Captive Insurance
An insurer owned by the businesses it covers, the forms it takes, and what separates a captive from simply retaining the risk.
Glossary
IFRS 17
The accounting standard that replaced a patchwork of national practice, and the profit measure at its centre: the contractual service margin.
IFRS 17 is the International Financial Reporting Standard that governs the recognition, measurement, presentation, and disclosure of insurance contracts. It explains how entities applying IFRS report their insurance obligations and recognize the financial results of providing insurance services.
Issued by the International Accounting Standards Board, IFRS 17 replaced IFRS 4. It became effective for annual reporting periods beginning on or after 1 January 2023, subject to the applicable jurisdiction’s adoption arrangements. The IFRS Foundation’s overview of IFRS 17.
What problem does IFRS 17 address?
Insurance creates a timing gap between collecting premiums, providing coverage, and paying claims. A policy sold today can create obligations extending for years, and the final cost may remain uncertain throughout much of that period.
An income statement based only on premium receipts and current claim payments would provide an incomplete picture. Large premium receipts can arrive before most services are provided, while a quiet claims-payment period may still involve substantial unpaid obligations.
IFRS 17 combines current estimates of insurance obligations with recognition of profit as services are delivered. It also separates the insurance service result from insurance finance income or expenses, helping readers distinguish operating performance from financial effects such as discounting.
Which contracts does it cover?
The standard focuses on the contract’s substance. An insurance contract transfers significant insurance risk: the issuer agrees to compensate the policyholder if a specified uncertain event adversely affects that policyholder.
Its scope includes insurance contracts issued, reinsurance contracts held, and certain investment contracts with discretionary participation features. Detailed scope exceptions and separation requirements also apply.
Reinsurance purchased by an insurer is assessed separately from the insurance it has issued. The existence of reinsurance does not allow the insurer simply to report the underlying policies as though it had only written its retained share.
The main measurement components
Under the general measurement model, three concepts explain the insurer’s position:
| Component | Meaning |
|---|---|
| Expected future cash flows, adjusted for timing | Estimates of relevant premiums, claims, benefits, and expenses within the contract boundary, discounted as required |
| Risk adjustment for non-financial risk | Compensation the entity requires for bearing uncertainty about the amount and timing of cash flows arising from non-financial risk |
| Contractual service margin | Unearned profit to be recognized as future insurance contract services are provided |
The first two components together are called fulfilment cash flows. They use current information about the obligations and the uncertainty around them. The contractual service margin, or CSM, is the separate unearned-profit component. The IFRS Foundation’s definitions of key terms.
The contract boundary determines which future cash flows belong to the existing contract for measurement purposes. It prevents the estimate from automatically incorporating every possible future renewal or sale to the same customer.
What the contractual service margin means
For a profitable group measured under the general model, expected profit is not all recognized on the day the contracts are written. The CSM carries the unearned portion and is released as the relevant services are provided.
Coverage units support that allocation. They reflect the quantity of benefits and the expected period of service. The pattern is therefore not necessarily a straight-line allocation over calendar months. The IFRS Interpretations Committee explains the role of coverage units when allocating the CSM to services. IFRIC’s discussion of service recognition under IFRS 17.
The CSM is an accounting amount. It is not a separate bank account, cash already available for distribution, or a guarantee that the expected profit will ultimately be earned.
A simplified CSM example
Consider a fictional group of contracts at initial recognition. For this illustration, the present values of the relevant cash flows and the risk adjustment are:
| Item | Amount |
|---|---|
| Expected premium inflows | $1,000 |
| Expected claim, benefit, and expense outflows | $900 |
| Risk adjustment for non-financial risk | $30 |
| Initial contractual service margin | $70 |
The expected margin after the risk adjustment is $1,000 − $900 − $30 = $70. The CSM prevents that $70 from being recognized immediately as profit from future services.
Assume the group provides equal quantities of service in two periods, with no changes in assumptions, no financing effects, and no other CSM adjustments. The illustrative CSM release would be $35 in each period.
