Strategic Report | Governance | Financial Statements | 151
1. MATERIAL ACCOUNTING POLICIES continued 1.5.3. Level of aggregation
Within each legal entity, the Group identifies portfolios of insurance contracts which comprise contracts that are subject to similar risks, and are managed together. Risks included in this assessment comprise both risks transferred from the policyholder and other business risks. For this purpose, Defined Benefit (DB), Guaranteed Income for Life (GIfL), and Care contracts have been determined to represent a single portfolio that is managed together and subject to primarily longevity and financial risk. Minor products including the small protection portfolio that is in run-off have been included in the same portfolio on the grounds of immateriality. The single annual portfolio for reporting purposes is divided into three groups: • contracts that are onerous on initial recognition, if any; • contracts that have no significant likelihood of becoming onerous, if any; and • any remaining contracts in the portfolio. Contracts within the single portfolio that would fall into different groups only because law or regulation specifically constrains the Group’s practical ability to set a different price or level of benefits for policyholders with different characteristics are included in the same group. This applies to contracts issued in the UK that are required by regulation to be priced on a gender-neutral basis. All GIfL and Care contracts are evaluated based on the margins that individual contracts contribute when measured on a gender-neutral basis. The Group has evaluated that these contracts all fall into the remaining contracts grouping in the current year. DB contracts are allocated either to the grouping of those contracts that have no significant likelihood of becoming onerous, or the remainder, based on whether contracts are Solvency II capital generative at inception. Each group of insurance contracts is further divided by year of issue for calculation of the CSM. The resulting groups represent the level at which the recognition and measurement accounting policies are applied. The groups are established on initial recognition and their composition is not reassessed subsequently. Reinsurance treaties are allocated to portfolios depending on whether they transfer longevity and financial (inflation and/or investment) risk or longevity risk alone. The Group has also concluded that both JRL and PLACL hold portfolios of reinsurance contracts that transfer only longevity risk, and that JRL holds a portfolio that transfers longevity risk and financial risks. Reinsurance CSM is computed separately for each reinsurance treaty for each underwriting year. 1.5.4. Contract boundaries The measurement of a group of contracts includes all of the future cash flows within the boundary of each contract in the group. Cash flows are within the boundary of a contract if they arise from substantive rights and obligations that exist during the current reporting period under which the Group has a substantive obligation to provide services or be compelled to pay reinsurance premiums, or can compel reinsurers to pay claims. 1.5.5. Initial measurement On initial recognition, the Group measures a group of profitable insurance contracts as the total of:
• the fulfilment cash flows; and • the CSM, if a positive value.
Fulfilment cash flows include payments to policyholders and directly attributable expenses including investment management expenses. Investment management expenses are considered to be directly attributable if they are in respect of investment activities from which the expected investment returns are considered in setting the price at outset for the policyholder benefits. Fulfilment cash flows, which comprise estimates of current and future cash flows, are adjusted to reflect the time value of money and associated financial risks, and a risk adjustment for non-financial risk. These calculations are maintained at contract level for GIfL and Care business, and at DB scheme member level. Insurance acquisition cash flows which are included in fulfilment cash flows at point of sale are costs incurred in the selling, underwriting and starting a group of contracts that are directly attributable to the portfolio of contracts to which the group of contracts belongs. The risk adjustment for non-financial risk for a group of insurance contracts is the compensation required for bearing uncertainty regarding the amount and timing of the cash flows that arise from non-financial risk. The measurement of the fulfilment cash flows of a group of insurance contracts does not reflect non-performance (own credit) risk of the Group. The detailed policies and methodologies used for the determination of the discount rate and the risk adjustment are included within note 26(b). The CSM of a group of insurance contracts represents the unearned profit that the Group will recognise as it provides services under those contracts. A group of insurance contracts is not onerous on initial recognition if the total of the fulfilment cash flows, any derecognised assets for insurance acquisition cash flows, and any cash flows arising at that date is a net inflow. In this case, the CSM is measured as the equal and opposite amount of the net inflow, which results in no income or expenses arising on initial recognition. If the total of the fulfilment cash flows is a net outflow, then the CSM grouping of contracts is considered to be onerous. The full value of the fulfilment cash flows is recognised as an insurance liability, and the net outflow recognised as a loss component in profit or loss on initial recognition. Reversals of loss components following re-projection of future cash flows are recognised in profit or loss only to the extent that they reverse the loss previously recorded in profit or loss, with any further amounts recognised on the balance sheet by creation of a CSM. The value of the run-off of the loss component as policyholder benefits are paid is excluded from insurance revenue.
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