158 | Just Group PLC | Annual Report and Accounts 2023
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS continued
1. MATERIAL ACCOUNTING POLICIES continued
Note
Item involving judgement
Critical accounting judgement
1.5, 26 Calibration of risk adjustment for insurance contract liabilities and reinsurance assets and liabilities
IFRS 17 requires that the future cash flows are adjusted by the risk adjustment for non-financial risk. The risk adjustment for non-financial risks reflects the adjustment to the best estimate cash flows required to provide a 70% level of confidence that longevity, expense and insurance contract specific operational risks will be covered by the liabilities when viewed over the lifetime of the contracts. This judgement represents the level of compensation that the Group requires for bearing the uncertainty regarding the amount and timing of the cash flows that arises from non-financial risk and is used as a core parameter within the Group’s pricing framework when assessing the profitability of new business. The reinsurance risk adjustment represents the extent to which non-financial risks are transferred to reinsurers and is measured using the same calibrations as applied to the underlying contracts. The CSM is recognised at point of sale based on the value of the fulfilment cash flows, including directly attributable acquisition expenses. The CSM is recognised in profit and loss over the terms of services provided to policyholders (coverage units). Coverage units will vary depending on the type of service provided. The Group uses the probability of the policy being in force in each time period for weighting the disparate types of coverage unit. This weighting reflects management’s view that the value of services provided to policyholders is broadly equivalent across the different phases in the life of contracts. These weightings are applied to the coverage units which are defined as follows: • In the deferred phase of Defined Benefit policies, investment return service coverage units are represented by the return on the funds backing the future cash flow liability in this accumulation phase. Insurance service in this phase is considered insignificant. • In the guaranteed phase of Defined Benefit and Guaranteed Income for Life policies, when payments outwards are being made regardless of any insurance event, investment return service is represented by the payments to annuitants. • In the life contingent phase of all policies, insurance service is represented by payments to annuitants, as confirmed by the IASB Interpretation Committee (“IFRIC”) during 2022. Assessment of fair value hierarchy for financial investments, which considers the market observability of valuation inputs. Where the market is not active, such as for illiquid assets including commercial mortgages, infrastructure loans and long income real estate, management applies judgement in selecting the appropriate valuation technique. The Group has selected and used a variant of the Black-Scholes option pricing formula with real world assumptions to determine the fair value of the no-negative equity guarantee component of the fair value of loans secured by residential mortgages. The Group has selected to use real world assumptions instead of risk neutral assumptions due to the lack of relevant observable market inputs to support a risk neutral valuation approach. This selected measurement approach is in line with common industry practice and there does not appear to be an alternative approach that is widely supported in the industry. We acknowledge that there has been significant recent academic and market debate concerning the valuation of no-negative equity guarantees and we intend to continue to actively monitor this debate.
1.5, 26 Subsequent measurement of CSM for insurance contracts
1.6.3 Financial assets – valuation method
1.6
The selection of an appropriate measurement model to determine the fair value of loans secured by residential mortgages which includes the no-negative equity guarantees
The table below sets out those items the Group considers susceptible to changes in critical estimates and assumptions.
Note
Item involving estimate
Critical estimates and assumptions
1.4
Determination of the fair value of insurance and reinsurance contracts issued prior to 1 January 2021
The Group has determined the fair value of these insurance contracts on 1 January 2022. The critical assumptions used as part of the determination of fair value included the selection of an appropriate weighted average cost of capital, the appropriate level of solvency capital required, and the selection of the asset portfolio to determine the discount rate. A comprehensive description of the approach applied, and the inputs used in the determination of fair value can be found in note 1.4.
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