CIA.IFRS17-1

Updates in Fall 2023 Added: Additional commentary in section 2 regarding level of aggregation for reinsurance Added: Additional commentary on identifying considerations when estimating the risk of non-performance of a reinsurer in section 3.2 Added: additional commentary on selecting RA for proportional and non-proportional reinsurance in section 3.2 Removed: Nature of actuarial input Removed: Commentary in section 4 Removed: identify considerations under PAA for reclassifying a group from non-onerous to onerous (section 5.4) Note: Section 6: UAF is now not treated under IFRS17

Reading: IFRS 17 – Actuarial Considerations Related to P&C Reinsurance Contracts Issued and Held

Author: Canadian Institute of Actuaries

# of pages: 27

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Study Tips

This reading is essentially a listing of miscellaneous topics and facts regarding the treatment of reinsurance under IFRS 17. There is also a lot of overlap with other IFRS readings, which is good. That means you can get through it a little more quickly than you might think and it also serves as a good review. My strategy is to spend roughly 4-5 hours doing the following:

• read the first 1-2 paragraphs of each section to get a sense for what each is about (there are 7 sections)
• select roughly 2 or 3 items from each section that look like good exam questions (not more than 20 items overall)
• try to keep my focus on reinsurance topics since that's what this reading is supposed be about (although much of the reading seems to apply to primary insurance as well??)

There are no calculations in this reading. Certain methods of calculation are described verbally but I think a calculation question from this material is very unlikely. There is a good calculation question in CIA.IFRS17-DR (Discount Rates).

IMHO, the most likely sections to be tested are:

• level of aggregation and onerous contracts (covered in Section 2)
• more information about onerous contracts (covered in Section 6)
• accounting treatment of FA (Facility Association) residual market mechanisms (covered in Section 7)

You can argue that the remaining sections also contain information important to actuaries but they seem less likely to be tested. No guarantee! (Just my opinion.)

Estimated study time: ½ day (not including subsequent review time)

BattleTable

No past exam questions are available for this reading.

reference	part (a)	part (b)	part (c)	part (d)

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In Plain English!

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 introductory section in the source reading has no other useful information.

Note that a portion of this reading relates to how IFRS treats both insurance and reinsurance.

Section 2: Level of Aggregation

The concept of "level of aggregation" was introduced in the section on Measurement Considerations in the wiki article CIA.IFRS17 so take a moment to review that if necessary. It basically says that insurance contracts are aggregated first into portfolios and then into groups within each portfolio. For example, your company may have 100,000 insurance contracts aggregated into 10 portfolios of 10,000 contracts each. Each portfolio may then be further subdivided into 3 groups of 7,000, 2,000, and 1,000 contracts each. Portfolios could correspond to provinces and territories. Groups are created based on whether the contracts are considered onerous.

Question: what does it mean for an insurance contract to be onerous

• 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

The key point is net outflow. It might help to recall the dictionary definition of "onerous" as something that's difficult and burdensome. An outflow of cash (instead of an inflow) is definitely a burden, and something we want to avoid! The concept of "onerous" is used to specify groupings of contracts under IFRS 17.

Question: based on IFRS 17, how shall an entity, at minimum, divide a portfolio into groups

(a) a group that is onerous at initial recognition (if any)

(b) a group that has no significant possibility of becoming onerous (if any)

(c) a group of any remaining contracts (if any)

These groups can be further divided any way the company wants (including based on cohort issue date) but according to the text:

• An entity shall establish the groups at initial recognition, and shall not reassess the composition of the groups subsequently.

It strikes me as a little strange that composition of groups cannot be reassessed. It also seems to directly contradict the very next sentence:

• At subsequent valuation, a group of insurance contracts issued that was deemed non-onerous at initial recognition may still become onerous subsequently (or vice versa) if the expectation regarding the future net cash flows of the group changes from positive to negative (or vice versa)

I think it probably means that a whole group can change from being onerous to non-onerous, and vice-versa, but that the set of contracts within each group cannot change. Anyway, the above comments apply to both insurance and reinsurance contracts. Note however that the level of aggregation for reinsurance contracts may differ from the level of aggregation of the underlying insurance contracts covered.

Question: does IFRS 17 permit disaggregation of individual insurance contracts

• No (usually.) Under IFRS 17, the lowest unit of account is the insurance contract.
• In most cases, it is not permitted to disaggregate individual insurance contracts.

An additional nuance for reinsurance contracts is the possibility of having a multi-line contract. The actuary can choose from several options for aggregating those contracts:

• Aggregating 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

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Section 3: Actuarial Calculations Related to Fulfilment Cash Flows

If you've read the CIA.IFRS17 wiki article then the basic IFRS 17 concepts will be familiar to you, but it doesn't hurt to do a quick review of some important concepts and abbreviations:

FCF: Fulfillment Cash Flows

→ basically the present value of an insurer's liabilities, including discounting and risk adjustments

RA: Risk Adjustment (for non-financial risk)

→ claims development  ←shout-out to WC18 & bicbic!

