Two things to consider before adopting the Premium Allocation Approach under IFRS 17
Under IFRS 17, an Insurer can adopt one of three approaches to measure their insurance liabilities: General Measurement Model (GMM - also referred to as the building block approach or BBA), Variable Fee Approach (VFA) and Premium Allocation Approach (PAA). The three approaches differ in complexity and involve a varying amount of work to become IFRS 17 compliant.
PAA is in effect a simplified approach designed primarily for insurance contracts with a coverage period of 12 months or less. Some insurers are considering the PAA approach as a simpler and quicker way to reach compliance. However, many are finding that “simpler” doesn’t necessarily mean simple and the approach may not meet their needs.
What is Premium Allocation Approach?
The PAA approach is a simplified measurement model for IFRS 17. You can use it if at the inception of a group of contracts:
- You reasonably expect the resulting liability for remaining coverage to be materially in line with the result expected using the GMM approach. The criteria aren’t met if there is expected to be significant variability in the fulfillment cash flows that would affect the measurement of the liability for remaining coverage during the period before a claim has been incurred.
- The coverage period of each contract in the group is one year or less.
PAA is “simpler” – but is it simple?
PAA is a simpler approach than the GMM or VFA approaches. However, that doesn’t mean PAA won’t require any complex accounting or technology changes to support adoption. Additionally, working out whether you are eligible for PAA is not as clear cut as it may initially seem.
If you are considering the PAA approach, we suggest you consider these two important things prior to going ahead.
Consideration one – are you eligible for PAA now and likely to remain eligible in the future?
Although at first glance, it may appear relatively easy to determine whether PAA is the most appropriate for you, it is worth giving this some thought before deciding. Given the significance of the changes being brought about by IFRS 17, looking into whether you are eligible now and how likely you are to remain eligible in the future is a key consideration before investing the time, effort and cost of reaching compliance.
A number of factors to consider:
- The assessment required for determining that PAA is a reasonable approximation to GMM requires a significant level of judgement. For example, this may include scenario testing based on actuarial data and may require sign-off by an auditor. The resulting reports would need to be audited as well.
- Even if your portfolios of contracts automatically meet the eligibility criteria, there are other considerations that could add complexity. This could mean a similar level of effort required for PAA as would have been necessary for GMM. An example of this might be accounting for significant financing elements or onerous contracts.
Ascertaining whether PAA is the right approach for you now as well as in the future, will prevent you discovering late in the day that an alternative approach is required or more appropriate.
Consideration two – does it makes sense to adopt the same approach at entity and group level?
If you are a subsidiary of a business, or an entity able to report independently, we recommend considering whether IFRS 17 should be approached at the group level or individual entity level. Some companies are choosing to approach IFRS 17 as separate business entities, with different approaches being considered at the group and entity level. For example, some subsidiaries with P&C (property and casualty) businesses may automatically be eligible for PAA but may roll up to entities that are using GMM for their group reporting. It is advisable to speak with your auditors before deciding what is most appropriate in your circumstances.
Even if one part of the business is eligible for PAA while another needs to use GMM, it may make more sense to approach IFRS 17 as one project using the GMM approach. The effort involved in reaching compliance using either approach will be significant, so it could be worth considering whether having two processes will add complexity and cost.
Despite rumors of the deadline being pushed back, the effort and budget will still need to be invested now. Approaching IFRS 17 in a non-consolidated way, could create additional work, add cost, require training people on two processes and ultimately take longer.
Approaching IFRS 17 with a strategic viewpoint could be beneficial during and after compliance adoption. Benefits could include an easier audit, a clearer view of consolidated financial data and simplified reporting processes.
We advise you to spend some time assessing whether PAA is the right option for you. In many cases, it is simpler, so if it is a good fit - now and in the future - it could be the right approach. But there are some important factors to consider before making the choice. With the level of investment required and the deadline fast approaching, our advice is to investigate your options, seek advice and get it right from the beginning of your project.