Definition of onerous

sant93sant93
in CIA.IFRS17-1

Per wiki:
"An insurance contract is onerous at the date of initial recognition if there is a total net outflow for the sum of:
→ FCFs (Fulfilment Cash Flows)
→ acquisition cash flows
→ cash flows arising from the contract at the date of initial recognition"

Is the third bullet referring to premium? So to be onerous means to be "loss-making"?

Comments

  • Staff-T1Staff-T1
    edited March 2022

    Hi,
    No premium would be included in FCFs. FCFs are defined as the PV of future cash flows + a risk adjustment for non financial risk. In current standards, that would mean it is: Expenses + Claims - Premiums + PFADs + Discounting.
    Yes onerous in a nutshell basically means the inflow of cash you are receiving is less than the outflow of cash for a group of contracts

  • a225khana225khan
    Can you please give an example of bullet point 3 "cashflow arising from contract at initial recognition". Thanks
  • Staff-T1Staff-T1

    Hi,

    I'd say expenses associated with starting a contract

  • bicbicbicbic

    wouldn't expenses associated with starting a contract be included in acquisition cash flow?

  • Staff-T1Staff-T1

    I think acquisition CFs are normally incurred when a policy is sold and not at initial recognition

  • bicbicbicbic

    Thanks, it makes sense

  • a225khana225khan

    What is the difference between "when policy is sold" and "initial recognition" of the insurance contract?

  • Staff-T1Staff-T1

    A policy is normally sold a couple of months before the contract coverage period begins. For example, a policy with coverage period of Jan 1 2022 - Dec 31 2022 could be sold in October 2021. Your date of initial recognition would be Jan 1 2022 while date the policy is sold would be Oct 2021

  • AndrewLAndrewL

    Hello,

    1. Could you please reconcile the definition of onerous from this reading and CIA.IFRS17?

    IFRS17 reading say that contract is onerous is FCF < 0. That is there is a net outflow of FCF.

    This reading, IFRS17-1 says that contract is onerous if sum(FCF, Acquisition CF, CF from starting contract) <0 (Net outflow).

    1. Regarding Expenses of insurance contract, under IFRS17, only expenses directly attributable to the portfolio are considered. Should not acquisition cost already be part of the FCF through the PV(Future CF)
  • Staff-T1Staff-T1
    1. The more correct definition is the one under IFRS17-1, but for the purpose of the exam just saying contract is onerous when FCF > 0 will suffice. Previously recognised insurance acquisition CFs and CF from starting contract probably will not be tested.
    2. Acquisition costs are part of the FCF
  • AndrewLAndrewL

    Thank you @Staff-T1 .

    Could you please explain why the concept of onerous does not exist for reinsurance contract held?

    This confuse me for the following reason:

    1. It implies all reinsurance contracts held would be profitable.
    2. Does point 1. above(being profitable) mean the contract is an asset? That is, if we have a CSM (profitable), does this mean the contract is recorded as an asset?

    Thanks

  • Staff-T1Staff-T1
    1. No, this is not true. Reinsurance has a net cost 99% of the time, otherwise the reinsurer would never write the contract. There are here to make money too. We don't consider a reinsurance contract hled as onerous because reinsurance is meant for risk and capital management and it wouldn't make sense to penalize an insurer on their income statement for purchasing reinsurance.
    2. CSM is always a negative liability. But yes, reinsurance held is always measured as an ASSET for remaining coverage or ASSET for incurred claims
  • CatherineGaoCatherineGao

    Hi, I am still confused about definition of onerous. If acquisition is part of FCF, why onerous definition separately listed FCF & acquisition?

    sum of:
    → FCFs (Fulfilment Cash Flows)
    → acquisition cash flows
    → cash flows arising from the contract at the date of initial recognition"

  • Staff-T1Staff-T1

    Acquisition cash flows that are not deferred are usually incurred immediately. DAC is what is included in the FCF

  • MicheleDonaMicheleDona

    Hi,

    You mentionned that CSM is a negative liability, however CSM amount would normally be a positive one correct?
    I see CSM as a liability that is there to offset the expected profitability of the contract so that profit is recognized as the contracts are earned.
    I am understanding this properly?

    Also considering onerousity, i am confused about the meaning of "Initial recognition", I always read that as the effective date of contracts, however the new IFRS17 articles in contract boundary section mentionned this :

    onerous contracts:
    - IFRS 17 must recognize liability of an onerous contract when signed
    (under current practice the entity can wait until effective date to recognize liabilities)

    So i refer to your comment earlier:

    A policy is normally sold a couple of months before the contract coverage period begins. For example, a policy with coverage period of Jan 1 2022 - Dec 31 2022 could be sold in October 2021. Your date of initial recognition would be Jan 1 2022 while date the policy is sold would be Oct 2021

    I am no longer sure when an onerous contract should be recognised, can you clarify?

    Thanks a lot for your time :)

  • Staff-T1Staff-T1

    CSM would normally be positive, EXCEPT for reinsurance held where it can be negative, reflecting a net cost of reinsurance.

    An onerous contract will be recognized at the earlier of initial recognition or inception. In this case, if a contract is onerous it would be recognized on Oct 31 2021, while if it is not onerous it would be recognized on Jan 1 2022

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