April 2020

In brief

IFRS 17 Insurance Contracts—Why annual cohorts?

Hans Hoogervorst
IASB Chair

This article explains why the International Accounting

Standards Board (Board) has retained unchanged the annual
cohort requirement in IFRS 17 Insurance Contracts for grouping
insurance contracts to measure and recognise profit.
The Board has decided annual cohorts are necessary to provide
useful information about an insurance company’s financial
performance, in particular about changes in profitability over
time. Any exemption from the requirement, even if aimed at
the very limited population of contracts for which the costs
and benefits of the requirement might be open to question,
runs too great a risk of an unacceptable loss of information.

The Board has concluded its redeliberations of the The Board is particularly concerned that financial
Exposure Draft of targeted amendments to IFRS 17. reporting presents fairly the financial performance
of businesses in each period and how profitability
The requirement to use annual cohorts as part of
changes over time. As emphasised by the Board’s
the process of accounting for the contractual service
Conceptual Framework, IFRS Standards must
margin (CSM) has been the cause of much debate
result in useful information about financial
since IFRS 17 was issued.1 In their responses to
performance as well as financial position. Much of
the Exposure Draft, some stakeholders advocated
existing insurance contract accounting is founded
the removal or amendment of the annual cohort
on prudential regulation that has a primary
requirement for some or all insurance contracts.
focus on solvency. We believe the dual focus of
However, the Board took the decision in February
IFRS Standards on financial performance and
2020 to confirm again the requirements in IFRS 17
financial position greatly enriches the information
relating to annual cohorts.
provided in financial statements. The statements of
In this article I explain the reasons for the Board’s financial performance often serve as a canary in the
decision. coal mine. An erosion of profits may be a foreboding
The Board sets Standards based on important of problems to come.
principles, such as identifying useful information
as having characteristics of relevance and faithful
representation.

1 The annual cohort requirement relates to the timing of the recognition of the profit in the contract, the CSM, in profit or loss. The CSM is determined for
groups of contracts and recognised in profit or loss when services are provided to the policyholders in that group. At a minimum, groups cannot include
contracts that were issued more than 12 months apart.

In brief: IFRS 17 Insurance Contracts—Why annual cohorts? | April 2020 | 1

To ensure a faithful representation of profit or loss, • Bank loan loss provisions—banks are required
one of the central principles of accrual accounting to calculate loan loss provisions on a loan-by-loan
is that income and expenses are recognised in the basis. If one borrower defaults (or shows increased
accounting period to which they relate. Profit risk of default) then that loan is written down and
should not be anticipated and recognised before a loss recognised. This requirement applies even
it has been earned, nor should it be artificially though banks, like insurance companies, often
deferred and recognised after a transaction has have voluminous contract portfolios and manage
been completed. This is particularly important for their businesses by pooling risks.
insurance contracts where there is a significant
• Fixed asset accounting—the price paid for fixed
timing difference between the cash flows and
assets is recognised as a depreciation expense over
the provision of the related services, where the
the useful life of the asset based upon how that
duration of contracts is long, and where features
asset contributes to the business. This calculation
of contracts, such as financial guarantees, have
is done at an individual asset level to ensure
different effects on contracts issued in different
that the appropriate depreciation expense is
economic conditions.
recognised in the appropriate accounting period.
Most financial reporting is applied In each of these situations, Standards that would
at the individual contract level have allowed the accounting requirements to be
applied at a more aggregated basis might have
In standard-setting many of the accounting
been less costly to apply, but could have led to
requirements are driven by what we call the
profit measures that would not faithfully represent
level of aggregation—whether accounting rules
performance. The Board and stakeholders accept
are applied to individual transactions, applied
that the cost of accounting for individual contracts
at a more granular level, such as components of
(which in the case of banks, for example, can be
transactions, or applied on a more aggregated basis.
very significant) is outweighed by the benefits of the
An appropriate level of aggregation is essential
resulting information.
to prevent onerous contracts being obscured by
profitable contracts or older, profitable contracts Although in principle the accounting should be
from masking the performance of newer contracts applied on a contract-by-contract basis, in practice
with lower profit margins. this may not always be necessary to achieve an
equivalent outcome. For example, if a group of
In fact, for most purposes it is the individual
fixed assets are similar in nature, have the same
contracts that drive financial reporting. Here are
useful economic lives and are unlikely to become
some examples:
individually impaired, then accounting for this
• Revenue recognition—each contract with group as a single ‘unit of account’ may produce
a customer is accounted for separately. the same answer as accounting for each asset
Consideration paid is recognised as revenue individually. When this is the case accounting for
only when goods or services are provided to individual contracts may not be necessary. This also
the customer. applies to annual cohorts, as I explain below.

