How is contract being recognized as Onerous at initial recognition?
Hi,
According to the source,
- "An insurance contract is onerous at the date of initial recognition if there is a total net outflow"
- "onerous groups are recognized when bound even if this is prior to the effective date of the contract"
Assume we are using risk-based pricing, how can we tell that the cash outflow will be greater than the cash inflow at contract inception? Technically, we would consider the risk characteristics along with the profit margin when setting the price for a contract. If the contract if not profitable, why would the firm take the contract at all?
I understand that non-onerous could become onerous during the contract term or vice versa, but I don't understand how is contract being recognized as onerous in the beginning and why would firm take it?
Please kindly advise!
Comments
Usually when ratemaking, an entire line of business may be profitable as a whole, where certain segments of the book may not. For example, personal auto Canada may be profitable, but Alberta PPA may not. Taking a loss-making group of business is usually a business decision to retain market share or grow. Another example is that Accident benefits Ontario may be profitable, but Bodily injury may be onerous at inception. However, you are not able to write one without another as they are both mandatory coverages
that's very helpful, thanks a lot! @Staff-T1
What does "when bound" mean in the above context? Is it just another way of saying you need to reflect the group as onerous in the financial statements at the moment you realize it is onerous?
Bound means when an agreement is entered into. For example, you would usually agree to bind new business 1-2 months before coverage actually begins