January 2019 International Accounting Standards Board meeting
May 2018 TRG meeting
February 2018 TRG meeting
What’s the issue?
IFRS 17 currently requires an insurer to recognise losses in profit or loss when it initially recognises onerous insurance contracts. However, no corresponding gains are recognised in profit or loss if the losses are covered by reinsurance contracts recognised at the same time. This can result in an accounting mismatch.
After initial recognition, if a group of insurance contracts that underlies a group of reinsurance contracts held becomes onerous, then the resulting changes in the fulfilment cash flows of the group of reinsurance contracts held is recognised in profit or loss. This avoids accounting mismatches that would arise otherwise.
What did the Board decide?
The Board has tentatively decided to propose amendments to IFRS 17 to address the accounting mismatch at initial recognition.
The amendments would require an insurer that recognises losses on underlying insurance contracts assessed as onerous at initial recognition, to also recognise a gain at the same time in profit or loss on reinsurance contracts held, to the extent that the reinsurance contracts cover the losses of the underlying contracts on a proportionate basis.
This gain would apply only to reinsurance contracts entered into before – or at the same time as – the onerous underlying contracts are issued.
The amendments would apply to contracts measured under the premium allocation approach and the general measurement model.
What’s the impact?
These amendments aim to provide better information about the economic effect of reinsurance contracts held by reducing an accounting mismatch and, as a result, reduce complexity for users of financial statements.
The discussion at the Board table clarified that the amendment applies to reinsurance contracts covering claims of each underlying contract on a proportionate basis, which will require careful drafting as the standard is updated. This scope differs from what is commonly known as proportional reinsurance, under which both claims and premiums are proportional to those of the underlying insurance contract. Non-proportionate reinsurance contracts are not covered by the amendment given there is no direct linkage between the underlying onerous contracts and the reinsurance contracts held.
As the Board’s discussions on reinsurance contracts held progress, insurers will need to continue developing new systems and processes to account for these contracts under IFRS 17 and may consider impacts on reinsurance programmes. They will have to consider how these activities could be impacted by the proposed amendments for reinsurance accounting.
In some jurisdictions, insurers are not permitted to defer acquisition costs but are required to recognise these costs up front, causing the potential for these contracts to become onerous on initial recognition. For these insurers, this amendment will provide a useful relief whereby the insurer may choose to enter into proportionate reinsurance agreement to offset these losses and recognise a corresponding gain in their financial statements.
What's the issue?
Some reinsurance contracts include terms that allow the reinsurer to reprice the remaining coverage under a contract prospectively, after giving notice to the cedant. Only if the reinsurer provides notice of repricing does the cedant have the right to terminate cover mid-term.
These features raise the question of whether an insurer holding such a contract should include in the contract boundary all expected cash flows on initial recognition, or only the expected future cash flows up until the end of the notice period.
What did the TRG discuss?
Previously, TRG members observed that cash flows within the boundary of a reinsurance contract held arise from the substantive rights and obligations of the cedant (see Boundaries of reinsurance contracts held).
For reinsurance contracts held:
Therefore, cash flows are within the contract boundary of a reinsurance contract held if they arise from substantive rights and obligations that exist during the reporting period in which the cedant:
The TRG members observed that since the cedant does not have control over its ability to terminate the coverage of the reinsurance contract, it remains compelled to pay premiums to the reinsurer. Therefore, the contract boundary for the cedant would include expected cash flows after the notice period.
What's the impact?
In some cases, the cedant can be compelled to pay reinsurance premiums for reinsurance contracts held. This obligation might impact the cash flows that will be used to measure the reinsurance contract.
Insurers should carefully analyse the terms and conditions of the reinsurance contracts that they hold and all of the relevant facts and circumstances to determine the contract boundary. This involves looking at the rights and obligations of both parties to the contract.
IFRS 17’s contract boundary requirements – which determine which cash flows are included in the measurement of contracts – appear to use terminology specific to insurance contracts issued by insurers.
This raises a question over how the requirements should be applied to reinsurance contracts held by insurers.
What did the TRG discuss?
TRG members appeared to agree that these requirements should be adapted in an appropriate way for determining the contract boundaries of reinsurance contracts held. Therefore, cash flows are within the boundary of a reinsurance contract held when the entity has a substantive right to receive services from the reinsurer.
This substantive right ends when the reinsurer:
What's the impact?
Many reinsurance contracts provide coverage for claims that occur on underlying contracts that are issued during a period of time.
Currently, most insurers holding these reinsurance contracts recognise and measure them to the extent the underlying contracts are written – i.e. without reflecting expectations of future underlying contracts that will be covered by the reinsurance contract held.
This may change under IFRS 17, because the initial and subsequent measurement of the reinsurance contract held can include cash flows from underlying contracts that are expected to be issued in the future if they are considered to be inside the boundaries of the reinsurance contract.
Consequently, the recognition pattern for reinsurance costs could change for many insurers. The processes and systems that are used to measure reinsurance contracts held might also need to change.
Insurers should analyse the terms and conditions of the reinsurance contracts they hold. For example, a term that provides the reinsurer with the ability to stop covering future underlying contracts with a few months’ notice, which is common in practice, might limit the cash flows included within the contract boundary.
This topic page is part of our Insurance – Transition to IFRS 17 series, which covers the discussions of the International Accounting Standards Board and its Transition Resource Group (TRG) regarding the new insurance contracts standard.
You can also find more insight and analysis on the new insurance contracts standard at home.kpmg/ifrs17.
Other topics in this series