Changes in the Reporting of Reinsurance Ceded Under IFRS 17
Separation of Direct Insurance from Reinsurance Ceded
Significant changes in the handling of reinsurance contracts held under IFRS 17 will have an impact on both Statements of Position and Statements of Financial Performance. These changes relate to both presentation and to the underlying calculations performed at the insurance contract level, the reinsurance cession level and the new contract group level which is required for the calculation of the Contractual Service Margin (CSM).
The valuation of the actuarial liabilities under Canadian GAAP prior to the adoption of IFRS 17 was focused on the total contractual liability net of the portion of that liability ceded to reinsurers. This integrated approach was fundamental to both the valuation methodology and to the presentation on the balance sheet. Under IFRS 17, reinsurance contracts are considered separately both in assessing the component amounts held and in their presentation as assets or liabilities, according to their sign, and this separation will be required in the reporting of income as well.
This fundamental separation of direct insurance from ceded reinsurance carries through to the definition and maintenance of CSM Groups specifically for reinsurance contracts following similar criteria as for direct insurance contracts. However, there is no concept of onerous contracts for reinsurance. This means that the net balance of Fulfillment Cash Flows (FCF) calculated at the initial recognition of a reinsurance contract group is offset by a comparable CSM balance, recognized as an asset or liability according to the sign, resulting in zero profit impact at recognition.
While reported separately, reinsurance is related to and must be valued consistently with the underlying insurance contracts. The FCF for a group of reinsurance contracts will include a Risk Adjustment that reflects the amount of non-financial risk transferred to the issuer of that reinsurance. The consistency requirement may cause a complicated interaction in the reporting of non-financial assumption changes so that these changes impact either CSM or profit and loss consistently for both reinsurance contracts and the underlying direct contracts affected by the change.
AXIS will be enhanced to enable the allocation of reinsurance cessions to reinsurance contract groups for the calculation and reporting of CSM balances. Since a reinsurance reinsurance agreement (ie. a Treaty) can include profit sharing or experience refund provisions, the cash flows projected at the reinsurance cession level and consolidated by Reinsurance Contract Group may need to be augmented by allocated costs from the Treaty level. AXIS will also need to be enhanced to include these higher level Treaty calculations in the CSM roll forwards as may be appropriate.
Under IFRS 17, reported revenue for insurance services provided in a period is anticipated to require an Earnings by Source capability that estimates the expected costs of current period services using assumptions in effect at the opening reporting date and is able to consistently calculate actual insurance costs based on experience during the reporting period.
In anticipation of the need to apply this analysis of expected and actual costs to reinsurance contracts separately from the underlying direct insurance contracts, the Earnings by Source modules of AXIS were enhanced earlier in 2017 to support this separation of treatment in both calculation and reporting capabilities.
Further technical discussions relating to the detailed implications of IFRS 17 and how Moody's Analytics is addressing its challenges will continue to be developed and communicated to all of our clients.