TAKEAWAYS
In previous articles comparing FRS 117 Insurance Contracts (FRS 117) with Risk-Based Capital 2 (RBC 2), we have looked into considerations around the scoping, unit of account and measurement. In this article, our focus turns to addressing the measurement issues of an entity applying the premium allocation approach (PAA) under FRS 117. An entity is allowed to measure its insurance liabilities using the PAA only when certain conditions are met. While the PAA brings some relief to some entities in particular general insurers1 on the adoption of FRS 117, our next two articles will dive deeper into the measurement issues when adopting the PAA, as well as the differences between FRS 117 and RBC 2 when adopting the PAA.
Group of contracts and portfolio definition
Under FRS 117, insurers are required to define their portfolio by aggregating contracts of similar risks and are managed together. Insurers are required to further split the portfolio into minimally annual cohorts and groups contracts which (i) are onerous on initial recognition, (ii) have no significant possibility of becoming onerous subsequently, and (iii) others. In this regard, for contracts applying the PAA, a simplification is allowed where the insurer shall assume no contracts in the portfolio are onerous unless facts and circumstances indicate otherwise.
In contrast, for RBC 2 reporting purposes, the valuation of the policy liabilities is required to be subdivided into risk lines with similar characteristics and allocated into the various regulatory prescribed lines of business. Furthermore, there is also a need to differentiate between onshore and offshore businesses. This may not be aligned with portfolios under FRS 117, depending on how the insurer defines its portfolio and group of contracts under FRS 117 using the “similar risks and are managed together” criteria. To bring about the most leverage from RBC 2 valuation basis for FRS 117 purposes, insurers should consider defining their FRS 117 portfolio to align with the valuation lines of business. This will help reduce the operational strain of having to perform the valuations of reserves under multiple levels of aggregation – one for FRS 117 and another for RBC 2. Insurers will also assess whether there are facts and circumstances which indicate that a group of contracts within a portfolio could be onerous.
Unit of account
FRS 117 emphasises that an insurance contract is the lowest unit of account that the accounting standard would be applied. For packaged multi-risk policies (for example, packaged property and travel policies for corporates) where the risks are highly interrelated2, insurers are required to measure them as a single insurance contract under FRS 117. This may differ from the RBC 2 treatment where it is common practice for insurers to split the policy into its risk classes for RBC 2 reporting purposes3. Treatment of other multi-risk arrangement or master agreements (for example, marine open cover contracts) that are not highly interrelated may differ depending on the facts and circumstances of the arrangement.
While this article addresses the areas where insurers can potentially leverage on existing RBC 2 premium and claim liability methodologies to determine insurance liabilities under the PAA for FRS 117, general insurers should first consider whether the use of the PAA is allowed for their insurance contracts. Contrasting this with RBC 2 where it prescribes one consistent approach to measure its liabilities for all general insurance products for RBC 2 purposes, insurers could land in a situation where there is a mix of contracts measured under the general measurement model (GMM) and PAA, depending on the PAA eligibility outcome.
The PAA is permitted only for contracts where the coverage period is one year or less, or where the measurement of the liability for remaining coverage (LFRC) under the PAA would not differ materially when applying the GMM. This could mean that multi-year policies covering risks such as construction, engineering, credit and surety, mortgage indemnity and warranty business may not meet the PAA eligibility criteria. Where an entity wants to adopt the PAA, an insurer will need to justify that LFRC under the PAA is not materially different from the LFRC under the GMM.
Should an insurer be eligible for the PAA, the LFRC (excluding the loss component) on initial recognition is calculated as the premiums received less directly attributable acquisition costs4. Subsequently, the LFRC is updated to reflect additional premiums received (if any), the revenue that has been recognised in the profit and loss for the coverage that was provided in that period, and amortisation of directly attributable acquisition cost for the period. For the revenue earned for the period, it is recorded as Insurance Revenue under FRS 117. In contrast with RBC 2, gross written premium is treated as top-line revenue, the net earned premium is determined after adjusting for the change in premium liabilities (net of reinsurance) and reinsurance premiums for the period.
We will further explore the other measurement differences under RBC 2 and FRS 117 in Part 6 of the series, to be published in the August 2023 issue of this journal.
This is Part 5 in 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 Life insurers issuing short-term insurance contracts may be eligible for the PAA as well.
2 Assessment of whether the risk components within a policy are highly interrelated depends on a number of facts and circumstances such as legal form, lapse condition of risk components and whether you can measure one component separately from the other.
3 Note that RBC 2 reporting also allows for presentation of multi-risk policies in the predominant class of risk, if the insurer is not able to segregate the premiums for each class of risk for reporting purposes.
4 FRS 117 allows insurers an option to not defer directly attributable acquisition cost if all contracts within the groups have a coverage period of one year or less.
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