IFRS 17- part 4

When to recognise(reflect in the Financial statement for thefirst time) a group of insurance contract

Earliest of:
a. The date the insurance cover starts.

b. The date the first payment by the policyholder become due.

c. When the group of contracts becomes onerous(for onerous contracts only)

How to determine the value at which a group of insurance contracts will be intially recognised
Remember that insurance contracts are grouped

Value when first recognised= Fulfilment cashflows+Contractual service margin  (total premium+profit)

Fulfilment cashflows=Present of estimated future cashflows(future premium)- adjustment for non-financial risk

The estimated future cashflows should be:

-current (applicable to the current economic situation)

-explicit (very clear)

-unbiased
-reflect all info available to the entity

- reflect perspective of the entity (i.e. where it is going) provided that the estimate of relevant market variables are consistent with observable market prices.

The discount rate used to discount the future cashflows should:

- reflect time value of money(obviously)

-exclude the effect of factors that don't affect the estimated future cashflows(this make sense because only
factors related to thr cashflows being discounted should  be considered

-reflect cashflow characteristics of the insurance contracts and also those of financial instruments whose CF characteristics are similar to those of the contracts.

Contractual service margin
It should be an amount that results in zero income/loss arising from:

-initial recognition of an amount for the fulfilment cashflows

-the de-recognition at that date of any asset and liability recognised for insurance acquisition cashflow

-any cashflow arising from contracts in the group at that date

IFRS 17-Part 3

SEPERATE OR MERGE??

SEPERATION
The insurance contract contains various items. Some are treated under IFRS 17 and some are not. The ones that are not should be 'seperated' i.e. they should be treated under other IFRS.

Steps an insurance company should follow to "seperate" non-IFRS 17 items

a. Determine if the contract contains an embedded derivative (i.e a derivative that is hidden in the contract) and determine how to account for it (usually fair value).

b. Seperate investment component (concerned with accepting deposits from the clients and paying them back the principal plus interest) IF they are distinct i.e seperately identifiable. IFRS 9 should be used to account for them.

c. Seperate promises to transfer non-insurance goods and services (this relates to revenue). These should be accounted for using IFRS 15.

AGGREGATION

Portfolios
IFRS 17 requires insurance companies to group insurance contracts that have similar risks and are managed together into portfolios.

Sub-division
The contract in a portfolio should be further divided into:

a. Onerous contracts i.e. cost of fulfiling/executing it> contract income

b. Contract that, when initially recognised, have no significant risk of becoming onerous.

c. Contract that don't fall into the first two groups.

Contracts issued more than 1 year apart can't be in the same group.

If the insurance contracts within a portfolio would fall into different groups only because law or regulation specifically constrains the entity's practical ability to set a different price or level of benefits for policyholders with different characteristics, theentity may include those contracts in the same group.

I'll explain this with a simple example.

Imagine XYZ insurance issues life assurance policies and that there are two policy holders, A and B. A is a smoker and an heavy drinker while B lead a healthy life.

Normally, the premium for A should be higher, but, due to legal restrictions, it has to charge both A and B the same premium.

The can make A's policy fall into the first group (onerous contracts) and B's to benin the second group.

In such a situation, IFRS 17 permits the insurance company to recognise the policies of both A and B in the second group.

IFRS 17 part 2

Definitions

Insurance contract

A contract under which one party (The issuer) accepts SIGNIFICANT insurance risk from another party(The policyholder)  by agreeing to compensate the policyholder if a specified uncertain future event adversely affects the poli­cyholder.

Portfolio of insurance contracts

A group of insurance contracts that have similar risks and are managed together.

Contractual service margin
This is the proportion of the carrying amount of an asset/liability line item of a group of insurance contracts that represents the unearned profit that the insurance company will recognise as it provides it services.

When the insurance company issues 100 policies at the start of the year, a percentage of their cost is its profit, but, it can't recognise it as profit yet because things might not go as planned...

Insurance risk
A risk other than finance risk that is transferred to the finance company.
A finance risk is the risk that an investment will flop i.e not yield expected returns.

Fulfilment cashflows
This the estimated amount an insurance company will pay to fulfil insurance claims

= PV of future cash outflows- PV of future cash inflows (adjusted for non-financial risk)

Risk adjustment for non-financial risk
Compensation required for bearing the uncertainty about the amount and timing of the cash flows arising from non-financial risk.

Non-financial risk are more unpredictable than financial risk, therefore there is a probability of losing more money. So, the insurance company has to be compensated for that.

IFRS 17 Part 1

Replacement
It will replace IFRS 4 which was an intermediate standard. IFRS 4 was like a quick fix that allowed IASB to buy more time to develop a more comprehensive standard.

Objective
It aims to ensure that insurance contracts are properly accounted for by insurance companies.

