This chapter provides the functional as well as a business overview of Oracle Insurance Accounting Analyzer.
Topics:
This section provides details about aggregating insurance contracts into groups.
To understand how Oracle Insurance Accounting Application features Level of Aggregation, see Level of Aggregation.
Identifying Portfolios of Insurance Contracts
Grouping Contracts at Initial Recognition According to Expected Profitability
IFRS 17 mandates group insurance contracts to reduce risks. This process is referred to as Risk Pooling. This grouping also helps in determining the profitability of the insurance contracts in the group.
What happens, if the insurance contracts are not grouped? At inception, the individual contracts are treated equally, and the probability of claim is also distributed equally. However, on subsequent measurements, the probability of claiming individual contracts may increase (expected cash outflows are increased) or decrease (expected cash outflows are decreased). The increase in the probability of claiming individual contracts marks a contract as onerous and is recognized immediately in the profit or loss. Also, the decrease in the probability of claiming individual contracts increases the CSM and is marked as profitable over the coverage period.
What happens, if the insurance contracts are grouped? The contracts in the groups are measured collectively and thus the change in expected cash outflows and the CSM remain unaffected (continue to recognize over current and future coverage periods). These profits are recognized over the coverage period.
To group the insurance contracts, as the first step the portfolios must be identified. Contracts in the same product line are expected to possess similar risks and can be managed together. Therefore, such contracts in the same product line are grouped in the same portfolio.
For example:
· Whole life insurance
· Annuities
· Car insurance
Portfolios of contracts are divided into groups of a minimum of the following:
· Onerous at initial recognition
· No risk of being onerous
· Remaining contracts in the portfolio
IFRS 17 permits these groups to be further sub-divided. For example, you can create sub-groups based on different levels of profitability.
The level at which to perform grouping assessment includes the following:
· An entity may assess a set of contracts if reasonable and supportable information enables it to conclude the contracts will be in the same group.
· Otherwise, groups are determined by considering individual contracts.
· Multiple sets or an individual contract can form a group.
NOTE:
If the requirements of IFRS 17 are met, a group can be formed with any number of contracts or an individual contract.
Initial recognition of insurance contracts is the process of grouping together the insurance contracts that are subject to similar risks. The initial recognition is performed at the beginning of the coverage period of the group of contracts (Policy Inception). During initial recognition, an insurance contract can be part of an existing group of insurance contracts if all the contracts have similarly expected profitability at the time of initial recognition and are issued within one year.
NOTE:
Insurance contracts that are issued more than one year apart should not be a part of the same group.
Once the initial recognition of a group of insurance contracts is completed, the carrying amount of the group at each reporting date is calculated as the sum of the liability for remaining coverage and the liability for incurred claims comprising the Fulfillment Cash Flows related to past service allocated to the group at that date.
The Liability for remaining coverage is comprised of the fulfillment cash flows allocated to the group at that date and the Contractual Service Margin (CSM) of the group at that date. CSM is the unearned profits recognized over the coverage period.
The requirements on when to recognize a group of reinsurance contracts held are different depending on whether the reinsurance contract held covers the losses of separate insurance contracts on a proportionate basis, proportionate reinsurance contracts, or the reinsurance contract held covers aggregate losses from underlying contracts over a specified amount, such as non-proportionate reinsurance contracts.
A group of proportionate reinsurance contracts held is recognized at the later of the beginning of the coverage period of the group or the initial recognition of any underlying insurance contract. This means an entity will not recognize a group of proportionate reinsurance contracts held until it has recognized at least one of the underlying insurance contracts. A group of non-proportionate reinsurance contracts held is recognized at the beginning of the coverage period of the group.
Onerous assessment includes multiple levels of processing. These include measuring an insurance contract or a set of insurance contracts at initial recognition. If they are found to be onerous, then they are marked as onerous at initial recognition. If not, the assessment to determine which of the following groups, should these contracts or group of contracts belong to, is performed:
· Remaining contracts in the portfolio.
· No significant possibility of becoming onerous at initial recognition.
Facts and circumstances can indicate if the contracts might form an onerous group even before typical initial recognition. This process is known as Early Recognition.
NOTE:
Contracts can fall into different groups because of legal or regulatory constraints, based on the ability to set different prices or levels of benefit for policyholders with different characteristics. Then under IFRS 17, an entity may include these contracts in the same group, by following all other IFRS 17 grouping requirements.
