IFRS 17 Insurance Contracts sets out how insurance contracts are recognised, measured, presented and disclosed. It replaced IFRS 4 and has applied to annual reporting periods beginning on or after 1 January 2023. Its core idea is that a group of contracts is measured at the fulfilment cash flows (a risk-adjusted present value of future cash flows) plus a contractual service margin (the unearned profit). That profit is released as cover is provided, while losses on onerous contracts are recognised immediately.
Why IFRS 17 replaced IFRS 4
IFRS 4, issued in March 2004, was always an interim standard. It let insurers carry on with a wide variety of national accounting practices, so two insurers writing similar business could report very different results. The IASB finished its insurance project with IFRS 17 in May 2017, amended it in June 2020, and set the 1 January 2023 effective date. Early application was allowed only alongside IFRS 9.
In the UK, IFRS 17 applies to entities reporting under UK-adopted international accounting standards. That includes every insurance group whose securities are traded on a UK regulated market, because section 403 of the Companies Act 2006 requires IAS group accounts. Insurers reporting under UK GAAP instead apply FRS 103, which FRS 102 paragraph 1.6 requires for insurance contracts issued and reinsurance contracts held.
What counts as an insurance contract
A contract is in scope if the issuer accepts significant insurance risk from the policyholder by agreeing to compensate them if a specified uncertain future event adversely affects them. Before measuring, the entity strips out specified embedded derivatives, distinct investment components and distinct performance obligations, and accounts for those under other standards.
The scope also catches some businesses that would not call themselves insurers, so non-insurers should check two points:
- Product warranties. Warranties given by a manufacturer, dealer or retailer in connection with the sale of its own goods or services are excluded and stay under IFRS 15;
- Fixed-fee service contracts. A contract that meets the insurance definition but mainly provides services for a fixed fee can be accounted for under IFRS 15 instead. This is allowed only if the price is not set by assessing an individual customer's risk, the customer is compensated with services rather than cash, and the insurance risk arises mainly from the customer's use of the services. The choice is made contract by contract and is irrevocable.
The building blocks of measurement
IFRS 17 does not measure contracts one by one. An entity first identifies portfolios (contracts with similar risks that are managed together), then divides each portfolio into at least three groups:
- Onerous at initial recognition. Contracts that are expected to lose money from the start;
- No significant possibility of becoming onerous. Contracts that are profitable and expected to stay so;
- The rest. All remaining contracts.
Contracts issued more than one year apart cannot be in the same group, which in practice produces annual cohorts. Each group is measured on initial recognition at the total of:
- Fulfilment cash flows. Estimates of future cash flows, an adjustment for the time value of money and financial risk, and a risk adjustment for non-financial risk;
- Contractual service margin (CSM). The unearned profit, recognised in profit or loss as insurance contract services are provided.
Worked example
An insurer writes a group of three-year contracts and receives premiums of £1,000. It expects claims and expenses with a present value of £800 and sets a risk adjustment of £60. The fulfilment cash flows are a net inflow of £140, so no profit is recognised on day one. Instead the insurer recognises a CSM of £140, released over the three years as cover is provided, about £47 a year if service is even. The figures are illustrative: the cash flows are taken as already discounted, and acquisition cash flows are ignored.
Change the facts so expected claims and expenses are £1,000. The fulfilment cash flows become a net outflow of £60. The group is onerous at initial recognition: under paragraph 47, the insurer recognises a £60 loss immediately and the CSM is nil. A group can also become onerous later, if unfavourable changes relating to future service exceed its remaining CSM.
Three measurement models
- General model. The fulfilment cash flows plus CSM approach described above, used by default, including for longer-duration contracts that do not qualify for the PAA;
- Premium allocation approach (PAA). An optional simplification, closer to unearned-premium accounting. It is available only if the coverage period of each contract in the group is one year or less, or if the entity reasonably expects the result not to differ materially from the general model. The one-year test makes it a natural fit for annual policies;
- Variable fee approach. The common name for the modified general model for contracts with direct participation features. These are substantially investment-related service contracts, where the policyholder shares in a clearly identified pool of underlying items and expects a substantial share of the fair value returns. Here the CSM absorbs changes in the entity's share of the fair value of the underlying items.
Presentation and transition
The income statement must separate insurance revenue (excluding investment components), insurance service expenses and insurance finance income or expenses. Entities also make an accounting policy choice about whether all insurance finance income or expenses go to profit or loss or some go to other comprehensive income.
On transition the standard required full retrospective application. Where that was impracticable for a group, the entity could use the modified retrospective approach or the fair value approach. Disclosures must still show the effect of those transition approaches on the CSM and insurance revenue in later periods, so their consequences remain visible in current accounts.
Primary sources: IFRS Foundation: IFRS 17 Insurance Contracts, Companies Act 2006 s403 and the FRC: FRS 102. For related standards, see our guides to IFRS 9 and IFRS 15.
Acumon works with insurers, intermediaries and non-insurers with insurance-like contracts on IFRS reporting and audit, through our IFRS accounts and financial services audit teams.