IFRS17 - Unlocking CSM

IFRS 17 has been designed to improve the transparency and comparability of financial reporting across insurance companies. One of the new features of the standard is unlocking the Contractual Service Margin (CSM) or Unearned Profit.

What does unlocking the Contractual Service Margin ("CSM")Mean?

Unlocking the CSM refers to the process of updating the Contractual Service Margin ("CSM") or Unearned Profit for changes in estimates of future cash flows or other assumptions used in the calculation.

This ensures that the CSM remains a consistent measure of the unearned profit over the life of the contract and that it reflects the most up-to-date information available to the insurer.

What do you do when you unlock the CSM?

• General Model: Under the general model, if the changes in the future cash flow estimates result in a decrease in the CSM, the reduced amount will be recognized as revenue in the current period [new]. This treatment ensures that the CSM reflects the most up-to-date information available to the insurer.
• Variable Fee Approach (VFA): For contracts using the VFA, the changes in future cash flow estimates generally do not result in an immediate recognition of the reduced amount as revenue in the current period. Instead, the CSM is adjusted to reflect the updated estimates, and the change is recognized over the remaining coverage period. The VFA is designed to provide a more accurate representation of the sharing of risks between the entity and the policyholder for contracts with direct participation features.

Is it Error Proof?

While the new standard aims to prevent the manipulation of financial statements, it is crucial for insurers to apply the standard diligently and exercise professional judgment when making assumptions.

Under the General Model, an insurer might be tempted to use optimistic assumptions in the early years to create a higher Contractual Service Margin (CSM) and then revise those assumptions later, leading to a reduction in CSM and an increase in recognized revenue - a new feature of the standard which is strange to the IFRS4 world.

However, this practice would be against the principles of IFRS 17 and could be seen as an attempt to manipulate financial results.

To mitigate such risks, IFRS 17 requires insurers to:

1. Use unbiased and probability-weighted cash flow estimates that reflect a range of possible outcomes.
2. Incorporate all available information, including new information, when updating cash flow estimates.
3. Disclose the significant judgments and assumptions used in measuring insurance contracts, allowing users of financial statements to assess the quality of the insurer's estimates.

Role of External auditors

External auditors play a critical role in ensuring the appropriate application of IFRS 17.

They assess the reasonableness of the insurer's assumptions, the consistency of the methodology applied, and the accuracy of the financial statements.

Risk Management

IFRS 17 does not completely eliminate the risk of insurers creating false profits through the manipulation of assumptions, the standard sets rigorous requirements for estimates and disclosures to promote transparency and accountability.

Insurers must exercise professional judgment and adhere to the principles of IFRS 17 to maintain the integrity of their financial reporting.