IFRS 15 and other standards are focusing on individual transaction level (individual contracts) to calculate and recognize profit. However, IFRS 17 considers a group of contracts as a base (unit of account) to measure contracts and recognize profit. This is due to the nature of insurance industry, because insurers issue similar contracts to generate profit from a pool of contracts (group) and not from each and every individual contract as other industries.
IFRS 17 requires to group insurance contracts based on profitability as a part of level of aggregation. Three main groups are, Contracts which are onerous at initial recognition, Contracts that are no significant possibility of becoming onerous subsequently and remaining contracts (profitable contracts).
Measurement model under IFRS 17 is based on group of contracts and not based on individual contracts. The logic behind these grouping is Insurers are not issuing policies to make profit from individual contracts, but from group of contracts. Some contracts will make losses and the rest may be profitable. The objective is to generate profit by issuing contracts for similar risks as a pool. Insurers issue more and more similar contracts to reduce the risk and optimize the profit.
Three type of groups based on profitability, is this really required? As explained above measurement under IFRS 17 is based on groups. If insurance contracts are not grouped as per expected profitability, performance measurement as per IFRS 17 will not give accurate results and preset objectives of IFRS 17 will not be achieved. Average values of the group can be considered when making adjustments under IFRS 17 to reflect the homogeneous individual contracts under a certain group. Tracking CSM by individual contract level is operationally difficult and it is costly, since IFRS 17 allows to track and measure CSM in group level.
Further, if no groups are made based on profitability, onerous contracts will not be recognized separately and losses will be offset with profitable contracts. Below example depicts the impact from grouping of contracts based on the profitability.
Assume that “Contract-8” is cancelled by the customer, then average profit (CSM) is $ 5 for the respective group and it is required to release and adjusted by $ 5, which is more closed to individual CSM of $ 3. If contracts are not grouped as per expected profitability, then adjustment for that cancellation will be based on total average CSM, which is $ 37. There is a significant difference in average profit for the group based on profitability ($ 5 Vs $ 37).
It is important to group contracts with high accuracy to achieve correct measurement results under IFRS 17 and this will be achievable easily after understanding the reason behind grouping based on profitability.
Teran Prasanna ACA (ICAEW-UK), FCA, CPA, Bsc (Accounting)