In brief: IFRS 17 Insurance Contracts—Why annual cohorts? | April 2020 | 2

So why not just account for If annual cohorts are not applied then it is likely
that:
individual insurance contracts?
• there will be co-mingling of different generations
The Board accepts that applying insurance
of contracts with different profitability, or
accounting at the individual contract level would
different changes in profitability, which could
often not be appropriate for insurance contracts.
result in profit being anticipated or deferred
The insurance business model is one of risk pooling
rather than being recognised as it is earned.2
and risk sharing. Some insurance contracts
These effects on the recognition of profit obscure
result in claims and others do not. In addition,
the presentation of the effects of different pricing
the probability of a future claim may increase for
decisions at different times, resulting in a lack of
some contracts during the coverage period but for
accountability for such decisions and impaired
others it declines. This means that some individual
ability for users of financial statements to model
contracts may incur losses or become onerous
future profitability.
even though the development of the group of
contracts is as expected. Accounting for individual • the recognition of a loss arising from onerous
contracts may result in losses being recognised insurance contracts would be delayed, potentially
during the early stages of the development of a for many years. In every other industry, if
group, only to be offset by later profits. The Board transactions turn sour and become unprofitable
decided that the best way to avoid this, and to then losses are recognised immediately this
present a fair development of the performance of becomes apparent.
insurance contracts, is to select a unit of account As a result, the absence of annual cohorts might
that is broader than the individual insurance lead to highly imprudent accounting, because
contract, but not so broad as to make a faithful of the failure to recognise profits or losses on
representation of an insurance company’s financial contracts in the appropriate periods.
performance impossible.
Objections to annual cohorts raised
Annual cohorts essential for
during the recent consultation
prudent accounting
Many respondents to the recent Exposure Draft of
The Board considered different approaches for the targeted amendments to IFRS 17 commented on
aggregation of insurance contracts into groups the Board’s decision not to propose any changes to
or portfolios, including segregation based on the annual cohort requirement. Some, including
similar profitability. The Board concluded the best several users of financial statements and securities
approach is one where insurance contracts are regulators, expressed support for the Board’s
broadly grouped based on expected profitability at decision not to amend the requirement and
initial recognition, including the separation of any urged the Board to reaffirm that decision. Other
contracts that are onerous at initial recognition. respondents asked the Board to amend or delete the
To this we added the annual cohort requirement, requirement.
meaning that all contracts in a group must have
originated within a 12-month period. The Board The objections to annual cohorts focused on
decided that the cohort approach is essential to insurance contracts that share risks across
ensure that aggregation is not so great as to generations of policyholders. Those objections
render profit measures meaningless. are that annual cohorts fail to reflect that
intergenerational sharing of risk or that CSM
allocations between annual cohorts may be
arbitrary. There were also concerns expressed over
the implementation cost for these contracts.

2 Advanced recognition of profit would occur where newly issued contracts are more profitable than those issued previously. If all contracts are combined,
then part of this higher profit is recognised earlier than it should be, considering the timing of services provided to each group of policyholders.

