A cohort creates a closed group for measuring allocation of Profit (CSM) without losing the trend of profitability over the time. Annual cohorts help to avoid re-averaging profit of a certain group of contracts when continuing with adding new contracts to the same group again.
Insurance contracts are required to be grouped based on the issue year to annual cohorts under IFRS 17 and a certain group should not be consisted contracts issued more than one year apart. The group is not required to be an annual group, it can be a quarterly group or less period than one year. However, maximum allowed time is one year.
The main reason to introduce the concept of annual cohorts is to ensure profit (CSM) of certain insurance contracts are recognized accurately. When the final contract is matured in the group, respective CSM should have been fully recognized to profit. Usually these profit should reflect the seasonality factors too. Profit will be recognized for the period based on served coverage units of a respective cohort and profit pertained to remaining coverage units will be lying as CSM (Unearned profit) in balance sheet.
Expected profitability of the contracts may change within same type of risks with time passing. The Insurer may change pricing strategy, cash flow patterns can be changed and ultimately profitability of the same type of contract with similar risks will be different if those respective contracts are not issued during the same period of time.
Grouping as cohorts provides another layer of filtering to have a group of contracts issued with similar characteristics (pricing strategies and under same economic conditions), apart from similar risks and similar level of profitability as a part of level of aggregation.
Grouping contracts as per cohorts is very important to recognize profit timely and accurately. If this concept was not introduced under IFRS 17, tracking profitability trend will be operationally difficult and there could be a chance of extending CSM release beyond the maturity of insurance contracts.
Teran Prasanna ACA (ICAEW-UK), FCA, CPA, Bsc (Accounting)