Risk adjustment reflects the compensation required to bear uncertainty about the amount and timing of cash flows that rise from non-financial risks. Movement of the risk adjustment during the reporting period, confidence levels and technique used for the calculation should be disclosed in the financial statements.
IFRS 17 requires to make an explicit risk adjustment when measuring insurance contract liabilities and this should be disclosed in financial statements. Risk adjustment plays a big role when pricing insurance contracts and recognizing profit as per the new standard. Risk adjustment reflects the compensation required to bear uncertainty about the amount and timing of cash flows that rise from non-financial risks and this covers non financials risks including insurance risks and lapse risks.
If Premium allocation approach is used as the measurement model, risk adjustment will not be required to calculate for liability for remaining coverage (LRC), But calculation of risk adjustment is required for liability for incurred claims (LIC) under premium allocation approach or General measurement model. However, if the respective group of contract is expected to be onerous, explicit risk adjustment is essential under any measurement model.
This is a common question, if there is no standard method for risk adjusment, how will IFRS 17 achieve comparability? When measuring non financial risks, the Insurers should use most eligilble method which reflects the risks profile as per the company’s inherent characteristics. Because, non-financial risks are entity specific, rather than market or industry specific. Different insurer may use different methods for the same portfolio reflecting entity specific factors and calculated value will give a more accurate value than using one standard method. Confidence levels used the calculation are required to be disclosed, this will help users to compare and understand financial statements.
Risk adjustment can be calculated at a higher aggregated level than group of contracts, then a methodology and a system should be developed to allocate the calculated risks among underlying group of contracts.
Teran Prasanna ACA (ICAEW-UK), FCA, CPA, Bsc (Accounting)