Measurement Models of IFRS17

IFRS 17(c)

In this article, we will provide a concise overview of the different measurement models under IFRS 17 and examine the types of insurance products to which these models apply. Each model is tailored to address the unique characteristics of insurance contracts, ensuring accurate and consistent financial reporting across various product types. In the next article, we will delve deeper into the details of these measurement models.

IFRS 17 introduces a comprehensive framework for the measurement of insurance contracts, ensuring consistency and transparency in financial reporting. The standard provides three distinct measurement models, each tailored to specific types of insurance contracts. These models are:

1. General Measurement Model (GMM)
2. Premium Allocation Approach (PAA)
3. Variable Fee Approach (VFA)

Let’s briefly explore each model.

1. General Measurement Model (GMM)

The General Measurement Model, also known as the Building Block Approach (BBA), is the default model under IFRS 17. It applies to all insurance contracts unless they qualify for the Premium Allocation Approach or the Variable Fee Approach. The GMM is based on four key components, often referred to as "building blocks":

• Fulfillment Cash Flows (FCF): These include: Expected future cash inflows and outflows: The cash flows expected to arise from the contract, such as premiums, claims, and expenses. Discounting: The time value of money is incorporated by discounting future cash flows to their present value. Risk adjustment: A margin to reflect the uncertainty in the amount and timing of future cash flows.
• Contractual Service Margin (CSM): The CSM represents the unearned profit from the insurance contract. It is recognized as revenue over the coverage period as the entity provides insurance services.

The GMM ensures that profits are recognized systematically over the life of the contract, aligning with the delivery of insurance services.

2. Premium Allocation Approach (PAA)

The Premium Allocation Approach is a simplified model designed for short-duration contracts, typically those with a coverage period of one year or less. It is an optional approach, provided the entity can demonstrate that the results would not differ materially from the General Measurement Model.

Key features of the PAA include:

• Simplified Measurement of Liability for Remaining Coverage (LRC): The LRC is measured as the premiums received, less acquisition costs, adjusted for the passage of time. This is similar to the unearned premium reserve under previous accounting standards.
• Liability for Incurred Claims (LIC): Claims incurred are measured using the same principles as the General Measurement Model, including the use of fulfillment cash flows.

The PAA reduces complexity and is particularly suitable for contracts such as motor, health, or property insurance.

3. Variable Fee Approach (VFA)

The Variable Fee Approach is a specialized model for insurance contracts with direct participation features. These are contracts where the policyholder shares in the returns on a pool of underlying assets. The VFA is designed to reflect the nature of these contracts, where the insurer acts as a steward of the policyholder’s investments.

Key features of the VFA include:

• Direct Link to Underlying Assets: The measurement of the contract reflects changes in the fair value of the underlying assets, which are shared between the insurer and the policyholder.
• Adjustments to the Contractual Service Margin (CSM): Changes in the value of the insurer’s share of the underlying assets are adjusted against the CSM, ensuring that profits are recognized systematically over the coverage period.

The VFA is typically applied to contracts such as unit-linked or with-profits policies.

Choosing the Right Model

The choice of measurement model depends on the nature of the insurance contract. While the GMM is the default, the PAA offers a practical alternative for short-term contracts, and the VFA is specifically designed for contracts with direct participation features. Each model ensures that the financial performance of insurance contracts is reported in a way that reflects their economic substance and aligns with the delivery of insurance services.

In conclusion, the measurement models under IFRS 17 provide a robust framework for recognizing and measuring insurance contracts. By tailoring the approach to the characteristics of the contract, IFRS 17 enhances the comparability and transparency of financial reporting in the insurance industry.