Estimates of discount rates must be consistent with other estimates used to measure insurance contracts to avoid double counting or omissions; for example [IFRS 17 B74]:
- Cash flows that do not vary based on the returns on any underlying items must be discounted at rates that do not reflect any such variability. Discount rates and characteristics of cash flows
- Cash flows that vary based on the returns on any financial underlying items must be discounted using rates that reflect that variability or adjusted for the effect of that variability and discounted at a rate that reflects the adjustment. Discount rates and characteristics of cash flows
- Nominal cash flows (i.e., those that include the effect of inflation) must be discounted at rates that include the effect of inflation. Discount rates and characteristics of cash flows
- Real cash flows (i.e., those that exclude the effect of inflation) must be discounted at rates that exclude the effect of inflation. Discount rates and characteristics of cash flows
Cash flows can vary based on returns from financial underlying items due to a contractual link to underlying items, or because the entity exercises discretion in providing policyholders with a financial return on premium paid. An entity need not hold related underlying items for cash flows to vary based on returns from underlying items [IFRS 17 B75].
When some of the cash flows vary based on returns from underlying items and others do not (e.g., a participating contract has fixed or guaranteed cash flows in addition to providing policyholders with financial returns), an entity may [IFRS 17 B76-B77]:
- Divide the estimated cash flows and apply appropriate discount rates to each type
Or Discount rates and characteristics of cash flows
- Apply discount rates appropriate for the estimated cash flows as a whole (e.g., using weighted average rates, stochastic modelling or risk-neutral measurement techniques)
The requirement for discount rates to be consistent with the characteristics of the cash flows of insurance contracts is from the perspective of the entity. IFRS 17 requires an entity to disregard its own credit risk when measuring the fulfilment cash flows [IFRS 17 31 and IFRS 17 BC197].
IFRS 17 does not require an entity to divide estimated cash flows into those that vary based on the returns on underlying items and those that do not. By not dividing the cash flows, an entity avoids the complexity of having to disentangle cash flows that may be interrelated. However, if an entity does not divide the estimated cash flows in this way, it should apply discount rates for the estimated cash flows as a whole in a way that is consistent with the principles of the standard; for example, using stochastic modelling or risk-neutral measurement techniques. Both approaches, dividing or not dividing cash flows, have their own conceptual and practical implications, so entities should carefully assess what methods will be most suited to the particular circumstances.
Entities should be aware that, even for participating contracts, at least some of the cash flows to policyholders are independent of returns on underlying items; for example, payments for fixed death benefit or expenses of the entity that do not vary with the underlying items.