That $35 is only the CSM contribution to the service result. It is not the insurer’s entire profit for the period, which also reflects other relevant income and expenses. A real calculation incorporates the applicable measurement rules and actual service pattern.
What happens to loss-making contracts?
A group is onerous when the measurement indicates a loss under the standard’s rules. Expected losses are recognized when identified rather than deferred in a negative CSM for future release.
For a separate simplified example, expected premium inflows of $1,000 against expected outflows of $1,020 and a $30 risk adjustment indicate a $50 initial loss, assuming no other relevant adjustments.
Subsequent changes are treated according to their nature. Changes relating to future service can affect the CSM where the rules permit, while other changes affect current results or insurance finance amounts. The distinction prevents every change in an estimate from being treated as the same kind of profit movement. The IFRS Foundation’s explanation of insurance profit and loss recognition.
Why contracts are measured in groups
IFRS 17 begins with portfolios of contracts subject to similar risks and managed together. Portfolios are divided further to distinguish loss-making business and different profitability characteristics.
Under the standard issued by the IASB, a group cannot include contracts issued more than one year apart. The grouping rules help prevent profitable new business from concealing losses in other contracts. The IFRS Foundation’s explanation of grouping.
These accounting groups are not necessarily the same as a product name, distribution channel, or policy year in an operational report. The organization needs a consistent mapping between the business it administers and the groups it measures.
General model, PAA, and VFA
The general measurement model provides the foundation. Two other commonly discussed approaches address particular contract characteristics.
The premium allocation approach, or PAA, simplifies measurement of remaining coverage for eligible groups. Eligibility can arise where each contract’s coverage period is one year or less, or where the simplified measurement is reasonably expected not to differ materially from the general model. It does not remove the need to measure incurred claims appropriately. The IFRS Foundation’s discussion of PAA eligibility.
The variable fee approach, or VFA, modifies the general model for insurance contracts meeting the conditions for direct participation features. It addresses arrangements in which policyholder returns are linked to underlying items and the insurer provides the relevant services. The IFRS Foundation’s overview of the VFA.
These approaches are selected according to eligibility and contractual features. They are not interchangeable accounting choices for any product.
Insurance revenue is different from premium cash received
IFRS 17 insurance revenue reflects services provided during the reporting period. Investment components are excluded from insurance revenue and the corresponding insurance service expenses.
Consequently, a large premium receipt is not automatically revenue of the same amount on that date. Written premium, premium cash, and IFRS 17 revenue answer different questions and should retain distinct labels in reports. The IFRS Foundation’s explanation of insurance revenue.
The balance sheet also distinguishes obligations for remaining coverage, concerning services still to be provided, from incurred claims, concerning insured events that have already occurred. A policy can have both kinds of obligations at the same reporting date.
Reinsurance held and the supporting data
Reinsurance held is accounted for separately, with requirements adapted to the nature of the protection purchased. It has its own coverage, cash flows, counterparty considerations, and measurement. Its eligibility for a simplified approach need not match that of the underlying policies. The IFRS Foundation’s guide to reinsurance held.
Producing the numbers requires connected records: policy terms and coverage dates, premiums, acquisition costs, claims, reinsurance, assumptions, and accounting-group assignments. Historical versions matter because the insurer needs to explain how an opening balance became a closing balance.
A policy administration system supplies operational facts, while actuarial and finance processes apply the measurement and accounting rules. A change to a policy or claim needs to reach those processes with its effective date and a traceable explanation.
IFRS 17 and Solvency II
IFRS 17 supports financial reporting about insurance contracts and performance. Solvency II supports prudential supervision, including the capital needed to withstand risk.
Both use estimates of future obligations, but their objectives and calculations differ. In particular, Solvency II has no equivalent to IFRS 17’s CSM. An insurer can share underlying data between the two processes without treating their resulting balances as identical. The IFRS Foundation’s comparison with regulatory reporting.
