Loss Component recognition
The battle cards and the wiki state that the LC is recognized immediately in P&L, whereas the CSM is released as service is provided.
However, it later says "We would normally release the LC over time, similar to the CSM using coverage units."
I'm unclear on how these two statements on the LC don't contradict. Could someone please elaborate?
Thanks!
Comments
LC is recognized in P&L immediately, but a negative liability is also recognized similar to the CSM on the balance sheet. This is amortized similar to the CSM as a reversal of losses. The total sum of the P&L entries related to the LC will be 0 over the life of the contract.
Thank you!
The source text also says this in section 6.5.1:
"In the rare case that there is a net gain from purchasing reinsurance, the resulting
CSM is negative and is booked in a liability position."
If reinsurance held CSM is the expected net gain/loss from purchasing reinsurance, why would it be negative if inflows > outflows? It says the CSM is calculated in the same manner as insurance contracts.
My thought was that expected net gain on reinsurance held --> positive CSM --> reduction in assets.
So, this reduction in assets (subtract the positive CSM from assets) would have the same effect as increasing the liabilities by CSM, but I still don't understand why they state CSM would be negative if we expect a gain on the reinsurance held.
I can't actually find that in the source - Mind giving me the page number in the pdf?
it is on page 40 (section 6.5.1) of the IFRS 17 LRC source material. Thanks!
Hi,
It's because normally for direct insurance contracts issued you have an LRC. However, when purchasing reinsurance you have an ARC (Asset for remaining coverage) which is why you swap the signs of the CSM. Does this make sense?
So the CSM (in terms of direction) would be {outflows - inflows} for reinsurance, whereas we have the opposite direction for insurance contracts.
Then if the reinsurance contract has an expected net gain, the CSM is negative, and it reduces the asset (or is booked as a liability) to defer the recognition of gain.
If it's a net loss, the CSM > 0 increases the asset.
This makes sense now, thanks!
You mentioned "LC is recognized in P&L immediately, but a negative liability is also recognized similar to the CSM on the balance sheet."
Can you elaborate further on that?
I don't understand why a negative liability is recognized for LC. I thought negative liability means we establish a CSM? And it's either LC or CSM?
Both the LC and the CSM are a negative liability.
Example:
Cash Inflow: 100
Cash outflow: 200
Loss component = 100
Let's assume there is only one payment for both the inflow and outflow that is settled at time 1.
With a LC on the balance sheet
At time 0:
P&L = -100
At time 1:
Inflow - Outflow = - 100
Release of LC = 100
P&L = 0
Total P&L: -100
Without a LC on the balance sheet
At time 0:
P&L = -100
At time 1:
Inflow - Outflow = - 100
Release of LC = 0
P&L = -100
Total P&L : -200
You can see without a LC we are double counting the losses
My understanding was that the LC is implicitly included in FCF under GMA, and explicit under PAA. Hence why we take LC = {FCF under GMA - LRC excl LC under PAA} when we need to calculate the LC for PAA.
Under which approach is your example?
With the formula I just wrote, the LC when added to the PAA LRC increases the liability to the amount under GMA. So I don't understand how it's a negative liability?
The concept of offsetting the loss at time 1 because we recognized it previously does make sense though. I just don't understand how the LC is 'stored' in the LRC until it's released (but I do get that it goes into P&L immediately)
Thanks!
Also, wouldn't the CSM be a + liability?
If the LRC without a CSM is negative (net inflow), then adding the + liability of a CSM would make the LRC 0 and defer profit recognition
Hi,
For your first statement that would not be the case. The PAA method is meant to be a simplification for ease of calculation. What we are doing is simply calculating the difference between the true estimate of your liability (GMA) vs the simplified estimate of your liability (PAA).
The illustration above is for both cases -> Recall that PAA with LC = GMA
And yes, I brought up the IFRS working paper again and the LC should indeed be a positive liability while the CSM is still a negative liability. My bad
Let's try writing it out in terms of accounting entries ~
Example (CSM):
Let's assume that we have a one year insurance contract with no RA and discounting. Premiums of 200 with 50 paid quarterly and losses of 100 paid mid year. CSM earned evenly
ISR = [Premium Revenue - change in PVFCF - losses + release of CSM ]
Time 0:
PVFCF = -100
CSM = 100
LRC = 0
Time 0.25:
PVFCF = -50
CSM = 75
ISR = 50 - 50 + 25 = 25
LRC = 25
Time 0.5:
PVFCF = -100
CSM = 50
ISR = 50 + 50 - 100 + 25 = 25
LRC = -50
Time 0.75:
PVFCF = -50
CSM = 25
ISR = 50 - 50 + 25 = 25
LRC = -25
Time 1:
PVFCF = 0
CSM = 0
ISR = 50 -50 + 25 = 25
LRC = 0
Total ISR = 100
The CSM is a negative liability because the CSM sits on the liability (LRC) side of the balance sheet but is essentially an asset
Balance Sheet View -> This is the deferral of profit.
