What is it?
The Variable Fee Approach is a variation of the General Measurement Model. The model follows the principles of the GMM but is amended to reflect the measurement of the investment profit an insurer might earn.
When is it used?
The VFA is used for insurance contracts that are substantially investment related contracts. An investment contract in this context is one where the insurer is promising a return based on a pool of underlying items. The standard does however restrict its use to very specific cases. The key words used is that the contract will contain Direct Participation Features (“DPF”).
The standard is very clear on the qualifying rules:
1) The policy holder must participate in a clearly identifiable pool of underlying items,
2) The insurer expects to pay out an amount equating to a share in the return on the underlying items
3) Any amounts payable to the policy holder will vary with changes in the fair value of the underlying items.
How does it work?
It works in a very similar way to the general model and we have the same building blocks and the CSM. The key difference is that included in the measurement of the contract is the entities share of the return on the underlying items, in other words the fee it earns from the investing activities. We can think of this in terms of the discounted future cash flows and risk adjustment including this fee. There are some options in how to set this up but a common approach is to consider two sides to the investing part, the asset and liability side.
The asset side is measured under IFRS9 and the liability side forms part of the measurement of the insurance contract. We can consider the future cash flows as having 3 components, the fair value of the underlying assets, ie the value of the account, the entities share of the return on the underlying assets and the future cash flows that do not vary with the underlying items. The sum of the last two is called the variable fee.
Given that the measurement of the contract reflects the fair movements of the underlying assets already then interest is not accreted on the CSM in the VFA. The non-investment cash flows are discounted using relevant current rates.
The final point to note is that because the contract includes both investment and insurance related services the coverage units and release of the CSM needs to reflect both.