then into groups within each portfolio. Example -- 100,000 contracts aggregated into 10 portfolios of 10,000 each then further subdivided into 3 groups of 7,000, 2,000 and 1,000 contract each. Portfolios could correspond to provinces and territories. Groups are created based on whether the contract are considered onerous (difficult and burdensome). Q\) What does it mean for an insurance contract to be onerous?\ A) An insurance contract is onerous at the date of initial recognition if there is a [total net outflow] for the sum of: - FCFs (fulfillment cash flows) - Acquisition cash flows - Cash flows arising from the contract at the date of initial recognition \*Onerous means difficult or burdensome and an outflow of cash is definitely burdensome versus an inflow! Q\) Based on IFRS 17, how should an entity divide a portfolio into groups?\ A) 1. A group that is onerous at initial recognition (if any) 2. A group that has no significant possibility of becoming onerous (if any) 3. A group of any remaining contracts (if any) Groups can be further subdivided but source says "an entity shall establish the groups at initial recognition and [shall not] reassess the composition of the groups subsequently" however, the whole group can change from non-onerous to onerous and vice versa if the expectation regarding the future net cash flows of the group changes from positive to negative (or vice versa). For reinsurance contacts held, there is a [net gain] on initial recognition which means reinsurance contracts held [cannot] be onerous. Portfolios of reinsurance contracts held are usually in an asset position\ Portfolios of reinsurance contracts issues are usually in a liability position Q\) Does IFRS 17 permit disaggregation of individual insurance contracts?\ A) No (usually) under IFRS 17 the lowest unit of account is the insurance contract which in most cases are not permitted to disaggregate. Q\) How are multi-line reinsurance contracts aggregated under IFRS 17\ A) - Based on predominant exposure - Creating a portfolio/group containing multi-line contracts - Separating reinsurance contracts into sub-contracts and assigning those sub-contracts to separate portfolios/groups Section 3: Actuarial calculations related to fulfillment cash flows ------------------------------------------------------------------- Q\) The FCF is calculated as...\ A) - An unbiased current estimate of future cash flows (at the expected value of the full range of possible outcomes) - An adjustment to reflect the time value of money (discounting) - A risk adjustment for non-financial risk (RA) Q\) Estimates of the FCF are used for...\ A) - Determining the LIC/AIC - Determining the LRC/ARC when using the GMA for reinsurance contracts issued/held - Estimating the LC for onerous groups (regardless of the use of GMA or PAA) and any associated LRECC on corresponding reinsurance contracts held Q\) Consistent assumptions can product differences between the estimates for FCF for insurance/reinsurance contracts issued and held due to...\ A) - Contracts grouping - Contract boundaries - Discount rates - RA - Expected Q\) Identify considerations when estimating the risk of non-performance of a reinsurer (related to CIA.Rein paper for considerations in estimating a credit provision for a counterparty)\ A) - Financial strength of the reinsurer - History of claims and coverage dispute with reinsurer - Risk of contagion across various reinsurance arrangements - Delays in payments - Concentration risk - Length of time over which liability are expected to be settled - Collateral available to mitigate risk Q\) Identify 3 options for grouping data when estimating the present value of future cash flows and the risk adjustment (RA) -- all make logical sense\ A) - Estimate gross and net losses then calculated the ceded as gross -- net - Estimate gross and ceded losses then calculate the net as gross -- ceded - Estimate net and ceded losses then calculated the gross and net + ceded \*Conceptually the RA for reinsurance can be viewed as the compensation to keep rather than to cede the risk. Reinsurance held will increase the ARC and is the opposite of the RA for direct insurance contracts. Section 4: Insurance service results considerations --------------------------------------------------- Q\) Under IFRS 17, how might insurance revenue for reinsurance contract issued differ from earned premium?\ A) - Seasonality -- if the release of risk differs from the passage of time - Reinstatement premiums -- reinsurer would apply this against insurance service expenses (ISE) - Ceding commissions on proportional reinsurance treaties -- reinsurer would classify this as any of... - Insurance revenue (TIR) - Insurance service expense (ISE) - Investment component (depends on other considerations) Section 5: LRC: PAA and GMA considerations ------------------------------------------ LRC = liability for remaining claims and consists of obligations relating to future services (unexpired portion of coverage period). It can be estimated using the GMA or the PAA from the formulas below... - GMA (general measurement approach): - LRC = (FCF related to future services) + CSM - PAA (premium allocation approach): - LRC = (unearned premium) -- (insurance acquisition cash flows) PAA eligibility for reinsurance contracts is mostly similar to direct insurance, a couple of key differences: - One year risk attaching reinsurance policies are not automatically eligible for PAA - PAA eligibility for the reinsurance contract has to be assessed separately from the underlying policies - Contractual features may affect contract bounder and therefore PAA eligibility Q\) How is the CSM concept modified for reinsurance contracts held?