that the underlying contracts are also measured using this approach. However, the
entity should use consistent assumptions to measure the estimates of the present value
of future cash flows for the group of reinsurance contracts held and the estimates of the
present value of the underlying insurance contracts. [IFRS 17.63].
In February 2018, in answer to a TRG submission, the IASB staff stated that ‘consistent’ in
this context does not necessarily mean ‘identical’ (i.e. the use of an identical discount rate
for measurement of the group of underlying insurance contracts and the related group of
reinsurance contracts held was not mandated). The extent of dependency between the cash
flows of the reinsurance contract held and the underlying cash flows should be evaluated in
applying the requirements of paragraph 63 of IFRS 17.30 In May 2018, in answer to a TRG
submission, the IASB staff further noted that consistency is required to the extent that the
same assumptions apply to both the underlying contracts and the reinsurance contracts
held. In the IASB staff’s view, this requirement does not require or permit the entity to use
the same assumptions used (e.g. the same discount rates) for measuring the underlying
contracts when measuring the reinsurance contracts held if those assumptions are not valid
for the term of the reinsurance contracts held. If different assumptions apply for reinsurance
contracts held, the entity uses those different assumptions when measuring the contract.
The TRG members did not disagree with either of the IASB staff statements.31
In addition to using consistent assumptions, an entity should make the following
modifications in calculating the fulfilment cash flows:
• the estimates of the present value of the future cash flows for the group of reinsurance
contracts held should reflect the effect of any risk of non-performance by the issuer of
the reinsurance contract, including the effects of collateral and losses from disputes.
[IFRS 17.63]. This is because an entity holding a reinsurance contract faces the risk that the
reinsurer may default or may dispute whether a valid claim exists for an insured event.
[IFRS 17.BC308]. The estimates of expected credit losses are based on expected values; and
• the estimate of the risk adjustment for non-financial risk should be determined so
that it represents the amount of risk being transferred by the holder of the group
of insurance contracts to the issuer of those contracts. [IFRS 17.64]. The risk
adjustment does not include an adjustment for the risk of non-performance (which
is already contained within the estimates of the present value of future cash flows),
a fact confirmed by the IASB staff to TRG members in May 2018 (TRG members
did not disagree with the IASB staff’s statement).32
IFRS 17 prohibits changes in expected credit losses adjusting the contractual service
margin. In the Board’s view, differences in expected credit losses do not relate to future
service. Accordingly, any changes in expected credit losses are economic events that
the Board decided should be reflected as gains and losses in profit or loss when they
occur. This would result in consistent accounting for expected credit losses between
4536 Chapter 52
reinsurance contracts held and purchased, and originated credit-impaired financial
assets accounted for in accordance with IFRS 9 (which does not apply to rights and
obligations arising under a contract within the scope of IFRS 17 such as a receivable due
under a reinsurance contract held – see 2.3 above). [IFRS 17.BC309].
In determining the contractual service margin on initial recognition, the requirements
of the general model are modified to reflect the fact that there is no unearned profit but
instead a net gain or net cost on purchasing the reinsurance. Hence, on initial
recognition: [IFRS 17.65]
• the entity should recognise any net cost or net gain on purchasing the group of
reinsurance contracts held as a contractual service margin measured at an amount
equal to the sum of the fulfilment cash flows, the amount derecognised at that date
of any asset or liability previously recognised for cash flows related to the group of
reinsurance contracts held, and any cash flows arising at that date; unless
• the net cost of purchasing reinsurance coverage relates to events that occurred
before the purchase of the group of reinsurance contracts, in which case the entity
should recognise such a cost immediately in profit or loss as an expense.
It is stated in the Basis for Conclusions that the IASB decided that the net expense of
purchasing reinsurance should be recognised over the coverage period as services
are received unless the reinsurance covers events that have already occurred. For
such reinsurance contracts held, the Board concluded that entities should recognise
the whole of the net expense at initial recognition, to be consistent with the treatment
of the net expense of purchasing reinsurance before an insured event has occurred.
The Board acknowledged that this approach does not treat the coverage period of
the reinsurance contract consistently with the view that for some insurance contracts
the insured event is the discovery of a loss during the term of the contract, if that loss
arises from an event that had occurred before the inception of the contract.
However, the Board concluded that consistency of the treatment of the net expense
across all reinsurance contracts held would result in more relevant information.
