Facts and circumstances: science or art?

How do we define facts and circumstances when assessing onerous contracts under IFRS 17? The IFRS 17 for GI Working Party considers the issue

One of the key objectives of IFRS 17 is to improve the transparency and comparability of financial statements across industries and countries. To achieve this, profitable groups of contracts and so-called onerous groups of contracts must be disclosed separately. An insurance contract is deemed to be onerous at the date of initial recognition if the fulfilment cashflows (ie premiums in, less all relevant claims, and expenses, less risk adjustments) are a net outflow in relation to the contract. Under IFRS 17, the expected loss from onerous groups of contracts cannot be offset by gains from profitable contracts.

The general measurement model requires the modelling of all contract fulfilment cashflows, including those related to the future coverage; this will determine whether groups of contracts are onerous. However, under the simplified Premium Allocation Approach (PAA), there is no expectation that fulfilment cashflows relating to future coverage be modelled. As a result, it is assumed that no contracts in the portfolio are onerous unless facts and circumstances indicate otherwise. If facts and circumstances indicate that a group of contracts may be onerous, an entity is required to assess onerousness and immediately recognise a loss component (if calculated to be non-zero) in the statement of financial performance.

As such, organisations using the PAA need to operationalise a process that balances simplicity, ease of explanation and accuracy in identifying potentially onerous contracts. This process should define facts and circumstances, as well as triggers for when a loss component calculation is required.  

Facts and circumstances

Facts and circumstances are required to provide a forward-looking view of expected profitability in the remaining coverage. The standard does not explicitly define what constitutes facts and circumstances; it does imply that the assessment of facts and circumstances should not necessarily involve creating new information but instead consider the way performance is currently analysed within the business.

This suggests facts and circumstances would likely arise from information included in internal management information, business planning, pricing information, regulatory change or any other technical analysis that may indicate changes in the expected profitability within the future coverage of contracts. When choosing the information used to assess facts and circumstances, consider the level of granularity required and the feasibility of gathering information in an efficient way. 

Calculating a loss component

IFRS 17 would suggest that it is necessary to support the facts and circumstances assessment under the PAA on both new and existing groups of contracts at each valuation period. In practice, a wide range of approaches could be used to identify when a loss component calculation is required – from simple adjustments to existing internal management measures, to full IFRS 17 fulfilment cashflow calculations.

On one end of the scale, existing internal management measures can be leveraged and combined with IFRS 17 concepts to obtain a view of expected profitability. This could be based on combined ratios compared against pre-determined thresholds. These thresholds should be calibrated to reflect IFRS 17 concepts such as discounting and risk adjustment. If this approach indicates a loss component is required, additional calculations may be required to quantify the loss component. An alternative approach could be to design a simplified IFRS 17 model to assess groups of contracts for expected profitability, where this can also be used to quantify the loss component.

The art is to use existing information adjusted for IFRS 17 concepts and find a balance between ease of explanation and accuracy. Also consider the ability to override results produced by the above suggested methods using expert judgment from relevant stakeholders. This would provide a qualitative assessment of facts and circumstances, but can be prone to bias.

In any case, this process will need to be supported by appropriate governance, and leverage existing processes where possible. This involves a wider range of stakeholders and results in disclosing the existence of loss-making business to users – so a closer link between different functions across the business will be key. The stakeholders involved will inevitably influence how this process is defined within an organisation. 

Alice Boreman is chair of the IFRS 17 for GI Working Party