\ A) - There is no unearned profit - Instead, there is a net cost or net gain on purchasing the reinsurance Q\) Describe a potential mismatch between revenues and FCFs when an entity uses GMA for LRC for reinsurance contract held\ A) - Revenues are recognized as they are earned - FCF projections include projected cash flows for policies to the end of the year - Example, at the end of Q1, 25% of annual revenues would be recognized (assuming uniform writings) but FCFs at the same quarter-end must include projected cash flows for 100% of the policies expected to be written throughout the year. More [details](https://www.battleactsmain.ca/vanillaforum/discussion/701/5-3-2-potential-timing-mismatch-reinsurance-contract-held-evaluated-under-the-gma): Q\) If a group becomes onerous, when do the losses have to be recognized under IFRS 17?\ A) Immediately, when the group become onerous. You can't wait until the cash outflows actually occur. For reinsurance contracts [held], the concept of onerous groups does not exist. Onerous is only relevant for contracts [issued]. Q\) Briefly describe the accounting treatment of onerous groups in financial statements\ A) - In the statement of financial position - LC is booked as part of LRC - In the statement of financial performance - LC is recognized as insurance service expense Q\) When are onerous groups recognized (AKA LC liability it shown) in financial statements?\ A) When bound even if this is prior to the effective date of the contract. Section 6: Accounting treatment of residual market mechanisms ------------------------------------------------------------- Q\) Briefly describe the accounting treatment for each of FA's (facility association) residual market mechanisms under IFRS 17\ A) UAF (uninsured automobile funds) UAF functions more like a levy which means that IFRS 17 would [not] apply (like a sales tax) --------------------------------------------- ---------------------------------------------------------------------------------------------------------- FARM (facility association residual market) Member companies account for their share of FARM and UAF insurance contract as direct business RSPs (risk sharing pools) Member companies use reinsurance accounting where the "reinsurer" is the collective FA membership. Ceded contracts are accounted for as reinsurance held while assumed contract are accounted for as reinsurance issued. CIA.IFRS 17-2 (RA) ================== [Educational Note: IFRS 17 Risk Adjustment for Non-Financial Risk for Property and Casualty Insurance Contracts](https://www.casact.org/sites/default/files/2023-05/6C_CIA_Educational_Note_IFRS_17_Risk_Adjustment_for_NonFinancial_Risk.pdf) Section 1: Introduction ----------------------- Definition of risk adjustment: RA adjusts PV (future cash flows) to reflect the compensation the entity requires for bearing uncertainty about the amount and timing of the cash flows. FCF = PV (future cash flow) + RA Q\) What are the 4 methods for calculating RA under IFRS 17?\ A) 1. Quantile methods 2. Cost-of-capital method 3. Margin method 4. A combination of methods Section 2: Transition from IFRS 4 to IFRS 17 -------------------------------------------- Q\) Considerations when transitioning from one method to another\ A) - Are current PfADs [consistent with] the compensation the entity requires for bearing uncertainty? - Are the diversification benefits included in current PfADs [consistent with] those that would be reflected in IFRS 17? Section 3: General considerations --------------------------------- Q\) 5 principles for calculating the non-financial risk adjustment in IFRS 17\ A) **Principle** **RA higher/lower** ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ --------------------- Risks where there is less information Higher Low frequency/high severity risks Higher Longer duration contract Higher Risks with wide probability distributions Higher Emerging experience -- to the extent that this reduces future uncertainty about the amount of timing of cashflows, RA, and non-financial risk AKA provides more clarity about the future Lower \*Further general considerations: - Pooling similar risks will lower the risk adjustment -- law of large numbers more risks imply lower variance - Pooling risks that are negatively correlated will lower the risk adjustment -- because negatively correlated risks will offset each other IFRS 17 establishes principles for RMPD (CIA.IFRS17 paper), MPD are also applicable to RA at each reporting date. +-----------------------+-----------------------+-----------------------+ | **Requirement:** | **Done