Industry-specific and emerging topics - Insurance contracts ...

Learning Outcomes

By the end of this article, you will be able to explain the scope and core principles of IFRS 17 Insurance Contracts, distinguish between measurement models, and understand recognition, measurement, and presentation requirements. You will learn to identify insurance risk, recognise when IFRS 17 applies, apply the general measurement model and its alternatives, and outline the main disclosures and transition provisions that impact insurance contracts for the ACCA SBR exam.

ACCA Strategic Business Reporting (SBR) Syllabus

For ACCA Strategic Business Reporting (SBR), you are required to understand the significance of IFRS 17 Insurance Contracts across different sectors and its impact on financial statements. Revision of the following syllabus areas is essential for success:

• Explain the objective and scope of IFRS 17 Insurance Contracts.
• Identify and define an insurance contract, differentiating insurance risk from other risks.
• Recognise and apply the general measurement model for insurance contracts.
• Distinguish between the Premium Allocation Approach (PAA) and the Variable Fee Approach (VFA).
• Apply recognition, measurement, and presentation requirements for insurance contracts in financial statements.
• Understand the required IFRS 17 disclosures and transition guidance.
• Analyse how IFRS 17 interacts with other standards such as IFRS 9 Financial Instruments.

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. Which of the following is a defining characteristic of an insurance contract under IFRS 17?
   1. Financial risk only
   2. Significant insurance risk transferred from policyholder to issuer
   3. Embedded derivatives
   4. Simple deposit arrangement
2. Under IFRS 17, which measurement model is normally applied to insurance contracts with variable returns linked to reference items?
   1. Premium Allocation Approach
   2. Cost Model
   3. Variable Fee Approach
   4. Fair Value Model

3. True or false? The liability for remaining coverage under the Premium Allocation Approach is measured similar to unearned premium in legacy accounting.

4. Briefly state when the recognition of an insurance contract begins under IFRS 17.

5. Name one key item that must be disclosed under IFRS 17.

Introduction

IFRS 17 Insurance Contracts is a major standard that transforms the accounting for insurance contracts for both insurers and entities that issue products meeting the definition of insurance. It introduces consistent measurement, recognition, and disclosure requirements, improving comparability across companies and industries for contracts that transfer significant insurance risk. IFRS 17 supersedes IFRS 4 and requires entities to measure insurance contract liabilities in a way that better reflects planned cash flows, uncertainty, and profit recognition over time.

Key Term: Insurance contract
A contract under which one party (the issuer) accepts significant insurance risk from another party (the policyholder) by agreeing to compensate the policyholder for a specified uncertain future event that adversely affects the policyholder.

WHAT IS AN INSURANCE CONTRACT?

IFRS 17 applies to all contracts that transfer significant insurance risk, whether issued by traditional insurers or other types of entities (such as banks or manufacturers providing extended warranties).

Identifying an Insurance Contract

A contract is an insurance contract if it transfers significant insurance risk to the issuer. Insurance risk is present if, on the occurrence of a specified uncertain future event, the issuer is required to compensate the policyholder for a loss.

Key Term: Insurance risk
The risk, other than financial risk, transferred from the holder of a contract to the issuer, upon the occurrence of a specified uncertain future event.

Distinguishing Insurance Risk from Financial Risk

• Financial risk is the risk of a possible future change in a specified interest rate, security price, commodity price, foreign exchange rate, etc.
• Insurance risk must involve an adverse effect on the policyholder, not just a change in a variable.

Contracts that only transfer financial risk (such as derivatives) are scoped out of IFRS 17 and instead fall under IFRS 9 Financial Instruments.

Key Term: Significant insurance risk
Insurance risk is significant if, and only if, an insured event could cause the issuer to pay substantial additional benefits at any scenario with commercial substance.

SCOPE AND EXCLUSIONS OF IFRS 17

IFRS 17 applies to:

• Insurance contracts issued (including reinsurance contracts held and issued)
• Investment contracts with discretionary participation features, if the entity also issues insurance contracts

Exclusions include:

• Product warranties outside of insurance context (apply to IAS 37)
• Employers’ assets and liabilities under employee benefit plans (apply to IAS 19)
• Financial guarantee contracts (unless previously accounted for as insurance)

Worked Example 1.1

An entity sells a two-year product warranty that covers manufacturing defects. If a defect occurs, the entity repairs the product or provides a replacement at no extra charge. Is this contract within the scope of IFRS 17?

Answer:
No. Standard product warranties that only cover defects are usually within the scope of IAS 37—unless the contract exposes the entity to significant risks beyond repair/replacement (for example, insurance for accidental damage), in which case it may fall within IFRS 17.

