Premium allocation approach

Last update 17/12/2019

The premium allocation approach is a simplified form of measuring insurance contracts in comparison with the general model. Use of the premium allocation approach is optional for each group of insurance contracts that meets the eligibility criteria, at the inception of the group:

[IFRS 17:53]
a) the entity reasonably expects that this will be a reasonable approximation of the General Model, or
b) the coverage period of each contract in the group is one year or less

Where, at the inception of the group, an entity expects significant variances in the fulfilment cash flows (FCF) during the period before a claim is incurred, such contracts are not eligible to apply the PAA. [IFRS 17:54]

Using the PAA, the liability for remaining coverage shall be initially recognised as the premiums, if any, received at initial recognition, minus any insurance acquisition cash flows. Subsequently the carrying amount of the liability is the carrying amount at the start of the reporting period plus the premiums received in the period, minus insurance acquisition cash flows, plus amortisation of acquisition cash flows, minus the amount recognised as insurance revenue for coverage provided in that period, and minus any investment component paid or transferred to the liability for incurred claims. [IFRS 17:55]

Differences between the premium allocation approach and the general model include:

• Simplified measurement of the liability for remaining coverage for groups of insurance contracts that are not onerous. The overall liability measurement of the premium allocation approach and the general model would the same for groups of contracts that are onerous (see ‘Onerous insurance contracts‘ and ‘Measurement of remaining coverage‘).
• An option not to adjust future cash flows in the liability for incurred claims for the effect of the time value of money and financial risk if those cash flows are expected to be paid or received in one year or less from the date they are incurred (see ‘Measurement of remaining coverage‘).
• An option to recognise any insurance acquisition cash flows as expenses when these costs are incurred, provided that the coverage period of each contract in the group is no more than a year (rather than adjust the liability for remaining coverage) — see ‘Measurement of remaining coverage‘.
• An entity need only assess whether a group of insurance contracts is onerous if facts and circumstances indicate that the group is onerous (the general model effectively requires an assessment of whether a group of contracts is onerous at each reporting date after the initial recognition of a group) — see ‘Onerous insurance contracts‘.

The accounting model for the premium allocation approach is broadly similar to the accounting model used under IFRS 4 by most non-life or short-duration insurers, sometimes referred to as “an earned premium approach”. There are some differences, for example:

• Presentation in the balance sheet
  • No separate asset is recognised for deferred acquisition costs. Instead, deferred acquisition costs are subsumed into the insurance liability for remaining coverage.
  • No separate presentation of a premium receivable asset in the balance sheet under IFRS 17 (implicitly included in the insurance liability for remaining coverage)
• Measurement of the liability for remaining coverage includes an explicit risk adjustment for non-financial risk when a group of contracts is onerous
• Measurement of the liability for incurred claims includes an explicit risk adjustment for non-financial risk and is subject to discounting (an entity need not discount the liability for incurred claims if settlement is expected within a year)

Practical expedients available under the PAA:

If insurance contracts in the group have a significant financing component, the liability for remaining coverage needs to be discounted, however, this is not required if, at initial recognition, the entity expects that the time between providing each part of the coverage and the due date of the related premium is no more than a year. [IFRS 17:56]

In applying PAA, an entity may choose to recognise any insurance acquisition cash flows as an expense when it incurs those costs, provided that the coverage period at initial recognition is no more than a year. [IFRS 17:59a]

The simplifications arising from the PAA do not apply to the measurement of the group’s liability for incurred claims, measured under the General Model. However, there is no need to discount those cash flows if the balance is expected to be paid or received in one year or less from the date the claims are incurred. [IFRS 17: 59b]

See also: The IFRS Foundation

Premium allocation approach