2. It is an optional measurement approach for contracts of short duration under IFRS 17, prior to and during the exposure period of the contracts.
3. This post focus on the liability before the occurrence of an insured event (liability for remaining coverage). There is no contractual service margin under the liability for incurred claims as by definition the contractual service margin is amortized over the coverage period of the contract.
4. The liability for incurred claims is measured using risk-adjusted expected present value of fulfilment cash flows.
APPLICATION
1. The use of the PAA is permited if a contract’s coverage period is 12 months or less. In cases where the contract is greater than 12 months in duration the standard indicates that the PAA can be used if it would produce estimates that would be a “reasonable approximation to those that would be produced when applying the requirements” of the BBA.
2. contracts would not meet the requirements to use the PAA if “at contract inception, the entity expects significant variability, during the period before a claim is incurred, in the fulfilment cash flows that are required to fulfil the contract.
3. significant variability is also applied around the fulfillment cash flows and not just the expected nominal cash flows. This include the amount of discount and risk adjustment, which is also sensitive to the time value of money.
INITIAL MEAUSUREMENT APPROACH
1. The initial amount recorded for a contract under the PAA is
Premium received at the time of contract recognition
|
(-) Acquisition costs paid at time of
recognition
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(+)/(-) other pre-coverage cash flows;
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(+) onerous contract liabilities
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2. The PAA, through approximating the building block approach of netting cash inflows and outflows, will clearly understate the future exposure by the amount of premium owed under the inforce contracts.
3. This measurement approach doesn’t capture any expectation of policy cancellations, which if significant on premiums paid could result in overstatement the liability.
CONTRACT BEING RECOGNIZED
1. The recognition criteria for contracts under the PAA are the same as the BBA. A contract is recognized at the “earliest of the following:
(i) the beginning of the coverage period;
(ii) the date which the first payment from the policyholder becomes due; and
(iii) if applicable, the date on the portfolio of insurance contracts which the contract will belong is onerous.”
2. Subsequently, the pre-claims obligation is reduced over the coverage period in a systematic way that best reflects the exposure, as follows:
(i) on the basis of the passage of time
(ii) BUT on the basis of the expected timing of incurred claims, if that pattern differs significantly from the passage of time
1. A portfolio of insurance contracts is onerous if the expected present value of the future cash outflows from that portfolio plus the risk adjustment exceeds:
(i) the expected present value of the future cash inflows from that portfolio (for the BBA)
(ii) the carrying amount of the liability for the remaining coverage (for the PAA)
2. A portfolio of contracts is onerous if it is expected to be loss making
3. For the PAA, onerous contracts should be measured on a basis which is consistent with the measurement of the liability for claims incurred
SUBSEQUENT MEASUREMENT APPROACH
1. At subsequent measurement periods the liability for remaining coverage is measured as the previous recorded amount:
(+) premium received in the period;
|
(-) Amount recognised as insurance
contract revenue for coverage that was provided in that period
|
(+) Any onerous contract liability
recognised in the period
|
(+)/ (-) the effect of any changes in estimates that
relate to any onerous contract liability recognised in previous periods
|
(+) any adjustment to reflect the time
value of money
|
RECOGNIZING REVENUE IN SUBSEQUENT MEASUREMENT PERIOD
1. The revenue should be recognized based on the passage of time, i.e. pro rata, unless “the pattern of release from risk differs significantly from the passage of time” where revenue should be recognized using the “expected timing of incurred claims and benefits”.
2. Care should be taken as to what should be considered significant. Large number of policies with subtle seasonal effects would have a significant impact on revenue. For example most auto policies incurred 72-74% of incurred losses over the first 9 months of a calendar year with the remaining 26-28% being incurred over the last quarter during winter.
3. This difference is subtle in terms of ultimate loss but could have a significant impact on the revenue recognition and bottom line profit of the company if the premium was recognized in line with the expected timing of incurred claims.
OTHER COMPREHENSIVE INCOME FOR PAA
1. If choosing the OCI option to minimise the volatility from changes in interest rates in profit and loss, the discount rate is locked in based on the date incurred losses are recognised. Effectively, for practical purposes, for each portfolio of contract this would imply the locked-in discount rate would be based on the average accident date of a period (quarterly or annual).
NOTE: If OCI selected for the BBA, the discount rate is locked-in at the start of the coverage period of the contract.
THOUGHTS
1. We are likely to see increasing documentation to justify the use of the PAA based on the duration of the contracts.
2. Those contract just over 12 months in duration in a stable, low interest rate environment will likely be justified with limited qualitative documentation outlining the nature of the business and why that business is not expected to result in significant variability in the fulfillment cash flows.
3. For contracts greater in length, three to five years in duration, or those shorter than three years but in higher or unstable interest rate environments are likely to require periodic testing to demonstrate the variability in the cash flows are not significant relative to the revenue recognition under the PAA.
(Source: Actuarial Notes)
