6.3.2.3. Measurement methods

Liability for remaining coverage corresponding to an entity’s obligation to:

• investigate and pay valid claims under existing insurance contracts for insured events that have not yet occurred (i.e., the obligation that relates to the unexpired portion of the insurance coverage); and
• pay amounts under existing insurance contracts that are not included in the aforementioned point and that relate to:
  • insurance contract services not yet provided (i.e., the liabilities that relate to the future provision of insurance contract services); or
  • any investment components or other amounts that are not related to the provision of insurance contract services and that have not been transferred to the liability for incurred claims.

On initial recognition, the total insurance contract liability comprises the liability for remaining coverage, and the carrying amount is zero for non-onerous contracts.

In line with the general measurement model, as well as within the variable fee approach, on initial recognition, the liability for remaining coverage is measured as:

• • the amount of cash flows from the performance of the contracts described in Section 6.3.2.4; and
• contractual service margin, representing unearned profit

The premium allocation approach does not account for the contractual service margin, risk adjustment for non-financial risk and the adjustment to reflect the time value of money. The liability for remaining coverage on initial recognition is measured as:

• premiums received on initial recognition;
• minus any insurance acquisition cash flows as at that date, unless the entity allows and decides to recognize these payments as expenses; and
• plus or minus any amount arising from the derecognition as at that date of:
  •  any assets for insurance acquisition cash flows paid before the date of initial recognition of the group of insurance contracts; and
  • any other asset or liability previously recognized for cash flows related to the group of contracts.

After initial recognition, as at the end of each reporting period liability for remaining coverage, excluding contractual service margin, is reassessed using fulfilment cash flows concerning contracts related to the subsequent coverage period, i.e., it covers the best estimate present value of the cash flows required to fulfil the liability together with a risk adjustment for non-financial risk.

In line with the general measurement model and variable fee approach, as at the end of the reporting period, liability for remaining coverage excluding contractual service margin is computed as:

• liability for remaining coverage as at the start of the reporting period, equal to the value of the said liability as at the end of the previous reporting period;
• plus/minus estimate expected amounts related to the payments of premiums, claims and expenses which are to be incurred in the reporting period, as estimated as at the previous reporting date;
• plus/minus changes in estimates resulting from changes in assumptions relating to future services;
• plus/minus interest accreted on the present carrying amount of future cash flows and risk adjustment for non-financial risk within the reporting period, with a discount rate applied on initial recognition;
• plus/minus the remaining interest accreted using current discount rates.

In line with the premium allocation approach, as at the end of the reporting period, the liability for remaining coverage is measured as:

• the value of the said liability as at the start of the period;
• plus the premiums received in the period;
• minus insurance acquisition cash flows;
• plus any amounts relating to the amortization of insurance acquisition cash flows recognized as an expense in the reporting period;
• plus any adjustment to a financing component, if applied;
• minus the amount recognized as insurance revenue for services provided in that period; and
• minus any investment component paid or transferred to the liability for incurred claims.

In the light of the foregoing, the PZU Group recognizes income and expenses for the following changes in the carrying amount of the liability for remaining coverage:

• insurance revenue — for the reduction in the liability for remaining coverage because of services provided in the period;
• insurance service expenses — for losses on groups of onerous contracts, and reversals of such losses;
• insurance finance income or expenses — for the effect of the time value of money and the effect of financial risk.

The contractual service margin is determined for non-onerous contracts at the initial recognition and reflects unearned profits. It is then released as profit over the life of the contract (group of contracts).

Contractual service margin may be defined as expected cash flows minus cash flows within the contract boundary, adjusted for non-financial risk and time value of money.

Contractual service margin is not determined when the premium allocation approach is applied. In line with the general measurement model and variable fee approach, the PZU Group measures contractual service margin on initial recognition of a group of contracts at an amount that results in no income or expenses arising from:

• the initial recognition of an amount for the fulfilment cash flows;
• any cash flows arising from the contracts in the group at that date;
• the derecognition at the date of initial recognition of:
  • any asset for insurance acquisition cash flows;
  • any other asset or liability previously recognized for cash flows related to the group of contracts.

As a rule, contractual service margin may not be used to recognize losses over time. Loss identified on recognition of a group of contracts is recognized in the financial result at an amount corresponding to the excess expected future cash flows over the expected future flows accounting for non-financial risk (through risk adjustment for non-financial risk). This approach is the opposite of the way to recognize the expected profit from insurance business, which is distributed over time in proportion to the insurance service provided.

Contractual service margin as at the end of the reporting period reflects the profit in the group of insurance contracts that has not yet been recognized in the financial result because it relates to future service to be provided under the contracts in the group.

As at the end of the reporting period, the carrying amount of the contractual service margin for a group of insurance contracts without direct participation features, measured in line with the general measurement model, equals the carrying amount as at the start of the reporting period adjusted for:

• the effect of any new contracts added to the group;
• interest accreted on the carrying amount of the contractual service margin during the reporting period, measured at the discount rates on initial recognition (so-called locked-in rates);
• the changes in fulfilment cash flows relating to future service, except to the extent that:
  • such increases in the fulfilment cash flows exceed the carrying amount of the contractual service margin, giving rise to a loss; or
  • such decreases in the fulfilment cash flows are allocated to the loss component of the liability for remaining coverage;
• the effect of any currency exchange differences on the contractual service margin; and
• the amount recognized as insurance revenue because of the transfer of insurance contract services in the period, determined by the allocation of the contractual service margin remaining at the end of the reporting period (before any allocation) over the current and remaining coverage.

