Insurance IFRS Seminar December 1, 2016 Darryl Wagner Session 10 Level of Measurement Darryl Wagner Insurance IFRS Seminar December 1, 2016 Darryl Wagner Session 10

Agenda Cash flows Risk adjustment and contractual service margin

Cash flows Estimates of cash flows in a scenario shall include all cash flows within the boundary of an existing contract that are directly attributable at the level of a portfolio of insurance contracts, and no others Portfolio level of insurance contracts as currently defined by IFRS 4: “insurance contracts that are subject to broadly similar risks and managed together as a single pool” Cash flows that are directly attributable to a portfolio of insurance contracts include direct costs and systematic allocations of costs that relate directly to the insurance contracts or contract activities

Contractual service margin and risk adjustment Contractual service margin (“CSM”) would be determined initially and subsequently at a portfolio level* If the measurement approach includes an explicit risk adjustment, portfolio of insurance contracts should be used to determine this adjustment, and diversification benefits should be reflected from an entity perspective in setting the amount of compensation it requires to bear risk Note: the level of measurement for the CSM was further clarified on an IASB board meeting. See slide 9.

Unit of Account: Portfolio Definition Total population of entity’s insurance contracts Consideration of what will take place at each “level” Entity Wide or Lower (Above Portfolio): IASB risk adjustment is calculated with reference to an “entity level” higher than the portfolio definition Entity-wide or lower Portfolio Level: Contract measurement – BBA/PAA Onerous contract test Determination of CSMs Acquisition costs Portfolio is a subset of contracts grouped based on: Subject to similar risks Similar profitability expectations Managed together Contract Level: BBA/PAA core calculations carried out at contract level, e.g. BEL Reinsurance risk transfer assessment

Unit of account/portfolio ambiguity (1) Significant ambiguity exists in the definition of portfolio and at what unit of account the CSM must be calculated and can be aggregated, specifically in consideration of onerous contracts. At its meeting on 25 April 2014 the IASB tentatively decided to consider in future meetings the non-targeted issues in that the staff identified as requiring further analysis and that may possibly need addressing. One of these issues is references to “unit of account” and “portfolio” and whether it will be possible to clarify the IASB’s intentions to provide more consistency.

Unit of account/portfolio ambiguity (2) At its meeting on 17 June 2014 the IASB tentatively decided to: (a) clarify that the objective of the proposed insurance contracts standard is to provide principles for the measurement of an individual insurance contract, but that in applying the standard an entity could aggregate insurance contracts provided that it meets that objective. (b) amend the definition of a portfolio of insurance contracts to be: “insurance contracts that provide coverage for similar risks and are managed together as a single pool”; and (c) add guidance to explain that in determining the CSM or loss at initial recognition, an entity should not aggregate onerous contracts with profit-making contracts. An entity should consider the facts and circumstances to determine whether a contract is onerous at initial recognition.

Unit of account/portfolio ambiguity (3) It also stated that: “in determining the contractual service margin at subsequent measurement an entity could combine contracts that have similar: (a) release patterns; (b) absolute amounts of CSM at initial recognition; and (c) inception dates and coverage periods.

Unit of account/portfolio ambiguity (4) At its meetings in January 2016,as well as in June 2016, the IASB tentatively decided to: (a) The objective for the allocation of the CSM is to recognise the CSM for an individual contract, or groups of homogenous contracts, in profit and loss over the coverage period of the contract in a way that best reflects the service to be provided by the contract. Hence if there is no more service to be provided by a contract after the end of the reporting period, the CSM for that contract should have been fully recognised in profit or loss. (b) An entity can group contracts for allocating the CSM provided that the allocation of the CSM for the group meets in (a). An entity that groups contracts is deemed to meet the objective in (a) provided that the contracts in the group: - have cash flows that the entity expects will respond in similar ways to key drivers of risk in terms of amount and timing; and - on inception had similar expected profitability; and - the entity adjusts the allocation of the CSM for the group in the period to reflect the expected duration and size of the contracts remaining after the end of the period (c) There should be no exception to the level of aggregation for determining onerous contracts or the allocation of the CSM when regulation affects the pricing of contracts.

Unit of account/portfolio the end of ambiguity? At its meetings in November 2016 the IASB tentatively decided to: to retain the definition of portfolio in draft IFRS 17 Insurance Contracts, ie that a portfolio is a group of contracts subject to similar risks and managed together as a single pool. IFRS 17 would provide guidance that contracts within each product line, such as annuities or whole-life, would be expected to have similar risks, and hence contracts from different product lines would not be expected in the same portfolio. to require entities to identify onerous contracts at inception and group them separately from contracts not onerous at inception. IFRS 17 would provide guidance that entities could measure contracts together if the entity can determine that those contracts can be grouped with others based on available information at inception

Unit of account/portfolio the end of ambiguity? At its meetings in November 2016 the IASB tentatively decided to: to require entities to measure insurance contracts not onerous at inception by dividing the portfolio into two groups—a group of contracts that have no significant risk of becoming onerous and a group of other profitable contracts. IFRS 17 would provide guidance that: an entity should assess the risk of the contracts in a group becoming onerous in a manner consistent with the entity’s internal reporting about changes in estimates. an entity should assess the risk of contracts in the group becoming onerous based on the sensitivity of the fulfilment cash flows to changes in estimates which, if they occurred, would result in the contracts becoming onerous. an entity is permitted to divide a portfolio into more than two groups. For example, an entity may choose to divide a portfolio into more groups if the entity’s internal reporting provides information that distinguishes the different risks of contracts becoming onerous.

Unit of account/portfolio the end of ambiguity? At its meetings in November 2016 the IASB tentatively decided to: prohibit entities from grouping contracts issued more than one year apart. to require entities to allocate the contractual service margin for a group of contracts on the basis of the passage of time. Thus the contractual service margin should be allocated over the current period and expected remaining coverage period and that allocation should be on the basis of coverage units, reflecting the expected duration and size of the contracts in the group. an entity should be permitted to use a weighted average discount rate for the accretion of interest on the contractual service margin, with an averaging period of up to one year. These decisions revise the Board’s previous decisions on the level of aggregation for the measurement of the contractual service margin.

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