Most IFRS audit standards recognize and also measure financials in ~ the individual contract level, for example, IFRS 15 revenue from contracts and customers, and IFRS 9 jae won instruments. However, insurance service providers underwrite huge numbers of comparable contracts to pool risk. Because that this reason, the IASB has introduced IFRS 17 guidelines for contract aggregation for functions of the calculation and also adjustment that the Contractual organization Margin (CSM). These guidelines enable the usage of a unit of account that is greater than the individual insurance contract.

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The unit that account is figured out by the level the aggregation, which identify the level of granularity at which onerous insurance allowance contracts space identified and how the insurance revenue is well-known in jae won statements. Therefore, the level of aggregation affects how the benefit of the company is reported. This influence on profit is the reason why the level the aggregation in IFRS 17 is at the facility of an sector debate.

This file summarizes the aggregation needs of the IFRS 17 typical from various perspectives, including size the groups, trend info that deserve to be extracted from groups, degree of profitability, level of aggregation that cash flows and also of CSM calculations, and risk sharing. It also includes comment from EFRAG(2018) in terms of comparing the conventional to market practices, and also issues elevated with the level the aggregation requirements. This file also addresses the aspects that an insurance company must think about to architecture its own IFRS 17 grouping methodology.

Summary of requirements

The goals of IFRS 17’s demands for the level the aggregation are:

Identify groups of onerous contract as quickly as possible, quite than obscure castle by offsetting your losses with profitable contracts in the bigger portfolio the contractsAvoid perpetual open portfoliosAllocate CSM as necessary to administer accurate information around profit trends and promote organized allocation rules over the coverage periodCreate consistency in profit acknowledgment within the industry

IFRS 17 requires insurers come organize insurance contract into teams according to 3 criteria:

Product portfolioDegree of profitabilityYear of issue

Product portfolio way contracts topic to the exact same risk kind and controlled together as a single pool. For example, contract in the very same product line – like whole life insurance, annuities, or car insurance – space expected come belong to the exact same portfolio.

Contracts likewise must be classified into teams according come the degree of profitability at initial recognition using the complying with criteria:

Groups of contracts that space onerous in ~ initial recognitionGroups that contracts the at initial recognition have actually no far-ranging possibility of ending up being onerousGroups of staying contracts

One that the most complicated aspects that the IFRS 17 standard, is that it needs separate report of onerous teams from financially rewarding groups, which effects when the entity have to reveal this onerous groups and their complete liability. If the onerous nature were revealed just by portfolio, a downward trend would most likely not arise quickly.

Groups of contracts conference the various profitability criteria need to be further break-up into ‘cohorts’ or ‘time buckets’ that represent an issuing duration of one year or less; for example,insurance contracts issued between 22 April 20X0 and 21 April 20X1 would certainly be break-up from those issued earlier or later. The rationale because that the division into yearly cohorts or less is thateconomic circumstances might change, profitability might change, or the insurer may modify the pricing that the contract. This permits identification of profit trends and also their disclosure in the financial statements. This break-up into time buckets, regularly referred to together the ‘annual cohort’ requirement, can also refer to shorter time periods, for instance quarterly cohorts.

Groups are established at initial recognition and also are not reassessed or modification subsequently during the coverage period. The following figure summarizes the three criteria assuming annual cohorts.

The following figure summarizes the three criteria:


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size of the group and also trend information

The definition of cohorts has vital role in the release of CSM to insurance revenue, since the dimension of the cohort will indirectly identify the lot of CSM released into revenue over time. The quantity of CSM released within every reporting period is based on an median CSM per coverage unit for the group. This mirrors the ratio of the service listed during the coverage duration to the total projected future business until the last contract that the team matures.

For example, imagine a team with one contract through a total CSM that 100€ and contract term of 5 years. If the contract represents 5 coverage units, the CSM will certainly be exit evenly, in ~ a rate of 20€ every year over the coverage period1.

By adding brand-new contracts issued each year, native year 2-6, through duration 5 years and one coverage unit a year, you have the right to introduce annual cohorts that help to identify trends inprofitability linked with continuous cohorts.

