Under the supervision of the IAA the below questions has been answered around the IFRS 17 regulation.
It is an educational document on an actuarial subject that has been adopted by the IAA in order to advance the understanding of the subject by readers of the chapter, including actuaries and others, who use or rely upon the work of actuaries.
More questions are available through the links above, this is a shorter version.
Questions & Answers
What are the requirements of IFRS 17 regarding the measurement of estimates of future cash flows?
IFRS 17 includes the key characteristics of the measurement of estimates of future cash flows, namely they:
a. Include all future cash flows within the contract boundary
b. Are the probability weighted mean of the full range of possible outcomes
c. Are unbiased,
d. Reflect the perspective of the entity
e. Are current
f. Are explicit (i.e. they don’t include the risk adjustment for non-financial risk)
What are the typical types of cash flows to be included?
Cash flows referred to in IFRS 17 are primarily payments of cash exchanged between the parties under an insurance contract in accordance with the terms and conditions of the contract. The term “cash flow” can also be used as shorthand for other transfers of economic resources (cash flow equivalents) that are not settled in cash between the parties to the insurance contract. They may also include such items as administration costs, payments to third parties and non-cash transactions such as the provision of goods and services.
One paragraph provides examples of cash flows that are typically included within the boundary of the contract. They include but are not limited to:
2. Payments to policyholders including claims that have been reported but not yet paid, incurred claims that have not yet been reported and future claims on unexpired risks.
3. An allocation of insurance acquisition costs.
4. Claim handling costs including those for payments in kind.
5. Policy administration and maintenance costs.
6. Transaction-based costs such as premium taxes.
7. Potential cash inflows from recoveries.
8. An allocation of fixed and variable overheads.
At what level are cash flows determined?
Cash flows are generally identified at the individual contract level but for measurement purposes, contracts may be aggregated. IFRS 17 allows, moreover, the entity to estimate the cash flows at whatever level of aggregation is most appropriate from a practical perspective.
What is a current estimate?
A current estimate at the report date is the entity’s estimate based on currently available information in a manner consistent with relevant accounting guidance. The term “current estimate” is used in this chapter as a short form for the “current unbiased estimate of the expected future contractual cash flows”. IFRS 17 defines the term “fulfilment cash flows” as including the risk adjustment and the effect of discounting.
What is the meaning of expected value?
For IFRS purposes, “expected value of cash flows” represents the mean of the (typically unknown) probability distribution of cash flows. In line with this mathematical concept, IFRS 17 requires that conceptually all scenarios are covered in determining the value of the cash flows, including scenarios in the extreme tails of the distribution.
Where the variability in future cash flows follows a uniform distribution, actuaries may conclude that the impact and likelihood of favorable and unfavorable extreme scenarios not explicitly considered in a model may broadly offset each other; however, where the distribution of future cash flows is skewed it may be necessary to adjust the expected value to reflect extreme scenarios not allowed for in the model.
What does “unbiased” mean?
An estimator is unbiased if its mean value equals the mean of the value to be estimated. Therefore, an unbiased estimate does not include either conservatism or optimism.
To what extent do the expected values have to differentiate contracts with different characteristics (e.g. age, gender), and other known peculiarities of contracts?
Statistical estimates are usually only differentiated for a limited number of characteristics of the item to be estimated and include the average effect of other characteristics. Since insurance is based on statistical estimates,
IFRS 17 does not require the entity to assess all characteristics of a contract which might be relevant to the outcome and establish estimates on that basis. The Standard does (paragraph B41) require consideration of “all reasonable and supportable information available at the reporting date without undue cost or effort.” Accordingly, it is a matter of judgement as to what degree characteristics of individual contracts are considered in the measurement.
What are the cash inflows to be considered?
All cash inflows arising under rights of the insurance contracts and within the contract boundary are considered. The primary inflow is, of course, premium. Investment income, other than that related to policy loans (see below), is not included since it is a cash inflow due to investments and not specifically related to the fulfilment of the contracts.
How are policy loans and repayments handled?
If policy loans are a component of the insurance contract, loans and repayments of policy loans are part of fulfilment cash flows.
What kind of data is used to estimate future cash flows?
The standard (IFRS 17 paragraph B41) requires assumptions to be based information obtained including, importantly, the entity’s own experience to the extent it is available, supportable and credible. This data can be adjusted if there is reason to believe that historical trends will not continue in the future or if other influences may affect them.
How are administration costs that are paid or expected to be paid prior or subsequent to contractual due date handled?
The measurement is based on the actual payment date, not the due date, and allows for any consequences of early or late payment (e.g. pre-paid or annualised commissions, interest accreted, penalties charged). If this can be shown to give materially the same result, the measurement could be based on due dates with an approximation of the interest effect to the actual payment date.
What methods are appropriate to estimate future cash flows that might be dependent on market variables?
Stochastic projections are allowed but are not necessarily required. Stochastic methods will more likely be used to develop estimates of a risk adjustment or interest rate dependent cash flows than the usual mean estimate.
What methods are appropriate to estimate expected future internally incurred costs?
Estimates of future management costs will usually make use of any forecasts the entity makes including budgets and business plans. Those future unit costs will usually anticipate inflation consistent with the discount rates being used. It is also appropriate to allow for expected future economies (or dis-economies) of scale, consistent with the likelihood of these scenarios and unbiased mean.
Are any taxes included in cash flows?
All transaction based taxes (such as premium taxes, value added taxes and goods and services taxes) and levies (such as fire service levies and guarantee fund assessments) are included in cash flows.