In brief: IFRS 17 Insurance Contracts—Why annual cohorts? | April 2020 | 3

 Do annual cohorts fail to reflect Of course, the smaller the insurer’s share of the
intergenerational sharing of risk? effect of the guarantee, the less likely it is that effect
will make an annual cohort onerous. However,
Some insurance contracts include provisions the global economy is in uncharted territory,
whereby different generations of policyholders with negative interest rates putting the insurance
share in a common pool of underlying assets, industry under severe stress. Rare events might
sometimes called mutualisation. Some stakeholders occur, and it is very important that accounting
argue that, as a consequence of mutualisation, standards perform well under such extreme stress
the profitability of each annual cohort is the same and result in transparent information.
and that no individual annual cohort can become
onerous without the whole portfolio being onerous. The application of annual cohorts is accordingly
As a result, they said annual cohorts are not needed very important. A failure to account for CSM by
for these contracts. annual cohort may result in financial statements
that do not recognise losses on a timely basis and do
The Board believes that intergenerational sharing not present meaningful trends in profitability.
of risk is not by itself sufficient to make annual
cohorts unnecessary. The extent of mutualisation  Do annual cohorts result in arbitrary
varies widely across different contracts—both in allocations?
the type of risk being shared and in the extent
to which the insurer retains some share of risk. Intergenerational sharing of risk, coupled with
Contracts that share all types of risks fully across discretion by the insurer over the sharing of returns
policyholders with the insurer bearing no risk are on underlying items between the insurer and
very uncommon. Much more common are contracts policyholders, requires adjustments to allow for
under which either (i) some types of risk are not changes in the fulfilment cash flows and, hence,
shared with policyholders or (ii) the insurer shares the CSM of each annual cohort. Some stakeholders
all types of risk with policyholders to some extent argued that these adjustments are, in effect,
but retains some share itself, or (iii) a combination arbitrary and that consequently the separate CSM
of both (i) and (ii). For these contracts, significant of each annual cohort is not meaningful.
differences in financial performance can occur The Board disagreed with this assessment and
between different annual cohorts, particularly when believes that, while judgement is required in these
contracts include minimum return guarantees. circumstances, the objective of the adjustments
Even if these guarantees are themselves is clear, and the outcome should still provide
mutualised—ie their effect is shared across relevant information about the profitability of
generations of policyholders—the insurer will still each annual cohort. The adjustments depict the
bear its share of the effect unless the contracts are extent to which profits from existing contracts
part of a mutual fund with no residual interest held are expected to subsidise future contracts or vice
by the insurer. The insurer’s share of the effect versa. For example, an insurer may issue new
could cause an individual annual cohort to become contracts that would be onerous were they not
onerous. to be subsidised by returns generated on invested
premiums from previous contracts.
This effect is one of the reasons why the Board
thinks that the application of annual cohorts is The Board agrees with stakeholders that argue
so important—minimum return guarantees are such subsidisation is a fundamental principle for
prevalent in many jurisdictions in insurance contracts with intergenerational sharing of risk.
products that participate in the returns on Accordingly, IFRS 17 requires the effect of that
underlying items. Falling interest rates have resulted subsidisation to be included in the measurement of
in many of these guarantees being ‘in the money’ the annual cohorts.
and the contracts onerous for the insurer.

In brief: IFRS 17 Insurance Contracts—Why annual cohorts? | April 2020 | 4

The resulting measures of the expected profit (after The Board concluded that any exemption would
the subsidisation is reflected) from new business are add further complexity to the Standard and would
similar to those provided in many existing insurance involve too great a risk of an unacceptable loss of
accounting practices—what has been missing to useful information.
date is any information on how that expected profit
The Board also felt that some methods initially
emerges or changes over time. Annual cohorts
considered by insurers for applying annual cohorts
provide such information.
were unnecessarily complex. Consequently, the
The Board concluded that tracking by annual cohort Board considered that the cost is potentially not
the information that results from the judgements as high as some suggest and noted that this is
an insurer makes in determining the adjustments becoming increasingly apparent as implementation
for the subsidisation between contracts will of the Standard progresses. For example, although
provide useful insights about how management the CSM for each annual cohort should be kept
expects business to develop and could assist users separate for the purpose of determining when that
of financial statements to hold management to profit is recognised, this requirement does not apply
account based on those expectations. to other elements of an insurance contract liability.
In particular, the measurement of fulfilment cash
 Are annual cohorts too costly for flows is not affected by the level of aggregation and
contracts with intergenerational sharing may be done at a higher level, as long as changes in
of risks? fulfilment cash flows can be allocated appropriately
to the CSM balance of each annual cohort.
It is important that IFRS Standards provide good
quality financial information to users of financial Finally, in practice annual cohorts may not always
statements but at a reasonable cost to preparers. be necessary. The requirements in IFRS 17 specify
Some stakeholders thought that it would be the amounts to be reported, not the methodology
burdensome to analyse CSM by annual cohort, in to be used to arrive at those amounts. In some
particular for contracts with intergenerational cases, applying the IFRS 17 requirements at a more
sharing of risk, and that consequently the aggregated level than envisaged by the annual
requirement did not pass the ‘cost-benefit’ test. cohort requirement may produce an outcome that is
not materially different from the outcome applying
The Board considered these arguments carefully
the annual cohort requirement. For example, if
and concluded that while the use of annual
all insurance contracts have the same profitability
cohorts adds complexity to accounting systems, the
and changes in estimates affect them equally then
requirement is still appropriate considering the
annual cohorts may not be necessary. The same
significant benefit to users of financial statements.
may be true for some participating contracts where
As explained above, the annual cohort requirement
returns are mutualised amongst policyholders,
results in useful information even for insurance
with no share of the returns being retained by
contracts that mutualise the returns on underlying
the insurer.
items and related minimum return guarantees.
There is only a very limited population of contracts This possibility—that applying the annual cohort
with specific features for which the balance of requirement may not always be necessary—is
the costs and benefits could be open to question. explicitly acknowledged in IFRS 17 and explained in
Further, it has proved impossible to identify robustly the Basis for Conclusions.3
that limited population of contracts for which an
exemption from the annual cohort requirement on
cost-benefit grounds might be justifiable.