The preceding table represents the as whole CSM roll-forward, through in force organization in gray and new business in no color. The following trend information deserve to be detected:

When considering individual contracts, over there is a downward trend in the benefit of new contracts. For example, Contract 1 through an yearly CSM relax of 20 € terminatesin year 6, and from that moment onward the yearly CSM becomes 16€; this trend proceeds over the complying with years. Among newly written contracts, over there is additionally the downwardtrend native Year 1 to Year 4, when yearly CSM goes indigenous 20 to 8. This tendency is reversed beginning in Year 5, when annual CSM rises from 8 to 16.When considering the in its entirety CSM released every coverage unit, we have the right to observe a downward trend kind Year 1 to Year 6, and a reversal beginning in Year 8.

Without yearly cohorts, and also with a higher level that aggregation, the trends described in point a) would not be identified and the only details extracted indigenous the CSM release would certainly be trend b).


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degree of profitability and also size of teams of contracts

Contracts are thought about onerous at initial recognition, if the fulfillment cash flow occurring from the contract is a net outflow2. In this case, the insurer recognizes an instant loss in the gaue won statements and a CSM that zero is established. The evaluate to identify if a contract the is no onerous has no far-ranging possibility of becoming onerous deserve to be based on the sensitivity that the profit to the presumptions used (which call for part judgment) and also on internal reporting information. The objective, however, is come ensure that contracts space separated into groups that are at first onerous, and contracts that could join the onerous group at a future date, so the there is fairly prompt recognition of accident on onerous contracts in ~ each issue year cohort.

If contracts are not onerous, lock are taken into consideration profitable, also if different groups will have different levels of profitability. For example, complying with EFRAG (2018), we assume one insurer issues 20 contracts. For simplicity, we assume each contract has one coverage unit each. This contracts add CSM at recognition varying from 1€ to 20 €. They room aggregated into team 1, i beg your pardon contributes CSM indigenous 1€ to 10€, and also Group 2 which contributes CSM from 11€ come 20€. The mean CSM per coverage unit will be the following:


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Working v averages permits us to protect against calculating CSM balances and releases top top contract-level de-recognition. Because that example, if a contract is derecognized earlier than expected, functioning at contract level would call for us to modify the CSM through adjusting the fulfillment cash operation of the specific contract. Due to the fact that individual contract CSM calculation and also reporting is operationally costly, the standard enables for grouping. Grouping enables us come de-recognize the contract indigenous the CSM by utilizing an average at the minute of the de-recognition.

Logically, the typical CSM at the portfolio level is different from the CSM the the individual contracts. Because that example, assume that we have to derecognize a contract v CSM 2€. If we work with a portfolio average, we would require to consider an median of 10.5€ i m sorry is significantly higher than the contract CSM. Whereas if we occupational with teams with high and also low profitability, the contract level CSM (2€) will certainly be closer come the CSM median of low profitability group (5.5€). Therefore, tracking profitability of the three standard groups enables us to track profitability more closely come the CSM contract-level amounts, there is no incurring in the operational costs of separation, personal, instance tracking. Moreover, working v groups allows us to avoid a instance where contracts v low profitability the are most likely to become onerous are mixed with contracts with high profitability. This mix makes the overall profitability assessment much more diluted and also opaque.

At a minimum, one insurer must divide contract in the 3 regulatory groups explained in the coming before section, yet the insurer can additionally opt for a larger variety of groups reflecting different levels that profitability. The crucial advantage of such level the aggregation is the possibility to spot and also track information around profitability trends that at a higher level of aggregation would certainly be lost. The standard explicitly permits the a propose grouping may be assessed because that profitability level by evaluation of the collection of brand-new contracts assigned to the team as a whole, if there is sufficient supporting details that permits us come conclude that the contracts need to belong come the exact same group. Otherwise the contracts’ profitability must be assessed one through one to entrust to suitable groups. In practice, the number of these groups and how to define them is in ~ the center of a debate.