The insurance contracts or cohorts onerous classification is performed in the application by checking whether the contracts are net outflow at inception. If the contracts are profitable at inception, then the CSM is projected into the future by using different assumption scenarios. For any projected period, a loss is recognized then the contract is marked as profitable with a significant possibility of turning onerous.
IFRS 17 requirements mandate that the contracts issued more than one year apart should not be included in the same group. To achieve this, groups can be further divided as required. Each of these groups can include contracts issued over any length of time up to one year. This period does not need to be restricted or aligned with the reporting period of the entity. This requirement is known as the Annual Cohort Requirement.
The contracts in the cohorts can be of less than one year as well. For example, if an entity manages contracts in quarterly cohorts it could choose to have groups issued within a reporting quarter.
A reinsurance contract held cannot be considered onerous by applying IFRS 17. Therefore, the requirements for dividing a portfolio into groups are modified for reinsurance contracts held. For a group of reinsurance contracts held, an insurer expects either to incur a net cost of purchasing the reinsurance or, sometimes, make a net gain from purchasing the reinsurance. Applying the grouping requirements to reinsurance contracts held, at a minimum, a portfolio is divided into the following:
A group of contracts on which there is a net gain at initial recognition if any.
1. A group of contracts on which at initial recognition there is no significant possibility of a net gain arising subsequently if any.
2. A group of remaining contracts in the portfolio if any.
For some reinsurance contracts held, applying the requirements in IFRS 17 will result in a group that comprises of a single contract.
This section provides details about the General Measurement Model. IFRS 17 introduces the General Measurement Model that provides pertinent information about the future cash flows and profitability of insurance contracts. The General Measurement Model provides a wide-ranging and intelligent structure with various features of Insurance Contracts and the opportunities to make them profitable.
Performing Initial Measurement
Performing Successive Measurements
In IFRS, insurance contracts are grouped as profitable and onerous to make it easier for the insurers to evaluate their profit or loss. Fulfillment cash flows and contractual service margin are two parameters that are considered while calculating the liability of the remaining insurance coverage, and thereby the profit or loss.
NOTE:
IFRS 17 requires financial institutions to update the fulfillment cash flows at each reporting date by using current estimates that are consistent with relevant market information.
The asset or liability measurement is performed by adding the fulfillment cash flows and the contractual service margin after the initial recognition of insurance contracts.
· Fulfillment cash flows are the current estimate of amounts that the insurer expects to collect from premiums and payout for claims, benefits, and expenses, including an adjustment for the timing and risk of those cash flows.
· The contractual service margin is the expected profit for providing future insurance coverage (unearned profit).
The measurement of the fulfillment cash flows reflects the current value of any interest-rate guarantees and financial options included in the insurance contracts.
After the initial asset or liability measurement at inception, subsequent measurements of ongoing group insurance contracts are also performed. The total liability of a group of insurance contracts is comprised of the liability of the remaining coverage and the liability for incurred claims. The liability for remaining coverage is calculated as the sum of fulfillment cash flows of the coverage to be provided in the future and the remaining CSM.
The liability for incurred claims is measured as the fulfillment cash flows for claims and expenses already incurred but not yet paid.
The fulfillment cash flows are measured again on each reporting date to reflect estimates based on current assumptions. This measurement applies the same requirements that were applied for the initial measurement. Changes in estimates of the fulfillment cash flows are reflected in profit or loss, other comprehensive income, or in some cases, the CSM is adjusted.
This section provides detailed information about the Reinsurance Contracts Held feature.
The amount an entity pays for a reinsurance contract held consists of the premiums it pays minus any amounts paid by the reinsurer to the entity as compensation for expenses incurred, for example, ceding commissions. The amount an entity recognizes for reinsurance contracts held can be viewed as the share of the reinsurer for the risk-adjusted expected present value of the cash flows generated by the underlying insurance contracts and a CSM that makes the initial measurement of the reinsurance asset equal to the amount the entity pays for the reinsurance contract.
Consistent assumptions are used when measuring estimates of the present value of future cash flows for a group of reinsurance contracts held and estimates of the present value of future cash flows for the group(s) of underlying insurance contracts. This includes any associated adjustments for the financial risk and the time value of money arising from the reinsurance contracts held. As a result, the cash flows used to measure the reinsurance contracts held to reflect the extent to which those cash flows depend on the cash flows of the underlying contracts that the reinsurance contract held covers.