Insurance companies should apply it to
a. Insurance contract they issue (to the general public, companies...)
b. Re-insurance contracts they issue (i.e contracts insuring risk insured by another insurance company)
c. Re-insurance contracts it holds (i.e insurance contracts issued to it by other insurance companies
d. Investment contracts provided that it also issues insurance contracts. Investment contract are like certificates of deposit. They evidence a deposit made with the insurance company that'll attract interest.

IFRS 17 or 15???
Some contracts meet the definition of an insurance contract, but, their aim is to provide services for a fixed fee.

An example is the optional nsurance fee that Jumia collects when selling phones. It is an insurance contract, yes. Also, the aim is to provide phone repair services (in theory) at a fixed fee.

In a case like this, Jumia can account for this income using IFRS 17 (as an insurance contract) or IFRS 15 (as revenue).

However,  3 conditions have to be met before it can account for it can account for it as revenue:
a. It doesn’t consider individual risk when setting the price. Jumia doesn't consider whether buyer A's screen is more likely to break than buyer b's when setting it's phone insurance premium.

b. Compensation is in form of a service and not monetary. Jumia won't pay money if the insured phone spoils, it can replace/repair.

c. Insurance risk arises from use of services rather than uncertainty over their cost. Jumia already knows how much it will repair a phone will cost. The risk it is exposed to is that the customer will actually make a claim.

Therefore, Jumia can use either IFRS 15 or IFRS 17 to account for the phone insurance income

Full Solution to ICAN May 2016 Case Study (Requirement 1)

                                                                                 Report
To: The Chief Finance Officer, Wonder Bank Limited
A (draft) report on the SWOT analysis of “Project Sky-High” and the method of finance
Prepared by: Hadley, Deolu and Co.(Chartered Accountants)
Date: 19th May, 2016

Disclaimer
This report (including any enclosures and attachments) has been prepared for the exclusive use and benefit of the WonderBank Limited and solely for the purpose for which it is provided. Unless we provide express prior written consent, no part of this report should be reproduced, distributed or communicated to any third party. We do not accept any liability if this report is used for an alternative purpose from which it is intended, nor to any third party in respect of this report.

1 SWOT analysis of “Project Sky-High”

1.A Wider Issues
WonderBank is currently one of the biggest banks in West Africa. It is planning to invest in a project, “Project Sky-High” to further consolidate its position.

1.B Strengths
The services offered in Wonderbank’s offshore operations will improve due to the migration of staff. This initiative will also improve its profits and cash flows.

WonderBank’s board is committed to the project. Therefore, it is more likely to be successful.

The project fits into WonderBank’s strategic plan because it will help it to achieve its environmental goals i.e. a green environment.

1.C Weaknesses
The projects targets seem too optimistic and may not be achievable within the set time frame. This is because a new project may have a slower start and may need to build momentum.

Also, the project does not seem to have a clear plan. To solve this problem, WonderBank can hire experienced project managers to manage the project. It can also prepare detailed cash flow forecasts to monitor the project.

It will lead to the retrenchment of many employees. This can lead to problems with the trade union. WonderBank should consider alternative courses of action.

1.D Opportunities
The project provides WonderBank with an opportunity for WonderBank to expand to and improve its image in other West African countries.

The planned reduction in paper use will allow WonderBank to contribute to a cleaner environment.

The use of cutting-edge technology will make WonderBank to be seen as a pioneer as far as technological advances are concerned. This will improve its reputation.

1.E Threats
There is a possibility of WonderBank’s competitors getting hold of information relating to “Project Sky-High”. It is also possible that staff retrenched in Lagos may over to its competitors thereby weakening its competitive position.

The problems organized by the workers’ union in Ghana may damage WonderBank’s reputation.
WonderBank may have lawsuits filed against it if it does not pay the retrenched staff a severance package. This may lead to it having to pay a heavy fine. It will also negatively affect its reputation.

1.F Source of information
The information used for the SWOT analysis was provided by its Chief Finance Officer. Therefore, they may be subject to bias.

1.G Ethical issues
WonderBank’s CFO seems to be more concerned about his personal benefits than the severance packages of the employees that will be retrenched. This is unethical and it is made public, it will generate negative press.

It should negotiate the severance packages with the trade union to arrive at the best terms for WonderBank and the employees affected.

1.H Outsourcing
The outsourcing of some services to outside contractors means that WonderBank will lose an element of control over them.

Also, the outsourcing of the security and programming of the robots to a firm in France means the resolution of security issues may not be quick due to the physical distance and language barrier between WonderBank and the french supplier.

1.I Other issues
The additional costs of the project may be understated. Also, maintenance and update
costs are not taken into consideration.

Due to technological advances, there’ll be an ongoing need to update robots. This will lead to additional cost.

1.J Conclusions
The project doesn’t seem to have a clear plan and its objectives are overly optimistic.

There is a risk that actual cashflows will be significantly different from estimated cashflows.

WonderBank may have lawsuits filed against it if it does not pay the retrenched staff a severence package.