TAKEAWAYS
The fifth article of the series by the IFRS 17 Working Group, published in the June 2023 issue of this journal, addressed measurement issues of an entity applying the premium allocation approach (PAA) under FRS 117 Insurance Contracts (FRS 117). Should an insurer be eligible for the PAA, this article further explores the measurement differences under Risk-Based Capital 2 (RBC 2) and FRS 117.
The premium earning pattern under FRS 117 is on the basis of passage of time unless the expected pattern of release of risk during the coverage period differs significantly from the passage of time. In such a scenario, the entity is required to earn the premiums on the basis of expected timing of incurred insurance service expense. Under RBC 2, for the purposes of determining the unearned premium reserve (net of reinsurance), premiums are generally earned on a basis of passage of time (applying a method not less accurate than the 1/24th method by default) with specific simplifications allowed for direct cargo policies and marine and aviation reinsurance policies. Hence, some alignment between FRS 117 and RBC 2 is possible except for products with non-uniform risk release patterns such as flood cover, aviation satellite or engineering risks, which may not be straight-line in their risk release patterns. For direct cargo policies and marine and aviation reinsurance policies, insurers will need to assess if the RBC 2 simplifications would produce an earning pattern similar to passage of time allowed for under FRS 117 based on the coverage periods of their marine and aviation policies and reinsurance policies.
FRS 117 requires revenue earned during the period to be adjusted based on expected premium receipts. In other words, the entity would recognise revenue after adjusting for any expected bad debts or expected premium adjustments. RBC 2 would account for bad debt as a separate expense and provision on the profit and loss and balance sheet. In line with this principle, for products with minimum premium deposit features (such as fleet motor cover) where premium adjustments are allowed based on actual volume, insurers will have to recognise revenue based on its estimated premium income (EPI) under FRS 117. This may deviate from RBC 2 depending on the insurer’s current accounting practices.
A contract applying the PAA may include an investment component1 which, if non-distinct, is not required to be separated from the contract to be measured under a different accounting standard. However, FRS 117 requires that the revenue earned and insurance service expenses incurred during the period to exclude the non-distinct investment component (NDIC). RBC 2 does not have the concept of investment component nor NDIC; insurers will need to consider the impact of NDIC when determining the revenue to be earned under FRS 117.
FRS 117 introduces an adjustment to the liability for remaining coverage (LFRC) calculations if a significant financing component exists within the group of contracts. The revenue recognised in the profit and loss, together with the LFRC, is adjusted to reflect the time value of money for premiums if, at initial recognition, the entity expects that the time between providing each part of the services and the related premium due date is no more than a year. Some alignment can be achieved as under RBC 2, insurance liabilities are allowed to be undiscounted so long as the impact of discounting is immaterial or if the duration of the contract is one year or less.
FRS 117 also clarifies that the insurance liabilities should be treated as a monetary item where liabilities denominated in foreign currency should be revalued, with its impact presented in insurance finance income/expense. Under RBC 2, the impact of foreign currency revaluation of policy liabilities is presented within the movement in the policy liabilities line, in profit and loss instead.
RBC 2 only allows for the deferral of commissions as part of acquisition costs. On the other hand, FRS 117 defines acquisition costs as costs of selling, underwriting and starting a group of insurance contracts. As such, when determining the deferral of acquisition costs for FRS 117 purposes, the insurer will need to consider other costs and overheads related to the selling and underwriting activities. This is expected to be more than the commission deferred under RBC 2.
Under FRS 117, where facts and circumstances indicate that a group of contracts is onerous, the entity is required to recognise a loss component determined by calculating the difference between the fulfilment cash flows related to the unexpired risks and the LFRC determined as described in Part 5 of our article.
For the purposes of determining the loss component under FRS 117, insurers could leverage on the methods applied for RBC 2 purposes, which define the premium liability as the higher of the unearned premium reserve (UPR) or the unexpired risk reserves (URR). As the URR is effectively a measure of all future liabilities required for the unexpired risk, the excess of URR against UPR would principally be similar to the FRS 117 loss component, barring some adjustments articulated below.
The URR methodology determined under RBC 2 can be adjusted to apply the same fulfilment cash flows required under FRS 117. Some adjustments may include an adjustment to risk adjustment, applying discounting and adjusting the expense loading2 to align them with FRS 117 principles. As FRS 117 requires the loss component to be calculated at the group of contracts level, general insurers will have to consider whether the level of granularity the URR is determined for RBC 2 purposes is sufficient for FRS 117. Furthermore, the URR will need to be adjusted to factor in the contract boundary of the contracts as defined under FRS 117, which may not be the same as RBC 2.
The PAA provides a simplified option for entities when compared against the general measurement model (GMM), and general insurers will find the approach similar to the current approach for UPR and claim liabilities. However, general insurers will need to consider the differences between the RBC 2 basis and FRS 117 before leveraging on the RBC 2 reporting processes for FRS 117 reporting.
This is Part 6 of a series of articles from the IFRS 17 Working Group (set up under the ambit of the ISCA Insurance Committee) to help insurers in Singapore navigate through the differences between FRS 117 and RBC 2.
Alvin Chua is Chairman of the IFRS 17 Working Group (WG) and Director, KPMG Services Pte Ltd; Poon Kai Hong is a WG member and Senior Manager, PricewaterhouseCoopers Risk Services Pte Ltd; and Adrian Chua is a WG member and Chief Financial Officer, Cigna Singapore.
1 An investment component exists when an insurer is required to repay an amount to the policyholder in all circumstances, regardless of whether an insured event occurs. Examples of product features that may create an NDIC are: no claim bonuses, experience refunds and profit commissions.
2 FRS 117 requires that only expense directly attributable to the fulfilment of insurance contracts should be included in the fulfilment cash flows. Expense not directly attributable to the fulfilment of insurance contracts should be excluded from the liability calculations. Under RBC 2, the unexpired risk reserves include any expense expected to be incurred in administering the policies and settling claims against those policies.
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