Applying the General Measurement Model in IFRS 17 Insurance Contracts to a portfolio of insurance contracts – the impacts of changes in assumptions
In this month’s edition, we will modify some of the assumptions we used in Example 1 from the October 2021 edition of Accounting Alert to demonstrate how differences between assumed and actual experience can impact the measurement of insurance contracts under IFRS 17.
Example 2
As outlined in Example 1 in the October 2021 edition of Accounting Alert, we assumed the following fact pattern.
BDO Pet Insurance Ltd has written 100 3-year insurance policies to commence on 1 July 2021. The policies insure the holder for up to 50% of any eligible veterinarian bills they incur in respect to their pets during the coverage period. Each holder of a policy is required to pay an annual $90 premium, payable on the first day of each year of the coverage period. For the purposes of measuring the insurance contracts under IFRS 17, and based on past experience with similar types of insurance policies, BDO Pet Insurance Ltd adopts the following assumptions:- Expected annual cash outflows are $7,000 per annum
- All insurance claims that are incurred during a year will be paid at the end of that year
- No policies will lapse during the coverage period and no extension periods are offered under the policy
- Discount rate of 5% per annum
- Pet Insurance Ltd is not exposed to any material financial risk in respect to the insurance policies
- The risk adjustment for non-financial risk is measured at 5% of the present value of the expected cash outflows, and
- BDO Pet Insurance Ltd incurs no initial acquisition costs in respect to the insurance policies.
For the purposes of the following example (Example 2), we will assume the same fact pattern as above, except for the following:
- Actual annual cash outflows for the year ended 30 June 2023 are $7,500
- At 30 June 2023, BDO Pet Insurance Ltd assumes the cash outflows for financial year ended 30 June 2024 will be $7,500, but actual outflows for the year are only $7,100
- The discount rate decreases to 4% per annum in the year ended 30 June 2023
- At 30 June 2023, BDO Pet Insurance Ltd assumes the discount rate for the year ended 30 June 2024 will be 4%, and this assumption proves to be correct, and
- The risk adjustment for non-financial risk reduces to 4% of the present value of the expected cash outflows during the year ended 30 June 2023, and is assumed to remain at this level for the remainder of the coverage period. This assumption also proves to be correct.
Based on the foregoing information, BDO Pet Insurance Ltd measures the portfolio of pet insurance policies on initial recognition as follows:
Table 1
| From example 1 | $ |
| Estimate of the present value of future cash inflows | (25,735) |
| Estimate of the present value of future cash outflows | 19,063 |
| Estimate of the present value of future (net) cash flows | (6,672) |
| Risk adjustment for non-financial risk | 953 |
| Fulfilment cash flows | (5,719) |
| Contractual service margin | 5,719 |
| Insurance contract (asset)/liability on initial recognition | 0 |
As BDO Pet Insurance Ltd’s assumptions at the commencement of the insurance contracts hold for the first year of the insurance contracts, the entity would measure the insurance contracts for the year ended 30 June 2022 as follows:
Table 2
| Year ended 30 June 2022 | Estimates of the present value of future cash flows ($) | Risk adjustment for non-financial risk ($) | Contractual service margin ($) | Insurance contract (asset)/ liability ($) |
| Opening balance – (asset)/liability | 0 | 0 | 0 | 0 |
| Changes related to future service: new insurance contracts | (6,672) | 953 | 5,719 | 0 |
| Cash inflows | 9,000 | 0 | 0 | 9,000 |
| Insurance finance expenses | 953 | 48 | 286 | 1,287 |
| Insurance finance income | (837) | 0 | 0 | (837) |
| Changes related to current service | 0 | (398) | (2,001) | (2,399) |
| Cash outflows | (7,000) | 0 | 0 | (7,000) |
| Closing balance – (asset)/liability | (4,556) | 603 | 4,004 | 51 |
As BDO Pet Insurance Ltd’s actual experience only started to deviate from its initial expectations during the second year (i.e., for the year ended 30 June 2023) of the three year coverage period, Tables 1 and 2 above are identical to Tables 1 and 2 provided for in Example 1 from the October 2021 edition of Accounting Alert. However, consistent with the changes experienced in the portfolio outlined above, in years 2 and 3 of the portfolio of insurance contracts, BDO Pet Insurance Ltd would have measured the insurance contracts as follows.
