The revised exposure draft (ED) issued by the IASB in June 2013 proposed a comprehensive model for measurement of all types of insurance contract liabilities. Based on recent developments of the IFRS 4 Phase II standards, we summarized results of a case study that analyzes potential impacts on the insurance accounting when applying the premium allocation approach (PAA) to a specific short-duration insurance contract.
Results of the case study are as follows: For short-duration contracts using the premium allocation approach the impact of risk margin, adverse development of ultimate loss ratio, accelerated claims occurrence and payment, and time value of money on reported financials has been studied.
Firstly, we noticed that premiums will be allocated over the coverage period in a way that reflects the transfer of services.
Secondly, we have realized that the insurance contract revenue (earned premiums) is related to the initial expected pattern of incurred claims, which is revised to reflect updates in estimates (i.e. change in ultimate loss and acceleration of incurred claims).
Lastly, the inclusion of risk margin generally leads to deferment of profits. Overall, it seems to us that under the newly proposed IFRS 4 Phase II reporting standards the financial impacts and profit profiles will most likely be specific to company and risk. They will at least be influenced by the following drivers and modeling decisions:
- Expected and actual development of claims and benefits,
- Selected methodology and release of risk margin, and
- Introduction of time value of money.
We understand that the premium allocation approach represents a simplification of the building block approach but at the portfolio level a significant amount of actuarial analysis may still be required. In particular, to account for risk margin and discounting of cash flows and to leverage from potential Solvency II procedures and other already existing actuarial systems, we believe that actuarial insight will be needed to satisfy necessary requirements regarding reserving processes, methods, systems, data, and disclosure.
Please find the full version of the case study here.