Acquisition of insurance contracts

Insurance contracts may be acquired in a transfer (often referred to as a portfolio transfer) or in a business combination, as defined in IFRS 3 Business Combinations.

In summary, insurance contracts acquired in a transfer or a business combination are classified and measured in the same way as those issued by the entity at the date of the combination or transfer, except that the fulfilment cash flows are recognised at that date.

1. Business combinations Acquisition of insurance contracts

IFRS 3 requires a group of insurance contracts acquired in a business combination to be measured at the acquisition date under IFRS 17, rather than at fair value [IFRS 3 31A], resulting in key differences for insurance contracts acquired in a business combination compared with the accounting used previously under IFRS 4, as follows:

  • Contracts are classified and grouped based on the contractual terms, economic conditions, operating or accounting policies and other pertinent factors and conditions as they exist at the acquisition date [IFRS 3 15]. Previously, when IFRS 4 applied, IFRS 3 contained an exception from this requirement for insurance contracts and stated that insurance contracts acquired in a business combination within its scope should be classified on the basis of the contractual terms and other factors at the inception of the contract rather than at the date of acquisition. This exception in IFRS 3 is withdrawn when IFRS 17 is applied. Acquisition of insurance contracts
  • Contracts are measured under the IFRS 17 requirements, rather than at fair value. Consequently, no option is available to split the value of the acquired insurance contracts into two components (i.e., a liability in accordance with the insurer’s accounting policies and an intangible asset representing the difference between fair value and the value of that liability under the IFRS 17 measurement model, commonly referred to as “Value of Business Acquired”). Acquisition of insurance contracts

Consideration

  • The consequential amendments to IFRS 3 require that, in a business combination, an entity should classify contracts (i.e., assess significant insurance risk in a contract) based on the contractual terms and other factors at the date of acquisition, rather than the original inception date of the contract. This also implies that other assessments, such as eligibility for the variable fee approach for direct participation contracts or the premium allocation approach (see ‘Insurance contracts with direct participation features‘ and ‘Measurement for remaining coverage‘, respectively) should be based on the contractual terms and conditions at the date of acquisition rather than at the date of the original inception of the contract. This approach may result in, for example, insurance contracts of the acquiree being investment contracts of the acquirer. Consequently, there will be a different accounting treatment between the consolidated financial statements that include the acquiree and the separate financial statements of the acquiree. However, this would reflect that the acquirer has purchased investment contracts rather than insurance contracts.
  • Rights to issue or renew contracts in the future (as opposed to existing insurance contracts) would not be part of the consideration paid or received for the contracts at the acquisition date. These separate intangible assets would have to be accounted for under IAS 38.

IFRS 17 requires an entity to treat the consideration received or paid for insurance contracts acquired in a business combination, including contracts in their settlement period, as a proxy for the premiums received. Thus, the entity determines the CSM in accordance with all other requirements of IFRS 17 in a way that reflects the premium paid for the contracts. In a business combination, the consideration received or paid is the fair value of the contracts at that date. However, IFRS 17 states that the entity does not apply the requirement in IFRS 13 that the fair value of a financial liability with a demand feature cannot be less than the amount payable on demand discounted from the first date that the amount could be required to be paid (i.e., a demand deposit floor) [IFRS 17 B94].

The consideration received or paid for the contracts excludes the consideration received or paid for any other assets or liabilities acquired in the same transaction. Therefore, an acquirer will have to allocate the consideration received or paid between contracts within the scope of IFRS 17, other assets and liabilities outside the scope of IFRS 17 and goodwill, if any [IFRS 17 B94].

For acquired insurance and reinsurance contracts measured using the general model, on initial recognition (i.e., acquisition) the CSM is calculated using the requirements described in sections 10 and 13, respectively. If insurance contracts acquired in a business combination are onerous at the date of acquisition, the excess of the fulfilment cash flows over the consideration paid or received should be recognised as part of goodwill or the gain on a bargain purchase [IFRS 17 B95].

If the premium allocation approach applies to insurance contracts acquired in a portfolio transfer or business combination, then the premium received is applied to determine the initial carrying amounts of the liability for remaining coverage and the liability for incurred claims.

If facts and circumstances indicate that a contract is onerous, the difference between the carrying amount of the liability for remaining coverage (as determined by applying the paragraph above) and the fulfilment cash flows that relate to the remaining coverage should be treated in the same way as a contract under the general model (i.e., recognised within goodwill or the gain on bargain purchase in a business combination).

Investment contracts within the scope of IFRS 9 are measured initially at fair value when acquired in a business combination.

Example – Measurement on initial recognition of insurance contracts acquired in a business combination

(Based on example 14 in IFRS 17 IE146-151) Acquisition of insurance contracts

An entity acquires insurance contracts as part of a business combination and estimates that the transaction results in goodwill when it applies IFRS 3. The entity determines that the acquired contracts form a group, as if it had entered into the contracts on the date of the transaction. The entity applies the general model to the measurement of the insurance contracts.

On initial recognition, the entity estimates that the fair value (i.e., deemed premium) of the group of insurance contracts is CU30 and the fulfilment cash flows are, as follows:

  • Example A — outflow (or liability) of CU20 Acquisition of insurance contracts
  • Example B — outflow (or liability) of CU45. Acquisition of insurance contracts

For simplicity, this example ignores all other amounts.