Table 3
| Year ended 30 June 2023 | Estimates of the present value of future cash flows ($) | Risk adjustment for non-financial risk ($) | Contractual service margin ($) | Insurance contract (asset)/ liability ($) |
| Opening balance – (asset)/liability | (4,556) | 603 | 4,004 | 51 |
| Changes related to future service: new insurance contracts | 0 | 0 | 0 | 0 |
| Cash inflows | 9,000 | 0 | 0 | 9,000 |
| Insurance finance expenses – refer (a) below | 521 | 24 | 200 | 745 |
| Insurance finance income | (343) | 0 | 0 | (343) |
| Changes related to current service – refer (b) below | 500 | (294) | (2,102) | (1,896) |
| Changes related to future service – refer (c) below | 589 | (45) | (763) | (218) |
| Cash outflows | (7,500) | 0 | 0 | (7,500) |
| Closing balance – (asset)/liability | (1,788) | 288 | 1,339 | (161) |
Table 4
| Year ended 30 June 2024 | Estimates of the present value of future cash flows ($) | Risk adjustment for non-financial risk ($) | Contractual service margin ($) | Insurance contract (asset)/ liability ($) |
| Opening balance – (asset)/liability | (1,788) | 288 | 1,339 | (161) |
| Changes related to future service: new insurance contracts | 0 | 0 | 0 | 0 |
| Cash inflows | 9,000 | 0 | 0 | 9,000 |
| Insurance finance expenses – refer (a) below | 288 | 12 | 67 | 367 |
| Insurance finance income | 0 | 0 | 0 | 0 |
| Changes related to current service – refer (b) below | (400) | (300) | (1,406) | (2,106) |
| Changes related to future service | 0 | 0 | 0 | 0 |
| Cash outflows | (7,100) | 0 | 0 | (7,100) |
| Closing balance – (asset)/liability | 0 | 0 | 0 | 0 |
From Tables 3 and 4 directly above, it is relevant to note that:
(a) Insurance finance expenses are calculated by using the actual discount rate for the year (claims for the reporting period are assumed to be paid at the
end of the reporting period). However, in relation to the contractual service margin, paragraphs 44(b) and B72(b) of IFRS 17 require it to be measured
at the discount rate determined on initial recognition of the group of insurance contracts.
(b) In accordance with paragraphs 44(e) and B119 of IFRS 17, BDO Pet Insurance Ltd reduces the carrying amount of the contractual service margin by
an amount attributable to current service provided under the insurance contracts. The amount is determined by identifying the coverage units in the
group of contracts. These coverage units reflect the quantity of benefits provided under each contract in the group and its expected coverage duration.
In this example, the service provided by BDO Pet Insurance Ltd in each period for the group of contracts is the same because all contracts are expected
to provide the same amount of benefits for all three periods of coverage. Accordingly, the amount of the contractual service margin recognised in profit or
loss for the year ended 30 June 2023 is $4,003 + 200/2 years. Nevertheless, there are potentially other ways in which an entity could allocate the
contractual service margin over the coverage period.
(c) Changes related to future service represent the financial impact of changes in input assumptions (in this case, expected future cash outflows, future
discount rates and future risk adjustments for non-financial risk) that relate to service to be provided by BDO Pet Insurance Ltd over the remaining
coverage period.
Next edition
In the next edition of Accounting Alert, we will look at the measurement of onerous insurance contracts under the General Model in IFRS 17.
For more on the above, please contact your local BDO representative.
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