Finally, laws or regulation may mandate a pricing framework that does no reflect the economic features of the contract. In this case, the standard enables insurers, together an exception, to ar contracts in the same team that normally would be spread in different groups. Because that example, consider two to adjust of contracts A and B, with comparable risks and managed together, and also where policyholders of collection B have higher risk characteristics. If policyholders of set B room charged a greater premium, then the contract may be profitable. Conversely, if they room charged the very same premiums as set A, over there is the possibility that the contracts will be onerous, so they will should be allocated to different groups. If, however, regulation restricts the insurer to fee for collection B the same premiums of set A, climate the 2 sets of contracts have the right to be inserted in the exact same group.

Level the aggregation of cash flows and of CSM

In IFRS 17, profits occurring from future company are treated in different way from losses. Profits developing from future company are recognized over the coverage period, if losses are known when they room identified.

The standard suggests estimating fulfillment cash flows at every little thing level of aggregation is more appropriate. This leaves open up the opportunity to version them at aggregated level or in ~ contract level. These different treatments and the flexibility permitted by the standard, allow companies to have a far-ranging degree of freedom in terms of level that aggregation, and to take on different level of granularity because that fulfillment cash flows and CSM calculations.

In regards to level of aggregation for CSM calculations, most of the suppliers we watch have chose to carry out calculations follow to the minimum granularity compelled by the standard, i beg your pardon is portfolios, onerous assessment, and also annual cohorts.

In terms of level the granularity of the fulfillment cash flows, we have observed the complying with trends:

The contract grouping offered for Solvency II will not occupational for IFRS 17, as such a new grouping policy should be placed in place. Regularly the new level that grouping involves not just amethodological decision, but additionally problems that data quality, like absent data.Companies that aim because that minimal compliance will try to minimization the work costs linked with finer granularity. They will certainly look in ~ a level of granularity in the group of cash flows that is constant with level that aggregation requirements for CSM, the is follow to the level of profitability.Companies with heterogeneous actuarial systems, regularly receive cash circulation with heterogeneous granularities. Lock may take into consideration their IFRS 17 task to be an opportunity toimplement a more granular and also homogeneous3 level that cash flows across the various entities of the group. In this case, they are likely to pursue granularity that is as fine as possible.We have observed carriers targeting plan level fulfillment cash flows. This alternative is most constant with principles-based approaches based on gross premiumvaluation, since individual contract calculations room much more sensitive to individual contract differences than model allude approaches, and also therefore the outcomes they return are much more accurate.Companies the have applied their accounting systems at the policy level, i m sorry is rare, will additionally be maybe to use such level the granularity.

Companies are currently seeking systems and expertise to support IFRS 17 calculations including specifically the CSM. We believe the tools compelled to investigate and attend to these worries should be:

Agnostic to the underlying valuation systems and also accept range of inputsAllow reconciliations come the groupings offered for various other reporting purposesFacilitate easy procedure management so that multiple runs have the right to be carried out to investigate different grouping strategiesAble to support plan level calculations, if requiredProvide insightful output to assistance determination that the optimal strategy, including considering alternate future outcomesRisk share in IFRS 17

IFRS 17 refers to risk pooling as threat sharing, meaning that countless policyholders act with each other as a loss soaking up buffer versus the event of an adverse event. IFRS 17 hazard sharing refers to the situation when an insurance contract in one team includes problems that impact the cash flows of policyholders in a different group (B67-71)4. Take, because that example, 2 policyholders that share the same pool of underlying assets, but A has a minimum guaranteed of 7% and also B has a minimum guarantee of 2%. If the return native the swimming pool of underlying assets is 5%, A will receive 7% as per the contract (2% an ext than the efficient fund return), while B will receive the residual return the 3% (1% much more than the contractual minimum, however 2% less the effective fund return). The payout come A is increased, while the payout come B is reduced. Hence, the 2 contracts space interdependent, and B absorbs a loss because that the advantage of A policyholders.

For IFRS 17, threat sharing occurs as soon as contracts that are interdependent in terms of cash operation belong to various units that account or groups. In this situation the approximated cash operation should additionally consider cash transfer in between groups.

Issues v level that aggregation

The following concerns were increased by EFRAG (2018), a consultation paper published to encourage a debate throughout the industry5. The first issue increased is the annual cohort requirement. Separating an insurance allowance product with a life expectations of, because that example, ten years means significantly multiplying the number of groups, which bears an extra operational price in terms systems updates and changes. The proliferation that the number of groups creates data administration issues, having to store CSM balances through group, permanently retain team assignment, and also manage the demanding roll-forward procedure by group.

