You have an expected claim and you know it will be paid a year from now. IFRS 17 discounts that claim as one part of measuring the insurance contract liability. So which discount rate do you use, where does it come from and how do you defend it to an auditor or an examiner?
What the rate has to capture
The discount rate under IFRS 17 is not a free choice and it is not simply the yield on the assets the insurer happens to hold. The standard sets out what the rate must reflect: the time value of money, the characteristics of the cash flows being discounted and the liquidity characteristics of the insurance contracts themselves. It must also be consistent with the other estimates, so nothing is counted twice or left out.
Two routes to a rate
Practice has settled on two ways of building a rate. The bottom-up approach starts from a risk-free curve and adds an illiquidity premium. The top-down approach starts from the yield on a reference portfolio of assets and strips out what does not belong to the insurance liabilities. Each puts the judgement in a different place, and the lesson treats them as peers.
When the routes disagree
Compliant approaches can produce different rates. What then? The lesson shows how a different rate moves the opening liability and the later finance expense. The entity then assesses its chosen rate against the IFRS 17 requirements, and the two need not converge.
The presentation choice
Insurance finance expense raises a separate election about where it is presented, either wholly in profit or loss or disaggregated between profit or loss and other comprehensive income, which can leave OCI nil. The lesson sets out both options as peers and follows each into the statements.
What the lesson works through
- what the discount rate must reflect under IFRS 17
- building a bottom-up and a top-down rate
- checking that the rate matches the cash flows it discounts
- discounting, accreting interest and settling the claim
- the journals and the presentation election
Build the rate yourself
Work through the Amatle Institute lesson on IFRS 17 discount rates and see each route built, tested and carried into the books.
Questions about this topic
What must an IFRS 17 discount rate reflect?
The time value of money, the characteristics of the cash flows and the liquidity characteristics of the insurance contracts, consistent with observable market prices and excluding factors that do not affect the insurance cash flows.
What is the difference between the bottom-up and top-down approaches?
Bottom-up starts from a liquid risk-free yield curve and adjusts for the liquidity characteristics of the contracts. Top-down starts from the yield on a reference portfolio of assets and removes factors that are not relevant to the insurance contracts, such as credit risk. The two can produce different rates.
Where is insurance finance income or expense presented?
An entity chooses, as an accounting policy, either to include it all in profit or loss or to disaggregate it between profit or loss and other comprehensive income using a systematic allocation.
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