LIC: Liability for Incurred Claims

→ insurer’s obligation to pay claims for events that have already occurred (earned business)

LRC: Liability for Remaining Claims

→ insurer’s obligation to provide insurance coverage for events that have not yet occurred (unearned business)

LC: Loss Component

→ expected net outflow of an onerous group (this is covered in more detail in Section 6: Onerous Contracts)

GMA: General Measurement Approach

→ an approach for measuring the LRC component of contract liabilities under IFRS 17

PAA: Premium Allocation Approach

→ a simplified approach (versus GMA) for measuring the LRC component of contract liabilities under IFRS 17

CSM: Contractual Service Margin

→ unearned profit from a group of insurance contracts (discussed more in CIA.IFRS17 - Overview)

Ian-the-Intern has been having trouble keeping all of of this straight in his head, but he's feeling more and more comfortable every day. It's just repetition. The reason it's confusing is that all of this IFRS material was dumped on him all at once and it's a lot to take in.

The title of this section, "Actuarial Calculations Related to Fulfilment Cash Flows", would lead you to believe it's a very important section but I think a better source for actuarial calculations is CIA.IFRS17-DR (Discount Rates) - Section 4. In that reading, there's an actual numerical example of calculating Fulfillment Cash Flows. The reading we're looking at now does not have any numerical examples and instead discusses actuarial calculations only in a conceptual way. I've pulled out some facts that seem important but I have not included everything that's in the source text. After you've familiarized yourself with what's listed below, you can skim the source text just so you have a sense for what's there.

From Section 3 (LIC)

Question: identify components of LIC (Liability for Incurred Claims)

• an unbiased current estimate of future cash flows (future cash flows is different from Fulfillment cash flows)
• an adjustment for discounting
• a risk adjustment

From Section 3.1 (Discounting & Cash Flow)

The IFRS 17 adjustment for risk of non-performance by a reinsurer is similar to the PfAD for reinsurance recovery under current practice. The key difference is the provision for non-performance risk is included in the estimate of the present value of future cash flows for reinsurance contracts held. Any changes in estimates of the non-performance risk would not adjust the CSM, but rather flow directly into the P&L

Question: identify considerations when estimating the risk of non-performance of a reinsurer

• financial strength of the reinsurers
• history of claims and coverage disputes with reinsurers
• risk of contagion across various reinsurance arrangements
• delays in payments and concentration risk
• length of time over which liabilities are expected to be settled
• collateral available to mitigate risk

These are similar to what Alice would consider under current practice when evaluating her own reinsurers. Since Alice was careful when selecting reinsurers, reinsurer risk is low for her company. No reinsurer would dare dispute a claim from Alice. :-)

One difference with IFRS (shout-out to MW!) that I found surprising however is that the RA for reinsurance recovery does not have to be calculated separately as is done under current practice. The reinsurance counterparty risk would be included in the measurement of the estimates of future cash flows for reinsurance contracts held. That doesn't seem very transparent and might like a good way for a sneaky CEO to hide problems with reinsurers. :-)

For discounting, this is generally similar to direct insurance contracts where the discount rate used would be based on the risk free rate + a illiquidity premium which is defined as the ability of the policyholder to exit the policy before its expiry and receive the value due without significant exit costs. AIC is generally illiquid while ARC is considered liquid. The AIC is considered illiquid as there is little leeway for a policyholder to influence the timing of claim payments

From Section 3.2: (Estimation for the RA or Risk Adjustment)

There is a separate document that discusses estimating the RA for contracts in general. This section focuses on estimating the RA for reinsurance contracts. The next question below is not an IFRS-specific concept. It applies equally to current practice and has come up on previous exam questions related to reinsurance.

Conceptually the RA for reinsurance can be viewed as the compensation to keep rather than to ceded the risk. Reinsurance held will increase the ARC and is the opposite of the RA for direct insurance contracts. The release of RA for reinsurance held reduces profit rather than increasing it for insurance contracts issued.

Question: identify 3 options for grouping data when estimating the present value of future cash flows and the RA

• estimate gross & net losses then calculate the ceded as gross - net
• estimate gross & ceded losses then calculate the net as gross - ceded
• estimate net & ceded losses then calculate the gross as net + ceded

These options are also discussed in CIA.IFRS17-DR (Discount Rates) and in that discussion, considerations are provided to help you determine which option is best. The following exam question is from an outdated reading but it shows you a type of question that can be asked relative to the above options:

E (2015.Fall #26)

For proportional reinsurance (QS treaties), you can expect that the ceded RA would be proportional to the gross RA. For non-proportional reinsurance (XoL treaties), the ceded RA is usually not proportional to the gross RA. In this case, the cost of reinsurance is usually viewed as evidence of the price the entity is willing to pay to be relieved of the risk and would be a good indicator on the compensation (RA) requirement.