Also, the expected present value of future cash flows includes an adjustment for the risk that the reinsurer may fail to satisfy its obligations under the reinsurance contract held. Changes in the fulfillment of cash flows that result from changes in the risk of non-performance by the reinsurer do not adjust the contractual service margin. Instead, these changes are reflected in profit or loss when they occur.
The requirements in IFRS 17 for risk adjustment for non-financial risk are modified for reinsurance contracts held. For reinsurance contracts held, the risk adjustment for non-financial risk represents the amount of risk being transferred by the holder of the group of reinsurance contracts to the reinsurer.
The contractual service margin for a reinsurance contract held represents the cost of purchasing reinsurance. This is different from the contractual service margin for underlying insurance contracts that represent unearned profit on those contracts. The cost of purchasing reinsurance is recognized as services are received under the reinsurance contract held. As an exception, if the reinsurance contract held covers events that have already occurred, the net cost at initial recognition is recognized immediately in profit or loss.
The amount an entity pays for reinsurance typically exceeds the expected present value of cash flows generated from that reinsurance plus the risk adjustment for non-financial risk. As such, the contractual service margin for a group of reinsurance contracts held at initial recognition typically represents a net cost of purchasing reinsurance.
The Variable Fee Approach is applied to direct participating contracts. It is defined by three criteria and is based on policyholders sharing in the profit from an identified pool of underlying items.
Variable Fee Approach (VFA) is applied to direct participating contracts. The Variable Fee Approach (VFA) is defined by these criteria, based on policyholders being entitled to a significant share in the profit from an identified pool of underlying items:
· The contractual terms specify that the policyholder participates in a share of an identified pool of underlying items.
· The entity expects to pay to the policyholder an amount equal to a substantial share of the fair value returns from the underlying items.
· The entity expects a substantial proportion of any change in the amounts to be paid to the policyholder to vary with the change in the fair value of the underlying items.
A variable fee is the insurance contract liability based on the obligation for the entity to pay the policyholder an amount equal to the value of the underlying items and the net of a consideration charged for the contract.
This approach requires that changes to the estimate of the future fees an entity expects to earn from directly participating contract policyholders be adjusted against the CSM. The CSM on direct participating contracts would be recognized in profit or loss as part of the insurance service results based on the passage of time of the entity.
This flexible approach helps to mitigate accounting mismatches. This approach matches assets and liabilities. According to VFA, there is no direct impact on profit and loss. Also, CSM is being released over the contract period. In VFA, the discounting rate will be equal to the current interest rate.
For reinsurance contracts held, the entity and the reinsurer do not share in the returns on underlying items and so the VFA criteria are not met, even if the underlying insurance contracts issued are VFA contracts. The contractual service margin for a group of reinsurance contracts held represents the net cost (or net gain) of purchasing reinsurance, considering the rights and obligations of the entity under the reinsurance contract. The insurer does not receive investment-related services from the reinsurer.
The Premium Allocation Approach (PAA) is similar to existing approaches for non-life insurance products. The Premium Allocation Approach only applies over the coverage period, not over the settlement period.
This section defines how the contract boundary is critical to analyzing whether an insurer can use the PAA for some contracts. The PAA, or simplified approach, can be used when the contract coverage period, including premiums included in the contract boundary, is one year or less or if the PAA produces a liability.
The first step to assess its use is to define the contract boundary and the coverage period. Many non-life insurance contracts meet the first criteria by having a coverage period of one year or less. However, contracts with longer coverage periods, such as surety, engineering, construction, or lenders mortgage insurance will need to demonstrate they meet the second criteria.
Non-life insurers in this scenario will need to develop more complex modeling than they currently apply, requiring more data and the development of long-term assumptions. This also means insurers will present financial statements with a mix of valuation techniques, complicating the way results are analyzed and communicated.
The premium allocation approach assumes that no contracts are onerous at initial recognition unless facts and circumstances indicate otherwise. Assessment of whether an individual or a set of contracts belongs to those groups is based on the likelihood of changes in applicable facts and circumstances.
Longer-term non-life contracts, such as construction, engineering, and lenders mortgage insurance, may not meet the criteria. As a result, the insurer will face additional complexity in its valuation, modeling, and associated processes. Some life insurance contracts currently using long-duration measurement models may qualify to be able to use the PAA approach, which simplifies the modeling required but may also lead to unexpected results.
An entity may use the premium allocation approach to simplify the measurement of a group of reinsurance contracts held. If at the inception of the group, the entity reasonably expects that the resulting measurement would not differ materially from the measurement applying the general model or the coverage period for each contract in the group of reinsurance contracts held is one year or less.