3 Paragraph BC138 of the Basis for Conclusions on IFRS 17.

In brief: IFRS 17 Insurance Contracts—Why annual cohorts? | April 2020 | 5

Deliberations (and redeliberations) On the question of annual cohorts, the Board
again concluded that the costs of the requirement
The Board has not taken the decision to retain were outweighed by the benefits of the resulting
annual cohorts lightly. The Board has debated and information. In fact, the Board concluded that
consulted on the issue on many occasions during the costs to investors of any exemption from the
the development of the Standard, during the requirement would be excessive, in terms of the
implementation phase after IFRS 17 was issued, risk of the loss of critical information and the
in the development of the targeted amendments difficulty in assessing the effect of the exemption.
to the Standard in the recent Exposure Draft, and
finally in the subsequent redeliberations. As is It is now time to implement the
always the practice with the Board, consultation Standard
with stakeholders has been extensive. All Board
papers and Board meetings have been public, and One of the Board’s objectives in this project is to
stakeholders have been forthcoming with their demystify the financial statements of insurance
advice and feedback. It is only after the most careful companies. Many investors consider that insurance
consideration that the Board has taken the decision accounting is accessible only to specialists and
to confirm that insurers should use annual cohorts even then does not satisfy their needs, as evidenced
when accounting for the CSM.4 by the widespread use of alternative reporting
methodologies, such as embedded value reporting.
The Board has demonstrated its willingness to It has been acknowledged by many stakeholders
consider and respond to the concerns of the that IFRS 17 will transform the quality of reporting,
insurance industry throughout the development make the insurance sector more ‘investible’ and
of IFRS 17. In response to feedback, the Board made improve communication between insurers and their
substantial changes to its proposals, for example investors.5 The targeted amendments to IFRS 17
the introduction of the variable fee approach and will shortly be finalised; it is now time to focus on
the option to use other comprehensive income. implementation.
These changes have added to the complexity of the
Standard and the costs for all involved, including
investors. However, the Board was persuaded by the
insurance industry that those costs were outweighed
by the benefits of the resulting information.

The views expressed in this article are those of the author as an individual and do not necessarily reflect the views of the
International Accounting Standards Board (Board) or the IFRS Foundation (Foundation). The Board and the Foundation
encourage members and staff to express their individual views. This article has not undergone the Foundation’s due process.
The Board takes official positions only after extensive review, in accordance with the Foundation’s due process.

4 More information about the Board’s deliberations regarding annual cohorts, together with worked examples to demonstrate the effect of not applying the
requirement, can be found in the Board paper Agenda Paper 2B Level of aggregation—annual cohorts for insurance contracts with intergenerational sharing of risks
between policyholders of the February 2020 Board meeting.
5 Extract from an analyst report for investors commenting on IFRS 17: ‘We think there will be a huge amount of information given to help investors
understand the movement of value and cash components that are currently either ignored or wrapped into a single black box under IFRS 4.’
Extract from factsheet IFRS 17 prepared by an insurer implementing IFRS 17: ‘As well as resulting in considerable implementation costs, this radical overhaul
of external reporting will also create numerous opportunities for the insurance industry in the long term: (a) the more economical representation of
insurance contracts, especially those in the life insurance business, will bring internal and external accounting closer together; (b) it may be possible to
re-use the IFRS financial statements to calculate own funds as defined by Solvency II regulation, which use a similar measurement framework, eliminating
duplication of effort; (c) all of this will create preconditions required to strengthen the transparency of the insurance industry.’

In brief: IFRS 17 Insurance Contracts—Why annual cohorts? | April 2020 | 6