[IFRS 17.BC312].
In addition, an inconsistency also arises when an underlying group of insurance
contracts is onerous at initial recognition since the resulting onerous loss at inception
must be recognised immediately (see 8.8 above) whereas any net gain on purchasing the
related reinsurance held is deferred and released to profit or loss as services are
received over the coverage period (see 10.4 below).
IFRS 17 provides no guidance as to how a cedant should account for the net cost of a
reinsurance contract held which provides both prospective and retrospective coverage.
Measurement of a reinsurance contract held on initial recognition is illustrated by the
following example, based on Example 11 in IFRS 17. [IFRS 17.IE124-129)].
Example 52.41: Measurement on initial recognition of groups of reinsurance
contracts held
An entity enters into a reinsurance contract that in return for a premium of £300m covers 30% of each claim from the
underlying reinsurance contracts. Applying the relevant criteria, the entity considers that the group comprises a single
contract held. For simplicity, this example ignores the risk of non-performance of the reinsurer and all other amounts.
Insurance contracts (IFRS 17) 4537
The entity measures the estimates of the present value of future cash flows for the group of reinsurance
contracts held using assumptions consistent with those used to measure the estimates of the present value of
the future cash flows for the group of the underlying insurance contracts as shown in the table below.
Underlying
Reinsurance
contracts
contract
£m £m
Estimates of the present value of future cash inflows
1,000
270
Estimates of the present value of future cash outflows/premium paid
(900)
(300)
Risk adjustment for non-financial risk
(60)
18
Contractual service margin
(40)
12
Insurance contract asset/liability on initial recognition
–
–
The entity measures the present value of the future cash inflows consistent with the assumptions of the cash
outflows of the underlying insurance contracts. Consequently, the estimate of cash inflows is £270m (i.e.
30% of £900m). The risk adjustment is determined to represent the amount of risk being transferred by the
holder of the reinsurance contract to the issuer of the contract and consequently the risk adjustment, which is
treated as an inflow rather than an outflow, is £18m (i.e. 30% of 60).
The contractual service margin (CSM) is an amount equal to the sum of the fulfilment cash flows and any
cash flows arising at that date. In this example, cash outflows exceed cash outflows and therefore there is a
net loss on purchasing the reinsurance and so the CSM is an asset.
If the premium was, say, only £260m then there would be a net gain of £28m on purchasing the reinsurance
(i.e. inflows of £270m plus the risk adjustment of £18m less outflows of £260m) and the CSM would represent
a liability of £28m in order to eliminate the net gain on inception.
10.5 Subsequent
measurement
Instead of applying the subsequent measurement requirements for the general model,
an entity should measure the contractual service margin at the end of the reporting
period for a group of reinsurance contracts held as the carrying amount determined at
the start of the reporting period, adjusted for: [IFRS 17.66]
• the effect of any new contracts added to the group;
• interest accreted on the carrying amount of the contractual service margin,
measured at the discount rates determined at the date of initial recognition of a
group of contracts using the discount rates as determined by the general model;
• changes in the fulfilment cash flows to the extent that the change:
• relates to future service; unless
• the change results from a change in fulfilment cash flows allocated to a group
of underlying insurance contracts that does not adjust the contractual service
margin for the group of underlying insurance contracts;
• the effect of any currency exchange differences arising on the contractual service
margin; and
• the amount recognised in profit or loss because of services received in the period,
determined by the allocation of the contractual service margin remaining at the
end of the reporting period (before any allocation) over the current and remaining
coverage period of the group of reinsurance contracts held.
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Changes in the fulfilment cash flows that result from changes in the risk of non-
performance by the issuer of a reinsurance contract held do not relate to future service
and should not adjust the contractual service margin. [IFRS 17.67].
The contractual service margin of a group of insurance contracts issued can never
be negative. In contrast, IFRS 17 does not include a limit on the amount by which
the contractual service margin of a group of reinsurance contracts held could be
adjusted as a result of changes in estimates of cash flows. In the Board’s view, the
contractual service margin for a group of reinsurance contracts held is different from
that for a group of insurance contracts issued – the contractual service margin for
the group of reinsurance contracts held depicts the expense the entity incurs when
purchasing reinsurance coverage rather than the profit it will make by providing
services under the insurance contract. Accordingly, the Board placed no limit on the
amount of the adjustment to the contractual service margin for the group of
reinsurance contracts held, subject to the amount of premium paid to the reinsurer.