Because groups of reinsurance contracts held are separate from groups of underlying insurance contracts, the assessment of whether a group of reinsurance contracts meets the conditions for applying the premium allocation approach may differ from the assessment of whether the group(s) of underlying contracts meet(s) those conditions.
A long-duration contract or long-duration targeted improvement (LDTI) is one that is generally not subject to unilateral changes in its provisions and requires the performance of various functions and services, including insurance protection, for an extended period. Examples include contracts that are non-cancellable or guaranteed renewable by the insurer, such as most term and whole life insurance and payout annuity contracts.
According to the revised guidance, the non-participating traditional insurance contracts and limited-payment contracts that are measured using the net level premium measurement approach are covered. Annual or more frequent updating of insurance assumptions is required, with the impact on the liability recognized on a retrospective catch up basis as a separate component of benefit expense. There is no provision for adverse deviation. The net premium ratio is capped at 100%, which replaces the premium deficiency test. Contracts from different issue years will no longer be permitted to be grouped, effectively resulting in a lower level of aggregation for determining contracts in a loss position.
The discount rate is standardized to an upper-medium grade (low credit risk) fixed-income corporate instrument yield (single A) that reflects the duration characteristics of the liability rather than expected investment yields. The discount rate is required to be updated at each reporting date, with the effect of discount rate changes on the liability recorded in other comprehensive income (OCI). The contract inception date discount rate is locked in for benefit expense purposes.
For LDTI transition, the application computes the Net Premium Ratio and Benefit Ratio in the following way:
· Net Premium Ratio: If the transition method is Full Retrospective, then the net premium as on inception is computed. If the transition method is Modified Retrospective, then the net premium as on transition date is computed by using the net premium ratio formula that is configured against the Transition Date.
· Benefit Ratio: If the transition method is Full Retrospective, then the Benefit Ratio as on inception is computed. If the transition method chosen is modified retrospective then the Benefit Ratio as on transition date is computed by using the Benefit Ratio formula that is configured against the Transition Date.
The sub-ledger function enables you to pass IFRS 17 compliant journal entries that are based on the results of Contractual Service Margin (CSM) calculations. The solution has seamless connectivity between the CSM engine and the sub-ledger function. The CSM results, that available post-execution, allow you to execute the sub-ledger definitions.
The sub-ledger function picks up data from the relevant tables and passes entries by using the pre-approved accounting rules. The entries are passed only for the runs that are marked for reporting.
The sub-ledger function comes with pre-ceded IFRS 17 compliant accounting rules that are configurable and can be customized. In terms of output, the solution comes with ready-to-use reports including a journal entry report and a ledger closing balance report. Both these reports are available at the selected granularity levels.
The Exchange Rate feature supports the ability to convert the foreign currency expected cash flows or actual transactions into the functional currency by using one of the Spot Exchange Rates supported by the Oracle Insurance Accounting Analyzer Application. The user can indicate the Exchange Rate Type against each input variable in the calculation preference configuration. The application uses the Exchange Rate Type to convert the foreign currency cash flows attached to that input variable into the Functional Currency using the same rate before executing the IFRS17 computations. The application also supports viewing of the IFRS17 results in different reporting currencies configured as per legal entity.
Acquired Insurance Contracts and Reinsurance held contracts in a business are treated as if they had been issued by the acquirer at the date of the transaction. The groups of contracts acquired are identified based on the level of aggregation requirements. This determines the issued CSM for Insurance Contracts and Reinsurance held contracts at the date of the transaction. For Onerous Contracts, the difference between the consideration received or paid and the fulfilment cash flows are treated differently. The application comes with the out of box logic, configured in the Calculation Preference Acquired Contracts templates to estimate the CSM and the loss as on Transaction Date for acquired business.
The groups of contracts acquired are identified based on the level of aggregation requirements. This determines the issued CSM for Insurance Contracts and Reinsurance held contracts at the date of the transaction.
Any consideration received for the contracts is used as a proxy for premiums received. This excludes any consideration for other assets and liabilities that are acquired in the same transaction.
For contracts acquired in a business combination, the Fair Value at the Transaction Date is considered. This Fair Value is determined by using the IFRS 13 requirements, except for the requirement where the Fair Value of a financial liability with a demand feature must not be less than the amount payable on demand.
For Onerous Contracts, the difference between the consideration received or paid and the fulfillment cash flows are treated differently.