A Closer Look at the Reinsurance Loss-Recovery Component (RLRC) under IFRS 17

Paragraph 284 of the IFRS 17 Basis for Conclusions states that the contractual service margin (CSM) represents the unearned profit arising from a group of insurance contracts. IFRS 17 does not permit this margin to become negative (except for reinsurance contracts held). If an insurer expects a group of insurance contracts to result in a loss (referred to as an “onerous” group) to the insurer, that loss is recognized immediately in the profit or loss statement.

But if the insurer has purchased reinsurance (to recover some of the losses), the related reinsurance contract held will likely result in a gain (positive CSM), which is not recognized immediately. This is because, applying IFRS 17, the insurer measures the present value of the future cash flows for the reinsurance contract held using assumptions consistent with those used to measure the present value of the future cash flows for the group of underlying insurance contracts.

This disconnect between the timing of losses and recoveries would appear to create an accounting mismatch, i.e., the loss from the insurance contracts issued (called underlying insurance contracts) is recognized immediately, but the gain from the reinsurance contract held is delayed. So why can’t the insurer offset the loss from its underlying insurance contracts with the expected recovery from the reinsurer at the same time?

This question was discussed by the IFRS Board in its November 2019 meeting. These discussions resulted in the introduction of the Reinsurance Loss-Recovery Component (RLRC). The RLRC was formally introduced as part of the amendments to IFRS 17 in June 2020.

This article provides some contextual information regarding the RLRC, how it is calculated under IFRS 17, and how it helps solve (to some extent) the accounting mismatch discussed above. To better understand that, the Loss Component (LC) associated with an onerous group of insurance contracts is a reasonable starting point.