As at the end of each reporting period, the carrying amount of the contractual service margin for a group of insurance contracts with direct participation features, measured in line with the variable fee approach, equals the carrying amount as at the start of the reporting period adjusted for:

• the effect of any new contracts added to the group;
• the change in the amount of the entity’s share of the fair value of the underlying items;
• the changes in fulfilment cash flows relating to future service;
• the effect of any currency exchange differences on the contractual service margin; and
• • the amount recognized as insurance revenue because of the transfer of insurance contract services in the period, determined by the allocation of the contractual service margin remaining at the end of the reporting period (before any allocation) over the current and remaining coverage.

The loss component is part of the liability for remaining coverage and represents losses from the group of onerous contracts. Initial loss is separate in the financial result, and, adjusted in subsequent periods for further losses, reversal of losses, and release over time, so that the loss component for a group of contracts is zero until the end of the coverage period of a group of contracts.

The loss component is set regardless of the measurement model applied (i.e., it is set for the general measurement model, variable fee approach, and the premium allocation approach).

An insurance contract is onerous at the date of initial recognition if the fulfillment cash flows (adjusted for non-financial risk and the time value of money) allocated to the contract, any previously recognized insurance acquisition cash flows and any cash flows arising from the contract at the date of initial recognition in total are a net outflow, recognized in the financial result.

For the purpose of the premium allocation approach, if at any time during the coverage period, facts and circumstances indicate that a group of insurance contracts is onerous, the entity establishes a loss component which can be expressed as the difference between the carrying amount of the liability for remaining coverage computed in line with PAA and the fulfilment cash flows that relate to remaining coverage of the group in line with the general model.

For the general measurement model and the variable fee approach, an insurance contract or group of insurance contracts becomes onerous (or more onerous) on subsequent measurement if unfavorable changes relating to future service arising from changes in estimates of future cash flows and the risk adjustment for non) exceed the carrying amount of the contractual service margin. In this case, the PZU Group recognizes the loss in profit or loss at the amount equal to the said excess.

If on subsequent measurement, there are favorable changes relating to future service, the PZU Group recognizes profit (reversal of losses) in profit or loss to the maximum amount of the loss component. Should favorable changes in measurement exceed the value of the loss component, the PZU Group recognizes profit equal to the recognized loss component, whereas the excess is recognized as contractual service margin in profit or loss in future periods.

In the case of the premium allocation approach, the valuation of the loss component in later periods is carried out using the same calculation method as at initial recognition.

Liability for incurred claims corresponds to an entity’s obligation to:

• investigate and pay valid claims for insured events that have already occurred, including events that have occurred but for which claims have not been reported, and other incurred insurance expenses; and
• pay amounts that are not included in the aforementioned point and that relate to:
  • insurance contract services that have already been provided; or
  • any investment components or other amounts that are not related to the provision of insurance contract services and that are not in the liability for remaining coverage.

In all measurement models, on initial recognition of a group of contracts, the liability for incurred claims is usually equal to zero, because no insured events have yet occurred.

The liability for incurred claims has to be established (separately for each insured event type) following a single insured event, covering the expected payment of claims for such a single insured event for which the claims have not yet been fully paid.

Liability for incurred claims covers cash flows related to the service performed as at the reporting date. The measurement of this liability is based on the same requirements concerning

• estimates of the future cash flows;
• discount rates; and
• risk adjustment for non-financial risk, which also apply to the liability for remaining coverage on initial and subsequent measurement.

For each reporting period, liability for incurred claims is measured as fulfillment cash flows related to incurred claims. This means that it covers the present value of expected estimates of future cash flows required to settle the liability for incurred claims and expenses for each insured event, along with risk adjustment for non-financial risk.

For all measurement methods, as at the end of the reporting period, the liability for incurred claims is estimated as:

• liability for incurred claims as at the start of the reporting period, equal to the liability as at the end of the previous reporting period;
• plus/minus expected cash flows related to past service;
• plus the increase in the liability for claims and expenses incurred in the period but not yet paid;
• plus/minus interest accreted on the best estimate present value of liabilities and risk adjustment for non-financial risk in the reporting period with a discount rate applied on initial recognition (so-called locked-in rate);
• plus/minus the remaining interest accreted using current discount rates.

After initial recognition, an entity recognizes income and expenses for the following changes in the carrying amount of the liability for incurred claims:

• insurance service expenses — for the increase in the liability because of claims and expenses incurred in the period, excluding any investment components;
• insurance service expenses — for any subsequent changes in fulfilment cash flows relating to incurred claims and incurred expenses; and
• insurance finance income or expenses — for the effect of the time value of money and the effect of financial risk.

For the purpose of its computations, the PZU Group has decided to recognize the values on a compound basis from the start of the year to the reporting date (Year To Date – YTD) Because of this, the “previous reporting period” referred to in the points hereinabove is, in every case, the December of the preceding year.