Estimate of PVFCF | RA | CSM | Total
-100 0 100 0
LRC = 0
Example (LC):
Let's assume that we have a one year insurance contract with no RA and discounting. Premiums of 200 with 50 paid quarterly and losses of 300 paid mid year.
ISR = [Premium Revenue - change in PVFCF - losses]
Time 0:
PVFCF = 100
CSM = 0
LC = 100
ISR = -100
LRC = 100
Time 0.25:
PVFCF = 150
LC = 75
ISR = 50 - 50 = 0
LRC = 150
Time 0.5:
PVFCF = -100
LC = 50
ISR = 50 + 250 - 300 = 0
LRC = -100
Time 0.75:
PVFCF = -50
LC = 25
ISR = 50 - 50 = 0
LRC = -50
Time 1:
PVFCF = 0
LC = 0
ISR = 50 -50 = 0
LRC = 0
Total ISR = -100
Balance Sheet View
Estimate of PVFCF | RA | CSM | Total
100 0 0 100
ISR(change in total) = -100
Don't think this example (LC) is in the syllabus though but I think the CSM example is fair game
thank you for the detailed example!
I think I am just confused because the CSM exists when there's a net inflow (liability in LRC is < 0). So I thought it would be a positive liability to bring the carrying amount of the LRC to 0 at initial recognition.
So in the first example at time 0, if PVFCF is a net inflow (negative liability), and adding the CSM brings the LRC to 0, I just don't understand how it's also a negative liability.
If you could explain how this offset of a negative liability when FCF is an inflow works, then I think the rest will fall into place!
Thanks
As I mentioned, it is a negative liability because it essentially functions as an asset -> If you have a profit at day 1 that you can't recognise immediately, then that essentially is an asset for you since it is money that you will eventually get. If it is a liability that would mean you will need to eventually pay out money which doesn't make sense as it is a profit making contract
In the LC example, why is the Loss Component reduced to 0 directly at time 0.5 instead of being amortized over the 4 quarters like the CSM? Is it because during the period, the futur outflows becomes lowers than the future inflows (claim is now paid, all that is left are the premiums). But if that is the case, why isn't the CSM reinstated?
Yup good catch - I have edited my comment. LC is supposed to be amortized just like the CSM
Hola!
I'm not able to reconciliate the ISR formulas with the example provided...
For the CSM example, is it possible the formula should be this instead?
At time 0.25 this gives 50 - (-50 - -100) - 0 - (75 - 100) = 50 - 50 + 25 = 25
For the LC example, shouldn't the LC values be "100 | 75 | 50 | 25 | 0" if amortized just like the CSM? If so, I conclude the second to last term of ISR calculation is the release of LC or "- change in LC". But then what does the last term refers to?
Also, at time 0, I understand a loss = LC must be recognized, but somehow using the formula I get -200 (Premium & losses = 0, but change in FCF & LC = 100 each so get -200). Could you tell me what I'm doing wrong please?
Thanks in advance!
Yeah, I think it is more appropriate to say the amount + 'CSM released in period'
So I checked the discount rate paper again and I believe I was mistaken. The formula for the Insurance service result = Insurance service revenue +insurance service expense where insurance service expense = Payments in period + change in RA + PVFCF(t) - PVFCF(t-1). Digging further, it seems that while the Loss Component release is part of the ISR, it would get cancelled out since it appears in both the insurance service revenue and insurance service expense equally, so for simplicity let's just ignore it which is what the CAS did I think:
https://www.actuaries.org.uk/system/files/field/document/IFRS 17_LC1_Why do loss components need to be amortised_20191106.pdf
I have made the changes to the original formula
For your last question, you wouldn't have any change in FCF. If you see the PDF from the IFOA, you see at time 0 the non-zero entry in the ISR formula is the establishment of the loss component
Thank you!
@Staff-T1 The link you posted was super helpful but I am curious, is this something within the scope of the syllabus? For example could they ask us to release CSM into a provided IFRS17 20.22 statement based on the link you provided? I only ask because I was looking through the source and none of the materials on the syllabus cover this specific topic in great detail.
In theory yes, but I don't think it will be asked, no. It's actually not too hard, you always release CSM and LC according to a pre-determined pattern (usually premium earning pattern) and then just accrete interest