at which | **Diversification | | | level:** | considered:** | +=======================+=======================+=======================+ | Measurement | Based on the [unit of | If units of account | | | account] | are diversified | | | (RA for a single | aggregate RA should | | | contract or group) | be lower (makes | | | | sense) | | | | | | | | Expressed as the sum | | | | of individual RAs and | | | | diversification | | | | benefit might not be | | | | accurately reflected | +-----------------------+-----------------------+-----------------------+ | Presentation | [Aggregate]{.underlin | Diversification will | | | e} | be considered | | | level | | +-----------------------+-----------------------+-----------------------+ | Disclosure | | | +-----------------------+-----------------------+-----------------------+ \*If done at an aggregate level then it will have to be allocated back to the unit of account level Reinsurance reflection under IFRS 17: - Reinsurance credit risk is reflected through a [reduction] in expected cash flows, not through the RA. - The RA also [increases] the ARC which is a little counterintuitive. Section 4: Quantile techniques ------------------------------ Quantile is a value that divides a dataset into equal-sized groups Q\) Briefly describe the quantile method with an advantage and disadvantage\ A) - Assess probability of the adequacy of the FCFs (fulfillment cash flow) - These probabilities are used to quantify the RA - Specific methods include VaR (value at risk) and CTE (conditional tail expectation) - Adv: satisfies the disclosure requirements regarding confidence level corresponding to the RA - Dis adv: if misrepresented, it may introduce false accuracy Section 5: Cost of capital method --------------------------------- Q\) Briefly describe the cost of capital method with an advantage and disadvantage\ A) - RA is based on the compensation an entity requires to meet a target return on capital, and not based on regulatory or actual capital - 3 components of this method - Projected capital amounts -- for the level of non-financial risk during the duration of the contract - Cost of capital rate(s) -- for the relative compensation required by the entity for holding this capital - Discount rates -- for the present value calculation - Adv: allows allocation of the RA at a more granular level - Dis adv: method is more complex because the projection of capital requirements is an input to the liability calculation Section 6: Margin method ------------------------ Q\) Briefly describe the margin method with an advantage and disadvantage\ A) - Select margins that reflect the compensation the entity requires for uncertainty related to non-financial risk - Adv/dis adv: none provided Section 7: Reinsurance held methods ----------------------------------- Q\) Identify methods for calculating the RA for reinsurance held\ A) - Quantile methods - Cost of capital - Catastrophe models -- specific to reinsurance - Use output from a cat model tailored to an entity's book of business - Select a percentile directly from the given distribution - Proportional scaling -- specific to reinsurance - Use the same percentage of FCFs for the ceded RA as for the direct RA but percentage could be modified for considerations such as: ceding, commissions, expense allowances, reinstatement premiums - Method may also work for non-proportional reinsurance if the cedes RA can consistently be expressed as a portion of the gross RA Section 8: Catastrophic reinsurance ----------------------------------- Ceded losses for CAT reinsurance may need a separate RA analysis from an entity's direct losses because: Section 9: Combining approaches and methods ------------------------------------------- The three methods from above... 1. Quantile techniques 2. Cost of capital method 3. Margin method...can be combined at different levels, either [unit of account] level or [aggregate] level. Level combined at: Definition: Primary methods: -------------------------- -------------------------------------------------------------- ----------------------------------------------------------------------------------------------- Unit of account approach More granular level then sum to get an aggregate RA For groups with less skewed distributions: use **VaR** (recall that VaR is a quantile method) For groups with highly skewed distributions: use **cost-of-capital method or margins** Aggregate approach Calculate a single RA for all contracts) to calculate the RA **Quantile method** **Cost-of-capital method** Section 10: Quantification of the confidence interval ----------------------------------------------------- If quantile method is primary method for RA no need to separate calculation of confidence interval If CoC or margin method are primary methods need a [secondary] method to quantify the confidence level corresponding to the RA to satisfy the disclosure requirement The best method for incorporating a confidence interval is the quantile method (it provides a confidence interval around the RA automatically) Appendix 1: Margins -- Brief Summary of IFRS 4 CIA Standards of Practice --------------------------------------------------------------------------------------------- Appendix 2: Simplified Calculation of RA based on CoC Method ------------------------------------------------------------ Basic concept behind this approach: - Reserve risk - Underwriting risk - Other risks that are not relevant to the RA Disadvantage: - Target profit margin may vary by portfolio or group CIA.IFRS17-LRC ============== Section 1: Introduction -----------------------  LRC = liability for remaining coverage claims that have not yet occurred\ LIC = liability for incurred claims normal claims that you think of\ LC = loss component relates to onerous contracts and is dealt with separately from the rest Definition of LRC: 1. LRC is an entity's obligation to: a. Investigate and pay valid claims under existing insurance contracts for insured events that have not yet occurred b. Pay amounts under existing insurance contracts that are not included in a) above and that relate to i. Insurance contract services not yet provided ii. Any investment components or other amounts that are not related to the provision of insurance contract services and that have not been transferred to the liability for incurred claims (such as investment component mentioned in IFRS17 section 4) Section 2: Definitions ---------------------- Definition of contract boundary: - Defines the cash flows that should be included when measuring the insurance liability arising from the contract - The relevant cash flows are triggered by the contract during the term of the contract (e.g., 1 year) - The cash flows include premiums paid by the policyholder and payments from the insurer to the policyholder in accordance with the contract Section 3: Level of aggregation and financial statement presentation -------------------------------------------------------------------- Linked to IFRS17-1 section 2 Remember: - All the policies owned by the insurer are subdivided into portfolios (e.g., provinces) - Portfolios are further subdivided into groups...so portfolios would generally contain multiple groups of policies For portfolio contracts... - if the expected cash inflows \> expected cash outflows, then the portfolio is in an **asset position**. - if the expected cash inflows \< expected cash outflows, then the portfolio is in a **liability position**. Section 4: LRC under the GMA -- insurance contracts issued ---------------------------------------------------------- ### 4.1: Definitions FCF (fulfilment cash flows) the sum of... - estimates of future cash flows - an adjustment to reflect the time value of money and financial risk (to the extent financial risk is not reflected in the estimates of the cash flows) - a risk adjustment for non-financial risk CSM (contractual service margin) represents unearned profit from a group of insurance contracts At contract inception, LRC = FCF + CSM but the proportion of these components change throughout the contract term/coverage period. 1. At inception of the contract, (total liabilities) + (paid amounts) = **LRC** = FCF~LRC~ + CSM (because at inception, all claims are \"remaining\" so there are no incurred claims and both LIC and paid claims are 0.) 2. As the coverage period is \"earned\", the height of the dark blue portion of the diagram corresponding to FCF~LRC~ gets smaller (this looks a lot like the earnings diagram for premium that you know from pricing) 3. At the same time, the height of the 2 [lighter blue] portions of the diagram corresponding to (FCF~LIC~ + paid claims) get bigger 4. At the end of the coverage period, **LRC** = FCF~LRC~ + CSM = 0 + 0 = 0 because there are no more remaining claims and FCF~LRC~ is fully replaced by (FCF~LIC~ + paid claims) 5. Note also that CSM = 0 at the end of the coverage period (this is indicated by the downward sloping line the **upper green** portion of the diagram The next diagram is the same just provides more details and breaks out the RA component (the scale is off) ### 4.2: Allocations - LRC and CSM must be determined at the group level - FCFs may be determined at a different level, then allocated to groups ### 4.3: Estimates of future cash flows Contract boundary: usually it is the effective and expiry dates of the policies, one exception may be if a policy is cancelled then you would use the cancellation date as the end date. Measurement: - Types of cash flows within the boundary include both inflows (premiums) and outflows (claims and directly attributable expenses) - The largest cash outflow usually relates to future claims and claim adjustment expenses. Source has more details here. ### 4.4: Effect of discounting Discounting involves determining a payment pattern for the predicted cash flows and then applying discount factors to reflect the time value of money. More info in IFRS17-DR paper which I will get to. For a given business segment, payment patterns for loss and ALAE are generally consistent for LIC and LRC, however there's additional guidance on selecting timing of LRC you could either: - Estimate a payment pattern on a group basis OR - Adjust the AY payment pattern used for LIC to a pattern consistent with the average