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Accession #: 220063

 

Publication Date:
May 08, 2020
Title:
Draft Educational Note: IFRS 17 Risk Adjustment for Non-Financial Risk for Property and Casualty Insurance Contracts
Other Details:
33 pages.
Author:
Actuarial Guidance Council
Description:
IFRS 17 Insurance Contracts (IFRS 17) establishes principles for the recognition, measurement, presentation, and disclosure of insurance contracts. The purpose of this draft educational note is to provide practical application guidance on Canadian-specific issues relating to the IFRS 17 risk adjustment for non-financial risk (RA) for property and casualty (P&C) insurers. References to specific paragraphs of IFRS 17 are denoted by IFRS 17.XX, where XX represents the paragraph number.

The requirement for the RA, which is a defined term in IFRS 17 Appendix A, is set forth in IFRS 17.37:

An entity shall adjust the estimate of the present value of the future cash flows to reflect the compensation that the entity requires for bearing the uncertainty about the amount and timing of the cash flows that arises from non-financial risk.

Further clarification is provided in IFRS 17.B86–B92. These paragraphs emphasize that the RA relates only to non-financial risk. Insurance risk, lapse risk, and expense risk are listed as examples of risks that are included, whereas operational risks and market risks are excluded. IFRS 17.B91 clearly states that IFRS 17 does not prescribe the estimation technique(s) used to determine the RA, and IFRS 17.B92 notes that “an entity shall apply judgement.”

IFRS 17.B91 states that the RA would have the following characteristics:
(a) risks with low frequency and high severity will result in higher risk adjustments for non-financial risk than risks with high frequency and low severity;
(b) for similar risks, contracts with a longer duration will result in higher risk adjustments for non-financial risk than contracts with a shorter duration;
(c) risks with a wider probability distribution will result in higher risk adjustments for non-financial risk than risks with a narrower distribution;
(d) the less that is known about the current estimate and its trend, the higher will be the risk adjustment for non-financial risk; and
(e) to the extent that emerging experience reduces uncertainty about the amount and timing of cash flows, risk adjustments for non-financial risk will decrease and vice versa.

The RA is explicitly included in the insurance contract liabilities and is disclosed per the requirements of IFRS 17.100–107 and IFRS 17.119.

Chapter 4 of the CIA Draft Educational Note Application of IFRS 17 Insurance Contracts (Draft Ed Note IFRS 17 Application) provides general guidance about the RA. The Draft Ed Note IFRS 17 Application adopts without modification the exposure draft of the proposed International Actuarial Note (IAN) 100 – Application of IFRS 17 Insurance Contracts of the International Actuarial Association (IAA).

In this draft educational note, “approach” is used to denote an overall way of addressing the RA, whereas “technique” and “method” refer to the detailed process (including calculations) to determine and allocate (if necessary) the RA.

Within the IAA guidance, Question 4.3 of the Draft Ed Note IFRS 17 Application states (emphasis added):
This general guidance means that there is no single right way for an entity to set the risk adjustment. In general, there are other important considerations that will be relevant to how an entity determines its approach to estimating the risk adjustment:
• consistency with how the insurer assesses risk from a fulfilment perspective;
• practicality of implementation and ongoing re-measurement; and
• translation of risk adjustment for disclosure of an equivalent confidence level measure.

Therefore, a variety of methods are potentially available, although their ultimate usage depends on the extent to which they meet the criteria above, given the specific circumstances of the company. Potential methods include, but are not limited to, quantile techniques such as confidence level or CTE [conditional tail expectation], cost of capital techniques, or even potentially simple techniques such as directly adding margins to assumptions or scenario modelling.

Regardless of the estimation technique, the actuary would ensure that the resulting RA represents the compensation the entity requires for accepting uncertainty in the amount and timing of the cash flows arising from non-financial risk (uncertainty related to non-financial risk). This draft educational note provides specific application guidance, as well as background and general information, to help inform Canadian actuaries when exercising judgment for derivation of the RA.

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