The consideration of CU30 received from the seller is a proxy for the fair value of the group of contracts. Consequently, on initial recognition, the entity measures the liability for the group of contracts, as follows:

(Amounts in CU)

Example A

Example B

Fulfilment cash flows

20

45

CSM

10

Insurance contract liability on initial recognition

30

45

The effect on profit or loss will be:
Profit (loss) on initial recognition’

In Example A, the entity measures the CSM as the difference between the deemed premium (30) and the fulfilment cash flows (20). Consequently, in Example A the CSM is 10 and the total insurance contract liability is equal to the deemed premium.

In Example B, the fulfilment cash flows exceed the deemed premium. Consequently, the CSM is zero and the excess of the fulfilment cash flows (45) over the deemed premium (30) is an adjustment against goodwill since there cannot be a loss on initial recognition of a business combination.

Consideration

The assessment as to whether a contract is eligible for the PAA should take place at the date of the transfer, consistent with any other assessment. Such assessment is expected to result in many of the liabilities for incurred claims becoming liabilities for remaining coverage for the acquirer. This is because the discovery of the loss, or the amount for that loss, for a past event would represent the insured event as a result of the transfer (and thus the service that the acquirer is providing). In case of long-tail settlements, these contracts are unlikely to qualify for the PAA and, in that case, would need to be accounted for under the general model.

1.1. Business combinations under common control

IFRS 3 does not apply to a combination of entities or businesses under common control (i.e., a common control business combination) [IFRS 3 2(c)]. IFRS 17 does not make any distinction between business combinations under common control and other business combinations. This raises the question as to whether insurance contracts acquired in a common control business combination should be recognised and measured by the acquirer based on the conditions at the date of acquisition (as for a business combination within the scope of IFRS 3 discussed in 1 above), or whether some form of predecessor accounting (also referred to as pooling of interests or merger accounting) can be used.

Consideration

It is assumed that the requirements above for business combinations were intended to apply only to business combinations within the scope of IFRS 3.

2. Portfolio transfers Acquisition of insurance contracts

When insurance contracts or reinsurance contracts held are acquired in a transfer that is not a business combination, IFRS 17 requires that an entity applies the aggregation requirements for the identification of portfolios of insurance contracts and divides those into groups as if it had entered into the contracts on the date of acquisition. The consideration paid or received for the acquired contracts should be used as the proxy for the premiums received under the contracts. Acquisition of insurance contracts

This means an entity should apply the same approach to measuring contracts acquired in a portfolio transfer as for contracts acquired in a business combination, as described above. However, for contracts acquired in a portfolio transfer, the excess of the fulfilment cash flows over the consideration paid or received is not recognised as an adjustment to goodwill, but as a loss in profit or loss (i.e., treated as onerous contracts at initial recognition) instead. The entity should establish a loss component of the liability for remaining coverage for that excess (i.e., the onerous group) and apply the guidance discussed in section 11 to allocate subsequent changes in fulfilment cash flows to that loss component.

Example – Measurement on initial recognition of insurance contracts acquired in a portfolio transfer

(Based on example 17 in IFRS 17 IE139-145) Acquisition of insurance contracts

An entity acquires insurance contracts in a transfer from another entity. The seller pays CU30 to the entity to take on those insurance contracts. The entity determines that the acquired contracts form a group, as if it had entered into the contracts on the date of the transaction. The entity applies the general model to the measurement of the insurance contracts.

On initial recognition the entity estimates the fulfilment cash flows to be:

  • Example A — net outflow (or liability) of CU20 Acquisition of insurance contracts
  • Example B — net outflow (or liability) of CU45 Acquisition of insurance contracts

For simplicity, this example disregards all other amounts.

The consideration of CU30 received from the seller is a proxy for the premium received. Consequently, on initial recognition, the entity measures the insurance contract liability, as follows:

(Amounts in CU)

Example A

Example B

Fulfilment cash flows

20

45

CSM

10

Insurance contract liability on initial recognition

30

45

The effect on profit or loss will be:
Profit (loss) on initial recognition’

-15

For contracts that are not onerous, the CSM is the difference between the premium and the fulfilment cash flows (i.e., 30 less 20 resulting in a CSM of 10 in Example A). Consequently, in Example A, the total insurance contract liability is equal to the premium received.

In Example B, the premium received (30) is less than the fulfilment cash flows (45). Therefore, the entity concludes that the contract is onerous. Consequently, the difference between 30 and 45 (15) is an expense in profit or loss and the insurance contract liability is equal to the fulfilment cash flows.

Consideration

When insurance contracts or reinsurance contracts held are acquired in a transfer that is not a business combination, these contracts should be classified (i.e., assessed for significant insurance risk and eligibility for the variable fee approach and the premium allocation approach) based on the terms and conditions at the transfer date, consistent with contracts that are acquired in a business combination.

3. Customer lists and relationships not connected to insurance contracts Acquisition of insurance contracts

The requirements discussed (see above) apply only to insurance contracts that exist at the date of a business combination or transfer. Therefore, they do not apply to customer lists and customer relationships reflecting the expectation of future contracts that do not meet the IFRS 17 recognition criteria. IAS 36 Impairment of Assets and IAS 38 Intangible Assets apply to such transactions as they apply to other intangible assets. The following example deals with customer relationships acquired together with a portfolio of one-year motor insurance contracts.

Example – Purchase of portfolio of one-year motor insurance contracts

Background Acquisition of insurance contracts

Parent A obtained control of insurer B in a business combination on 31 December 2021. B has a portfolio of one-year motor insurance contracts that policyholders may cancel annually.

Analysis Acquisition of insurance contracts

Because Insurer B establishes its relationships with policyholders through insurance contracts, the customer relationship with the policyholders meets the contractual-legal criterion for recognition as an intangible asset. IAS 36 and IAS 38 apply to the customer relationship intangible asset [IFRS 3 IE30(d)].

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