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Section 4: Insurance Service Results Considerations

Here is something that stood out for me because it highlights a fact about reinsurance under IFRS 17 that's different from the "normal" revenue stream of earned premium

Question: under IFRS 17, how might insurance revenue for reinsurance contracts issued differ from earned premium

• For entities applying PAA, the revenue recognition requirements
• Treatment of reinsurance cash flows that are contingent on claims of the underlying contracts
• Treatment of amounts paid to the purchaser of reinsurance contracts, not contingent on claims of underlying contracts

I felt that the remainder of this section was too detailed and did not include it in the wiki.

Section 5: LRC: PAA and GMA Considerations

Recall that LRC stands for Liability for Remaining Claims and consists of obligations relating future services (the unexpired portion of the coverage period). The LRC can be estimated using the GMA or the PAA (General Measurement Approach or Premium Allocation Approach)

Question: how is the LRC estimated under GMA and PAA

• GMA:

→ LRC   =   (FCF related to future services) + CSM

• PAA:

→ LRC   =   (unearned premium) – (insurance acquisition cash flows)

There is a separate reading for PAA: CIA.IFRS17-PAA so we won't discuss it any further here. There is also a slightly more detailed formula at the following link for LRC under PAA in the wiki article CIA.IFRS17-LRC. The extra term given in the formula there is "minor term" and is probably equal to 0 most of the time anyway.

From Section 5.2 (PAA Eligibility)

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 boundary and therefore PAA eligibility

From Section 5.3 (GMA Considerations)

I didn't want to leave this section blank in the wiki but these next 3 items of information feel very disconnected. It would help so much if there were numerical examples to illustrate these points. I would be shocked if any of what I've listed below appears on the exam. Unfortunately, I'll never know because exams will no longer be published. :-(

Question: how is the CSM concept (Contractual Service Margin) modified for reinsurance contracts held. (Click for an example) (shout-out to RL!)

• there is no unearned profit
• instead there is a net cost or net gain on purchasing the reinsurance

Question: describe a potential mismatch between revenues & FCFs when an entity uses GMA for LRC for reinsurance contracts held

• revenues are recognized as they are earned
• FCF projections include projected cash flows for policies to the end of the year

→ For example, at the end of the first quarter of a year, 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. There is another example in this forum discussion.

And one last little tidbit:

Question: if a group of contracts become onerous, when do the losses have to be recognized under IFRS 17

• immediately: when the group becomes onerous

(in other words, you can't wait until the cash outflows actually occur!)

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Section 5.4: Onerous Contracts

For reinsurance contracts held, the concept of onerous groups does not exist. This section relates to insurance and reinsurance contracts issued. Topics covered include:

• accounting for onerous groups
• recognition of LC on onerous groups
• assessment of onerous contracts under PAA

Recall that LC (Loss Component) is the expected net outflow of an onerous group.

Question: briefly describe the accounting treatment of onerous groups in financial statements

• 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

Question: when are onerous groups recognized in financial statements

• onerous groups are recognized when bound even if this is prior to the effective date of the contract

("recognition" means that the LC liability is reflected in financial statements)

The rest of this section has detailed information relating to groups whose liabilities are measured using PAA (Premium Allocation Approach) as well as the Loss Recovery Component. Recall from Valuation Methods under IFRS 17 that there are 2 approaches: GMA and PAA. Recall also that PAA is a simplified version of GMA that can be used if certain conditions are met. The last factoid from this section lists considerations in reclassifying a group of contracts from non-onerous to onerous under PAA:

Section 6: Accounting Treatment of Residual Market Mechanisms

Recall from Dutil.FA that Facility Association administers the following residual market mechanisms:

FARM (Facility Association Residual Market)

RSPs (Risk-Sharing Pools)

UAF (Uninsured Automobile Fund)

FA is a heavily tested topic and Alice thinks this next question would make a pretty good exam question.

Question: briefly describe the accounting treatment for each of FA's residual market mechanisms under IFRS 17

UAF: UAF functions more like a levy which means that IFRS17 would not apply

FARM: member companies account for their share of FARM and UAF insurance contracts as direct business

RSPs: member companies use reinsurance accounting where the "reinsurer" is the collective FA membership. Ceded contracts are accounted for as reinsurance held while assumed contracts are accounted for as reinsurance issued

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