accident date of the group. ### 4.6: Contractual service margin CSM unearned profit from a group of insurance contracts (more info in IFRS17 -- section 2) CSM @ end of period = CSM @ start of period + adjustments Adjustments can be - In the effect of new contracts - Interest on the CSM carrying amount during the reporting period Good example in BA that helps explain it. ### 4.7: Coverage units Coverage units -- is the quantity of insurance contract services provided by the contracts in the group. Determined by considering (for each contract) the quantity of the benefits provided under a contract within its expected coverage period. \*Coverage units determine how the CSM is released into profit (or loss) Examples of units to measure it in: - Passage over time (most P&C contracts, except for CAT insurance) - Maximum contract cover - Cover amounts for which policyholders could validly claim in each period Simple example from BA, red is given and the rest you have to calculate: Q\) What is the key principle for determining coverage units based on judgment and estimates?\ A) To reflect the insurance contract services provided in each period Q\) Identify specific ways this key principle is applied\ A) - Quantity of benefits relates to the amount that can be claims by the policyholder (not the expected costs to be incurred by the entity) - Discounting is optional (if discounting is applied, it is based on judgment but should be applied consistently) - Coverage period extends to the end of the period in which insurance contract services are provided (unless claims in settlement are included in LRC rather than LIC) Highlights to remember: \*More coverage units = more work for the insurer, ---------------------------------------------------------------------------- That work is not necessarily related to expected claims or release of risk Type of product Amortization pattern --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- ---------------------- Contract with **same** policy limit throughout the coverage period Uniform Contracts with **decreasing** policy limit over the coverage period (mortgage insurance contracts -- since unpaid principal will decrease over time) Declining Contracts with **increasing** policy limit over the coverage period (product warranty contract with replacement coverage -- due to the fact that risk of failure rises with aging of product, as well as prices raise with inflation) Increasing ### 4.8: Loss component LRC = FCF + CSM (true for both onerous and non-onerous groups)\ also\ LRC = (LRC excl. LC) + LC +-----------------------+-----------------------+-----------------------+ | | Non-onerous | Onerous | +=======================+=======================+=======================+ | LRC = | FCF + CSM | FCF | | | | | | | (future cash inflows | (future cash inflows | | | - future cash | - future cash | | | outflows + effect of | outflows + effect of | | | discounting -- RA) + | discounting -- RA) | | | CSM | | +-----------------------+-----------------------+-----------------------+ | | Cash inflow -- good | Cash outflow -- bad | +-----------------------+-----------------------+-----------------------+ | | CMS = yes | CSM = no | +-----------------------+-----------------------+-----------------------+ | | LC = no | LC = yes | +-----------------------+-----------------------+-----------------------+  Entities are required to separately track the two components: LRC excl. LC and LC because they want to keep non-onerous and onerous contracts separate. Q\) Briefly describe the measurement of an onerous group of contracts subsequent to initial recognition - If there are no changes in underlying assumptions: - LC is expected to be systematically decreased - If there are changes in underlying assumptions that are favorable - Allocate changes to the LC until it reaches 0 then a CSM may be re-established Q\) Briefly describe the measurement of a non-onerous group of contracts that becomes onerous subsequent to initial recognition - Reduce CSM to 0 and establish an LC (this would happen when unfavorable changes in the fulfilment cash flows exceed the carrying amount of the CSM) Summary table: Non-onerous Onerous -------------------- ------------------------------------------------------------------- --------------------------------------------------------------------- No change Systematically decrease CSM just like on the graph in section 4.1 Systematically decrease just like CSM Favorable change Keep increasing CSM Add them up to bring on the same basis as they were prior to change Unfavorable change Use up CSM up until 0, then establish LC Keep increasing LC Section 5: LRC under PAA -- insurance contracts issued ------------------------------------------------------ GMA = general management approach\ PAA = premium allocation approach\ PAA is a simplified version of GMA for measuring LRC (PAA does not apply to LIC) PAA does not require estimation of FCFs (future cash flows)\ PAA does not require a CSM (contractual service margin) PAA may be used for LRC when one of these eligibility requirements assessed at contract inception is met: - Short term contracts (\