IFRS 17: What is an Onerous Contract?

IFRS 17 is the new accounting standard for insurance contracts that is expected to replace IFRS 4 by January 1, 2023. One of the key changes brought about by IFRS 17 is the calculation of the liability for insurance contracts, which will now be based on the estimated future cash flows of the contract, rather than the current premiums.

One of the concepts introduced by IFRS 17 is the notion of an „onerous contract“. An onerous contract is a contract that will result in a loss for the insurer, when the estimated future cash flows of the contract are compared to the carrying amount of the contract liability. In other words, an onerous contract is a contract where the insurer is currently paying more in claims and expenses than it is receiving in premiums.

Under IFRS 17, an insurer is required to recognize an onerous contract liability if the expected future cash flows of the contract are negative. The amount of the onerous contract liability is the excess of the carrying amount of the contract liability over the present value of the expected future cash flows of the contract.

It is important to note that the recognition of an onerous contract liability does not necessarily mean that the insurer is in financial difficulty. Rather, it simply means that the insurer is in a situation where the current premiums being collected under the contract are not sufficient to cover the current claims and expenses being paid out.

The recognition of an onerous contract liability will result in a reduction of the insurer`s profit or an increase in its loss for the period. It will also result in a higher liability on the balance sheet, which may impact the insurer`s financial ratios and credit ratings.

In conclusion, IFRS 17 introduces the concept of an onerous contract, which is a contract where the insurer is currently paying more in claims and expenses than it is receiving in premiums. Insurers are required to recognize an onerous contract liability if the expected future cash flows of the contract are negative. The recognition of an onerous contract liability has implications for the insurer`s profit, balance sheet, financial ratios, and credit ratings.