RECOGNITION OF INSURANCE CONTRACTS

IFRS 17 requires contracts to be grouped (“portfolios” and “groups of contracts”) for measurement and presentation. An insurance contract is recognised at the earlier of:

• The beginning of coverage
• The date the first premium is due or received
• When the contract becomes onerous (i.e., loss is expected)

MEASUREMENT MODELS

There are three main measurement models under IFRS 17:

• General Measurement Model (also called Building Block Approach)
• Premium Allocation Approach (a simplified option for certain short-duration contracts)
• Variable Fee Approach (for some contracts with direct participation features)

General Measurement Model

All insurance contracts are measured at initial recognition as the sum of:

1. Fulfilment Cash Flows: Estimate of present value of future cash inflows less outflows, including an explicit risk adjustment for uncertainty.
2. Contractual Service Margin (CSM): Unearned profit deferred and released as insurance service is provided.

Key Term: Contractual Service Margin (CSM)
The unearned profit that the entity recognises evenly over the coverage period as it provides insurance services.

At subsequent measurement, fulfilment cash flows are re-estimated each reporting period, and changes that relate to future service adjust the CSM, ensuring profits emerge over the contract’s life.

Premium Allocation Approach (PAA)

Permitted for short-term insurance contracts (coverage period ≤ 1 year, or if it produces a measurement materially the same as the General Model). Under PAA:

• Initial liability is equal to premiums received less any acquisition cash flows.
• Claims are recognised as incurred.
• The liability for remaining coverage is measured similarly to unearned premiums.

Key Term: Premium Allocation Approach (PAA)
A simplified measurement for certain short-duration insurance contracts, approximating the General Measurement Model.

Variable Fee Approach (VFA)

Applies to contracts with direct participation features (e.g., some unit-linked or participating contracts). The contractual service margin reflects the entity’s share of fair value changes in reference items, not just insurance service.

Key Term: Variable Fee Approach (VFA)
A measurement model for contracts where policyholders participate in a share of reference pool returns, reflecting both variable returns and insurance risk.

PRESENTATION AND DISCLOSURE

Insurance contract revenue and insurance service expense are presented in the statement of profit or loss based on the release of the contractual service margin and claims paid. Key items disclosed include the reconciliation of contract balances, significant assumptions and judgements, risk exposures, and the effects of changes in fulfilment cash flows.

Worked Example 1.2

An insurer issues a portfolio of three-year property insurance contracts for $1 million premium. Expected claims (incurred evenly) are estimated at $700,000. At the end of year one, the insurer revises expected claims up to $750,000 due to increased risk.

Question: How should the insurer reflect the revised claim estimate under IFRS 17?

Answer:
The insurer updates the fulfilment cash flows to reflect higher claims. Changes relating to future service (years 2–3) are offset against the remaining CSM, spreading the impact across future periods. If the increase causes a loss (no CSM), a loss is recognised immediately.

Exam Warning

When grouping contracts, do not combine contracts issued more than one year apart in the same group. Loss-making contracts should not offset profit from other contracts; they must be reported in a separate group.

Revision Tip

Use diagrams to visualise the split between fulfilment cash flows (expected cash in/out) and the CSM (unearned profit). Understanding this distinction helps with exam questions on measurement changes.

TRANSITION TO IFRS 17

On first applying IFRS 17, entities must measure insurance contracts at the transition date using the full retrospective approach if feasible, or the modified retrospective approach/fair value approach if not.

• Disclose the approach used and impacts of transition.
• Adjust opening equity for differences arising from applying IFRS 17.

Summary

IFRS 17 establishes a single accounting model for all insurance contracts that enhances comparability, transparency, and relevance of financial reporting in the insurance sector. Practitioners must identify insurance contracts, choose the appropriate measurement model, apply recognition and measurement rules, and make required disclosures. Transition provisions require careful attention to methodology and clear communication of the impact on financial statements.

Key Point Checklist

This article has covered the following key knowledge points:

• Explain the scope, objectives, and recognition criteria for IFRS 17 Insurance Contracts
• Identify and define insurance contracts and insurance risk
• Describe and compare the General Measurement Model, PAA, and VFA
• Apply initial and subsequent measurement requirements under IFRS 17
• Outline key presentation and disclosure obligations under the standard
• Summarise transition requirements when first adopting IFRS 17

Key Terms and Concepts

• Insurance contract
• Insurance risk
• Significant insurance risk
• Contractual Service Margin (CSM)
• Premium Allocation Approach (PAA)
• Variable Fee Approach (VFA)