An insurance contract is onerous at the date of initial recognition if the fulfilment cash flows allocated to the contract, including any previously recognised acquisition cash flows and any cash flows arising from the contract at the date of initial recognition in total are a net outflow.
Onerous contract loss recognised immediately in profit or loss
Present value of
estimated cash inflows
Present value of
estimated cash outflows
The onerous contract test is performed at the level of the IFRS 17 group (as described in section 4). Under existing IFRS 4 reporting, entities apply liability adequacy tests at an aggregation level determined by previously grandfathered accounting policies. IFRS 17 is likely to require a more granular assessment.
An entity must group contracts that are onerous at initial recognition separately from contracts in the same portfolio that are not onerous at initial recognition (see ‘Portfolio of insurance contracts‘). An entity must [IFRS 17 48]:
- Recognise a loss in profit or loss for the net outflow for the group of onerous contracts, resulting in the carrying amount of the liability for the group being equal to the fulfilment cash flows and the CSM of the group equalling zero
- Establish a loss component of the liability for remaining coverage for an onerous group depicting the losses recognised
A loss component is a notional record of the losses attributable to each group of onerous insurance contracts. The liability for the expected loss is included within the liability for remaining coverage for the onerous group (as it is within the fulfilment cash flows). It is necessary to keep a record of the loss component of the liability for remaining coverage to account for subsequent changes in the fulfilment cash flows of the liability for remaining coverage and to disclose separately their effect on the loss component (see ‘Explanation of recognised amounts‘). The loss component determines the amount presented in profit or loss as a reversal of losses on onerous groups, and is excluded when determining insurance revenue (see ‘Insurance revenue‘) [IFRS 17 49].
Subsequent measurement Onerous insurance contracts
A group of insurance contracts to which an entity applies the general model, becomes onerous (or more onerous) on subsequent measurement if unfavourable changes in the fulfilment cash flows allocated to the group arising from changes in estimates of future cash flows relating to future service exceed the carrying amount of the CSM. (Onerous contracts to which an entity applies the premium allocation approach or the variable fee approach are discussed in ‘Measurement of remaining coverage‘ and ‘Subsequent measurement CSM using the variable fee approach‘, respectively). Onerous insurance contracts
After an entity has recognised a loss on an onerous group of insurance contracts, it should allocate subsequent changes in the liability for remaining coverage noted below between the loss component and the liability for remaining coverage, excluding the loss component, on a systematic basis [IFRS 17 50]. Onerous insurance contracts
Changes in the liability for remaining coverage that are allocated on a systematic basis between the loss component and the remaining (non-loss) component are [IFRS 17 51]:
- Estimates of the present value of future cash flows for claims and expenses released from the liability for remaining coverage because of incurred insurance service expenses
- Changes in risk adjustment for non-financial risk recognised in profit or loss because of the release from risk Onerous insurance contracts
- Insurance finance income or expenses Onerous insurance contracts
As required by IFRS 17, the systematic allocation of these changes to the liability for remaining coverage should result in the total amounts allocated to the loss being equal to zero for a group of contracts by the end of the coverage period [IFRS 17 52]. Onerous insurance contracts
Subsequent increases or decreases in fulfilment cash flows allocated to the group arising from changes in estimates of future cash flows for future service should be allocated solely to the loss component until that component is reduced to zero. The decreases in fulfilment cash flows for future service, in excess of amounts that reduce the loss component of the liability for remaining coverage to nil, re-establish a CSM. Onerous insurance contracts
Example – Application of the loss component for a group or onerous contracts
An entity determines that a group of insurance contracts without direct participation features is onerous at initial recognition. On initial recognition, the fulfilment cash flows (disregarding discounting and other adjustments) are a net cash outflow of CU50. Therefore, this is recognised as a loss in profit or loss; there is no CSM. The loss component of the liability for remaining coverage is CU50. Onerous insurance contracts
At the entity’s next reporting date, it calculates that the fulfilment cash flows for the liability for remaining coverage have decreased by CU60. CU40 adjusts the loss component of the liability for remaining coverage by a credit to profit or loss. The remaining CU20 reduction does not adjust the loss component of the liability for remaining coverage. Consequently, at the reporting date, the loss component of the liability for remaining coverage is CU10 (i.e., CU50 less CU40). The remaining loss component of CU 10 will be reduced to nil in future reporting periods.
Tracking the loss component of the liability for remaining coverage for each group of onerous contracts will be a new and complex task, particularly for many life insurers. Most non-life insurers will be familiar with the concept of running off provisions for unearned premiums and unexpired risks, and we expect that tracking a loss component should be easier for short duration contracts.
Changes in the liability for remaining coverage due to insurance finance income or expenses, release from risk, and incurred claims and other insurance service expenses, need to be allocated between the loss component and the remainder of the liability for remaining coverage on a systematic basis. An entity could allocate the effect of these changes to the loss component in proportion to the total liability, though other bases could be appropriate. Whichever approach is adopted, it should be applied consistently.
Entities will need to track the loss component from formation through run-off during the remaining coverage period of a group of insurance contracts. This will be a new systems and process requirement for most insurers. Tracking the loss component is not equivalent to maintaining a negative CSM.