In this latest update from the Actuaries Institute's AASB 17 Implementation Taskforce, Benoit Laganiere discusses considerations related to aggregation and contract boundaries to assist Australian actuaries involved in implementing the new accounting standard.
The Aggregation and Contract Boundary work stream is another of the technical work streams of the Institute of Actuaries’ AASB 17 Implementation Taskforce which overall is focused on producing guidance for Australian actuaries involved in implementing the new accounting standard.
The scope of this particular work stream covers questions relating to the formation of Portfolios and Groups, inclusive of considerations related to onerous contracts, contract boundary and elements of insurance contracts that may potentially fall outside of AASB17. Reinsurance specific considerations are also covered.
While the above topics are not as technical as previous subjects covered in similar updates, practicing actuaries will need to dedicate a significant amount of time engaging with various stakeholders within the entity they review in order to set groups of insurance contracts which will form the basis of the insurance liability valuation results.
Similar to other work streams involved with the AASB17 taskforce, the Aggregation and Contract Boundary volunteers meet on a regular basis and include a wide range of participants from general insurance, health insurance and life insurance backgrounds.
How are aggregation considerations expected to impact the current practice?
At its core, AASB17 deals purely with insurance contracts regardless of the insurance sector serviced by the entity. This is arguably a change from the current standards which are more focused on the insurance entity as a whole. Fundamentally, practicing actuaries will need to ensure that insurance contracts are grouped together depending on whether or not contracts are ‘subject to similar risks’ and ‘managed together’. These words shouldn’t be too unfamiliar to most as a similar statement can be found in the current standards. However, AASB17 goes further by setting the expectation that contracts in different product lines would not be expected to have similar risks. Therefore, an initial level of aggregation of contracts is expected to broadly follow lines of business and/or distribution streams underwritten by the insurance entity. This initial level grouping is referred to in the standard as “portfolios of insurance contracts”.
Once portfolios of insurance contracts have been defined, each portfolio will need to be divided into a minimum of three 'groups'.
- a group of contracts that are onerous at initial recognition, if any;
- a group of contracts that at initial recognition have no significant possibility of becoming onerous subsequently, if any; and
- a group of the remaining contracts in the portfolio, if any.
Furthermore, no contracts incepting more than twelve months apart shall be grouped together.
As you can now appreciate, it is expected that the above rules will result in much more granular groupings than current practice. Finally, it is worth mentioning that while each group will form a unit of account, the standard stipulates that further allocation of the liability valuation results is quite acceptable. This means that the actuarial valuation models could be performed at higher or lower level that the entities’ adopted groupings. Valuation results will then either be allocated or aggregated to each group.
Why is the consideration of the contract boundary of insurance policies important under AASB17?
Since no contracts incepting more than twelve months apart can be grouped together, contract boundary considerations are intrinsically linked to groupings.
The boundary of a contract is determined when the insurer has the practical ability to set a price or level of benefits that fully reflects the risks of a particular policyholder. If this criteria is not achieved for a single contract, it is possible to reach a boundary if the insurer has the practical ability to set a price or level of benefits that fully reflects the risks of a portfolio that contains the contract, and if the pricing of premiums for coverage only relate to risks up to the assessment date. If neither of above considerations are met, the obligation continues for this portfolio of insurance contracts.
For some contracts, the above considerations can easily be determined. However, it is expected that for certain forms of life insurance contracts, there will be a fair amount of judgement involved in assessing the boundary limits. Some general insurance and health insurance contracts will also require careful justifications when landing on a position on the boundary.
Contract boundary considerations will also directly impact the valuation approach used. If the boundary is determined to be twelve months or less, the simpler Premium Allocation Approach can be used without having to test results against the more detailed General Approach (or Building Block Approach).
What other considerations will be reviewed by this work stream?
As mentioned earlier in this article, AASB17 deals purely with insurance contracts. It is therefore possible that some contract features may fall outside of this standard such as certain types of annuities or non-participating investment features of life insurance contracts. General insurers will also need to carefully consider cash flows related to salvage and subrogation, especially if such activities are covered by other standards (i.e. inventories).
Under AASB17, reinsurance contracts are accounted for as separate contracts and will therefore be aggregated in distinct groups. This will have a direct impact on valuation and reporting activities. Considerations when aggregating reinsurance contracts will potentially differ from primary insurance contracts given the vast diversity of reinsurance protection available in the market today, some of which span across several lines of business.
In summary, actuaries will need to dedicate a significant amount of time reviewing the inventory of an entity’s insurance policies. Any subjective assessment of contract boundary and aggregation level will need to be documented so that company auditors can follow the assessment process undertaken and validate the justifications of key decisions made.
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