Strategic Report | Governance | Financial Statements | 157
1. MATERIAL ACCOUNTING POLICIES continued 1.6.6. Financial assets measured at amortised cost
Financial assets held at amortised cost are measured using the effective interest rate method and are impaired using an expected credit loss model. The model splits financial assets into those which are performing, underperforming and non-performing based on changes in credit quality since initial recognition. At initial recognition financial assets are considered to be performing. They become underperforming where there has been a significant increase in credit risk since initial recognition, and non-performing when there is objective evidence of impairment. 12 months of expected credit losses are recognised within expenses in the Consolidate statement of comprehensive income and netted against the financial asset in the Consolidated statement of financial position for all performing financial assets, with lifetime expected credit losses recognised for underperforming and non-performing financial assets. Expected credit losses are based on the historic levels of loss experienced for the relevant financial assets, with due consideration given to forward-looking information. The most significant categories of financial assets held at amortised cost for the Group are its portfolio of investments in sovereign gilts (see note 19) and cash available on demand. Investments are reclassified from performing to under-performing when coupons become more than 30 days past due, in line with the presumption set out in IFRS 9, or when the financial institution is no longer considered to be investment grade by the rating agents. Due to the nature of the investment in sovereign gilts, the Group concludes that these investments are low credit risk and there has been no significant deterioration in credit risk in the investments. 1.6.7. Investment contract liabilities Investment contracts are measured at fair value through profit or loss in accordance with IFRS 9. The fair value of investment contracts is estimated using an internal model and determined on a policy-by-policy basis using a prospective valuation of future retirement income benefit and expense cash flows. 1.6.8. Loans and borrowings Loans and borrowings are initially recognised at fair value, net of transaction costs, and subsequently amortised through profit or loss over the period to maturity at the effective rate of interest required to recognise the discounted estimated cash flows to maturity. There is no change in accounting for loans and borrowings on adoption of IFRS 9. 1.6.9. Other financial liabilities Except for derivative financial liabilities, all other financial liabilities are held at amortised cost and measured using the effective interest rate method. 1.7. Material accounting policies and the use of judgements, estimates and assumptions The preparation of financial statements requires the Group to select accounting policies and make estimates and assumptions that affect items reported in the Consolidate statement of comprehensive income, Consolidated statement of financial position, other primary statements and Notes to the financial statements. The adoption of IFRS 17 and IFRS 9 by the Group has resulted in changes to significant accounting estimates and judgements. All estimates are based on management’s knowledge of current facts and circumstances, assumptions based on that knowledge and predictions of future events and actions. Actual results may differ significantly from those estimates. Sensitivities of investments and insurance contracts to reasonably possible changes in significant estimates and assumptions are included in notes 20(d) and 26(h) respectively. The major areas of judgement used as part of accounting policy application are summarised below.
Note
Item involving judgement
Critical accounting judgement
1.3
Method of transition in the adoption of IFRS 17
The Group has concluded that is impracticable to apply the fully retrospective approach to all insurance and reinsurance contracts prior to 1 January 2021 and has elected to adopt the fair value approach to these contracts. The Group has elected to apply the top-down approach for the determination of discount rates. Discount rates are determined based on a reference portfolio of assets and allow for deductions for credit risk (both expected and unexpected). The reference portfolio consists of the actual asset portfolio backing the net of reinsurance best estimate liabilities and risk adjustment and is adjusted in respect of new contracts incepting in the period to allow for a period of transition from the actual asset holdings to the target portfolio where necessary. No adjustment for liquidity differences between the reference portfolio and the liabilities is made. For calculation of the CSM at the inception of contracts, discount rates are based on the yields from a reference portfolio assumed to be represented by the current target portfolio mix based on the latest investment strategy. A weighted average discount rate curve is used for accreting interest on the CSM and for calculating movements in the CSM due to changes in fulfilment cash flows relating to future service. This separate “locked-in” discount rate curve, is determined for each annual cohort at the end of the cohort’s first year and then does not change throughout the remainder of life of the group of contracts.
1.5
Selection of method to determine the discount rate for insurance and reinsurance contracts
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