Contract Boundaries for Solvency II and IFRS 17

Discussion in 'SA3' started by Steve Parry, Apr 11, 2019.

  1. Steve Parry

    Steve Parry Member

    Having a bit of difficulty trying to understand how these are different (if at all). From my understanding:

    Solvency II
    • The contract boundary is defined as the point when the company can terminate the contract, refuse premium, stop paying claims, or change the premium so it fully reflects this risk i.e. at renewal or MTA stage.
    • If there are contractual obligations to renew the policy, this must be included within the boundary. However, this should be excluded if, in the case of motor insurance, the policy has auto-renewal but the policyholder changes provider.
    IFRS 17
    • The contract boundary is defined as the point when the company can change the premium to fully reflect the risk (as per Solvency II); or
    • As per the core reading, the premiums for coverage up to date when the risks are assessed does not take into account the risks that relate to periods after the assessment date.
    It's the second bullet point under IFRS 17 which I don't fully understand. Does it mean that if there are contractual obligations to renew the policy e.g. auto-renewals, then these should be excluded (in contrast to Solvency II)?

    Thanks in advance.
     
    Uroš likes this.
  2. Ian Senator

    Ian Senator ActEd Tutor Staff Member

    Hi Steve
    Interpreting the wording of each bit of Core Reading is quite tricky without examples, we agree. After Googling, we found some docs by PWC that also state the difference, but to be honest, we're not really any the wiser. We've contacted an 'expert' in the field and will post here if/when we find out more (sorry it won't be in time for the exam tomorrow!). In the meantime, do look at the Solvency II question on contract boundaries that came up recently in the exam.
    Ian
     
  3. Uroš

    Uroš Active Member

    Hi,
    the only possible difference I found on the topic is the following:

    Some contracts are composed of a few components, IFRS 17 and SII could lead to different contract boundary interpretation about bundled products. With that in mind, this could be more material for longer-term business (one example - life cover with personal accident rider).

    I would add another question on CBs:
    what about the right of the company to cancel the cover, eg. after 3 month in reinsurance treaty, does this influence the CBs?
    This could be interpreted as change in premium/benefits.
     
  4. BenL

    BenL Made first post

    Hi,

    I think this part of the standard actually relates more to life insurance contracts. As an example, where a policyholder is sold a level premium whole of life policy, there is a certain level of "pre-funding". Ie premiums outweigh expected claims in early years, which are built up to cover expected claims outweighing premiums in later years. Thus the premium takes into account risks in later years when set in the current period.

    Even though the policy can technically be repriced at the next anniversary (though practical reasons prohibit the insurer from ever doing so), they then have to extend the contract boundary on point 2 above.

    I'll def be asking some people at work on Monday to confirm!

    Ben
     
  5. Mateusz

    Mateusz Member

    I think Uros made a valid point about life contracts with multiple coverages. Under SII, for a policy with protection riders you'd assess contract boundary for each rider separately, while IFRS 17 states that the assessment is made for a contract in its entirety. This interpretation has been confirmed by the TRG in this paper:

    https://www.ifrs.org/-/media/featur...3-cash-flows-within-the-contract-boundary.pdf

    See par 18: "For a contract that includes two insurance components and that is considered a single contract, the assessment of the cash flows within the boundary is performed for the contract in its entirety. The contract is not split into two separate insurance components to assess the contract boundary of each component as if they were issued as separate contracts."

    What this changes is, if you have a life assurance policy (with premium gteed for the whole term N) and protection riders with premium reviewable every X<N years, the contract boundary would most likely by set to N years, because the full contract cannot be repriced (i.e. there is no full reflection of all PH risks in the contract). The paper provides another example with a similar conclusion.
     
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  6. Ian Senator

    Ian Senator ActEd Tutor Staff Member

    Update from our experts in the field:

    With S2, the key thing is the date the insurer is obliged to accept the contract. But with IFRS 17, it's the earliest of a) contract inception, b) premium becomes due, c) legal obligation and contract is onerous.

    An example would be a 31/12 valuation date. With S2, most contracts that are due to incept on 1/1 will be accounted for. But IFRS 17 would include them only if the premium was due by 31/12 or it was onerous and legally bound.

    With the above differences, it doesn't sound to me like a massive difference in the majority of 'normal' cases, as business will be often sold throughout the year.
     
    Last edited: May 16, 2019
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  7. Uroš

    Uroš Active Member

    Thank you.
    The difference would then be mostly at the beginning of the contract, while contract boundary ends at the same time.

    Typically, many reinsurance treaties incepts 1.1. implying that there could be a bit more material differences.
     
  8. Ian Senator

    Ian Senator ActEd Tutor Staff Member

    Yes, you're absolutely right. For reinsurance (which is treated very differently under IFRS 17) it's more complicated as there are different rules for prop and non-prop, and the treatment of cashflows varies depending on whether it's LOD or RAD. More details can be found in IFRS 17 Paragraph 62 if you're really interested...
     

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