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IFRS 17 Insurance contracts - Part 2
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Almost all accounting standards describe the approach to use in computing the numbers. For example, IAS 2 will tell you to use First-In-First-Out or weighted average method to compute the value of your inventories.
Likewise, IFRS 9 will tell you to use general or simplified method for the value of your impairment allowance on financial assets.
If you consider the complexity in IFRS 9 and IFRS 17, you may see why IFRS 17 did not hesitate to create a simplified method alongside the general method.
There are 3 measurement models for accounting for insurance contracts under IFRS 17.
- General model (Known as the Building Block Approach)
- Simplified model (Known as the Premium Allocation Approach)
- Variable Fee Approach
But before we discuss each of them, there's an important term to note. It's called Participation Feature.
If you are new to insurance, you may be surprised as I am, that there are some contracts that gives the policyholder the benefit of sharing in the gains of the insurer. What this means is that when the insurer receives premiums from the policyholder and invests those premiums, the gains on the investment is shared between the insurer and the policyholder.
This is referred to as a participation feature and it can be direct or indirect.
What is a direct participation feature?
A direct participation feature (DPF) means that the kind of gain that the policyholder gets from the premiums invested meets the 3 criteria below. If they don't, then they are indirect.
- The underlying items (the investments) that the policyholder wants to participate in must be clearly identified
- The amount that the insurer wants to pay the policyholder must be a substantial share of the value of the investments
- Any changes in the amounts the insurer wants to pay the policyholder must vary with the change in the investments
So now let's briefly talk about when you should use the 3 measurement approaches.
If there is a DPF in an insurance contract, the variable fee approach is used. This is because the insurer will deduct a variable fee for the insurance service it has rendered to the policyholder through the investments.
This implies that the general model and the simplified model are used for other insurance contracts especially when there is no participation feature.
Also, the general model is used for the indirect participation feature.
Simplified model is a simplification of the general model and is often used for insurance contracts that are one year or less, or whose result is similar to the general model.
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