[IFRS 17.BC314].
It is stated in the Basis for Conclusions that the Board considered the situation that
arises when the underlying group of insurance contracts becomes onerous after
initial recognition because of adverse changes in estimates of fulfilment cash flows
relating to future service. In such a situation, the entity recognises a loss on the group
of underlying insurance contracts (this situation would apply also to the subsequent
accounting of an underlying direct contracts that were already onerous at their
initial recognition). The Board concluded that corresponding changes in cash
inflows from a group of reinsurance contracts held should not adjust the contractual
service margin of the group of reinsurance contracts held, with the result that the
entity recognises no net effect of the loss and gain in the profit or loss for the period.
This means that, to the extent that the change in the fulfilment cash flows of the
group of underlying contracts is matched with a change in fulfilment cash flows on
the group of reinsurance contracts held, there is no net effect on profit or loss.
[IFRS 17.BC315].
These requirements are illustrated by the following example, based on Example 12 in
IFRS 17. [IFRS 17.IE130-138].
Example 52.42: Measurement subsequent to initial recognition of groups of
reinsurance contracts held
An entity enters into a reinsurance contract that in return for a fixed premium covers 30% of each claim from
the underlying insurance contracts (the entity assumes that it could transfer 30% of non-financial risk from
the underlying contracts to the reinsurer). In this example the effect of discounting, the risk of non-
performance of the reinsurer and other amounts are ignored, for simplicity. Applying the relevant criteria, the
entity considers that the group comprises a single contract held.
Insurance contracts (IFRS 17) 4539
Immediately before the end of Year 1, the entity measures the group of insurance contracts and the reinsurance
contract held as follows:
Insurance
Reinsurance
contract
contract
liability
asset
$m
$m
Fulfilment cash flows (before the effect of any change in estimates)
300
(90)
Contractual service margin (CSM)
100
(25)
Insurance contract liability/(reinsurance contract asset)
400 (115)
immediately before the end of Year 1
In this example, the difference between the CSM for the reinsurance contract held of $25m and 30% of the
underlying group of insurance contracts of $30m (30% × $100m) arises because of a different pricing policy
between the underlying group of insurance contracts and the reinsurance contract held.
At the end of year 1, the entity revives its estimates of the fulfilment cash flows of the underlying group of
contracts and estimates an increase of $50m and a decrease in the contractual service margin by the same
amount (the group of underlying insurance contracts is not onerous). As a result, the entity increases the
fulfilment cash flows of the reinsurance contract held by 30% of the change in fulfilment cash flows of the
underlying group of insura
nce contracts ($15m = 30% of $50m). The CSM is then adjusted by the whole
amount of the change in the fulfilment cash flows because the whole change of the fulfilment cash flows
allocated to the group of underlying contracts adjusts the CSM of those underlying contracts.
Therefore, at the end of Year 1, the entity measures the insurance contracts liabilities and the reinsurance
contract asset as follows:
Insurance
Reinsurance
contract
contract
liability
asset
$m
$m
Fulfilment cash flows (including the effect of any
350 (105)
change in estimates)
Contractual service margin (CSM)
50
(10)
Insurance contract liability/(reinsurance contract asset)
400 (115)
at the end of Year 1
There is no effect of these change in estimates on profit on loss as all changes in the fulfilment cash flows go
to the CSM.
The answer would be slightly different if the change in the underlying fulfilment cash flows did not wholly
affect the CSM.
Suppose, at the end of Year 1, that the entity estimates that there is an increase in the fulfilment cash flows of the
underlying group of insurance contracts of $160m. This change makes the group of underlying insurance contracts
onerous and the entity decreases the original CSM of $100m to zero and recognises the remaining $60m as a loss
in profit or loss. As a result, the entity increases the fulfilment cash flows of the reinsurance contract held by $48m
(i.e. 30% of $160m). The entity then adjusts the CSM of the reinsurance contract held for the change in fulfilment
cash flows that relate future service to the extent this change results from a change in the fulfilment cash flows of
the group of the underlying insurance contracts that adjusts the contractual service margin for that group.
4540 Chapter 52
Consequently, the change in the fulfilment cash flows of the reinsurance contract held of $48m are recognised
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 897