The current accounting practice monitors profitability in ~ a higher level the aggregation. This is in part due to IFRS 4, which permits for greater flexibility in terms of unit the account. To do things much more challenging, we must likewise consider that under the previous standard different aspects of the jae won statement have the right to use various units the account and the exercise varies from one company to another. Furthermore, companies may use various levels of aggregation in different internal processes, for example product design and also pricing, risk assessment, monitoring and reporting.

IFRS 17 has listed a new model for identifying onerous contracts. Before, contracts were grouped in a bigger pool to calculate profitability. Currently losses can not be diluted in a huge pool, they need to be made explicit when they are recognized. For example, take into consideration an insurance agency selling 2 insurance contracts, one through characteristic X, and also one there is no it. If X is included, the contract is onerous at 50 €, if if X is excluded, the contract is financially rewarding at 200€ over the coverage period. If measured individually, loss is well-known immediately, when if measured together, end the coverage duration the profit will certainly still it is in 150 €. However, a lesser quantity of useful information is gathered with this collection of contracts, and the loss info is recorded gradually end the coverage duration rather than immediately. The advent of the concept of onerous contract might also affect the pricing of part contracts due to the fact that the timing of reported earnings will be impacted.

The separation of mutualized quantities into teams of contract is viewed by EFRAG together artificial and also divergent from present practices. IFRS 17 go not use the term “mutualization”,it refers instead to “risk sharing.” In practice, follow to EFRAG, the term incorporates a larger variety of effects, such as individual contract requirements, hazard diversification, and cross-subsidization. EFRAG therefore suggests considering mutualization in the decision of the insurance money groups.

Current exercise in the insurance sector leverages the use of open portfolios, whereby contracts are included and eliminated continuously native an insurance money group. As presented above, among the IFRS 17 goals is to prevent perpetually open up portfolios.

Conclusions

The level of aggregation that CSM calculations have to reflect the true financial nature of the underlying groups of insurance money contracts. In ~ the very same time, granularity that is too in-depth may introduce noise and also increase complexity in terms of data volumes. The level the aggregation need to be designed follow to the data available, and associated come the attributes of the plans that will make the analytics systematic over the final CSM results. In conclusion, the optimal level the aggregation that CSM calculations relies on the varieties of insurance plans and availability of data to produce helpful analytics of contract groups.

The conflict in the industry is animated, sustained by initiatives like EFRAG (2018). Together insurance providers embark top top CSM implementations, we believe that best practices will arise in terms of methodology for level the aggregation, offering guidelines that deserve to be embraced by the whole industry.


EFRAG (2017), “EFRAG TEG - educational Session“, 23 November 2017, Agenda document 03-05

IFRS (2017), “IFRS 17 insurance allowance Contracts”, may 2017, https://www.idc.ac.il/he/specialprograms/accounting/fvf/Documents/IFRS17/WEBSITE155.pdf

IFRS (2018), “IFRS 17 webcast: Level the aggregation”, 18 January 2018, http://www.ifrs.org/news-and-events/2018/01/new-ifrs-17-webcast-level-of-aggregation/


1 The even release of the CSM over the coverage period is a simplification, specifically for contracts that have actually a probability of being terminated by claim or through policyholder lapse. The standard allows the forecast of expected coverage units over the contract period with the expectation that company delivered decreases steadily end time. With median lapse prices of 10 to 15% or much more in early on years and also termination rates enhancing by period to a high amount in later years, the decrease will not be linear like in this example. A much more realistic instance would i think a continual 5 / 10% slide away rate.

2 A simplification is listed in IFRS 17, paragraph 47 for the Premium Allocation strategy (PAA) methodology: an entity can assume the no contracts room onerous in ~ initial recognition, unless facts and also circumstances indicate otherwise. The reality will need to assess whether contracts belong to the two remaining groups based upon likelihood of transforms in these facts or circumstances.

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3 Homogeneous granularity permits firms to provide a typical data structure throughout group entities to the CSM calculations, i beg your pardon lowers job complexity and also risk.