Ported from the open-source IFRS 17 Calculation Engine — ifrs17-template/PracticalUseCases/SingleVsMultipleCsmSwitch/CsmSwitchReports.ipynb — originally written for Systemorph Cloud.

The CSM / loss-component switch

Theory

A fundamental concept of IFRS 17 is the contractual service margin (CSM): the unearned profit an entity expects to earn as it provides service. It is defined at the smallest granularity, the group of insurance contracts (the unit of account), and applies to every approach for the liability for remaining coverage except the premium allocation approach.

Four principles govern the CSM and the loss component:

Principle 1. When an insurer writes profitable business, it may not recognise the expected profit immediately; it must spread that profit over time.

Principle 2. When an insurer writes loss-making business, it may not spread the expected loss over time; it must recognise that loss immediately.

A profitable group carries a CSM next to the risk adjustment and the present value of outflows; a loss-making group carries a loss component next to the present value of inflows.

Principle 3. The CSM is adjusted for every change — every AoC step — that relates to future service. A favourable mortality update increases it; unfavourable lapse experience decreases it.

Principle 4. When business previously expected to be profitable is now expected to be loss-making — because of a change relating to future service, say — the insurer may not spread the expected loss either. It first extinguishes the CSM and then establishes a loss component (LC) for the remaining excess. That is a switch from CSM to LC.

Along the analysis of change the technical margin moves step by step; while its running total is below zero it is allocated to the CSM, once it crosses zero it is allocated to the loss component.

Two switch logics

The technical margin gives, for each AoC step, an amount that is either asset-like (negative, allocated to the CSM) or liability-like (positive, allocated to the loss component). Which side a step goes to depends on the sign of the margin accumulated from the opening to that step. Along the chain the accumulated margin can cross zero several times. How its steps are then allocated is the switch logic, and there are two reasonable ones:

Multiple switches — the allocation may change at every step, whenever the accumulated margin changes sign. This is the open-source engine's standard methodology.
Single switch — the allocation changes at most once per period, and only if the accumulated margin at the opening and at the closing have different signs (an odd number of crossings). With an even number of crossings there is no switch at all.

The original's case study compares two groups with identical inputs — the same parameters, cash flows and actuals — that differ only in the switch logic.

What the comparison shows

The standard implementation computes the margin separately for in force and new business: many analysts treat the new-business part of the CSM as a key performance indicator.

In the case study the opening and the closing margin have the same sign (negative), so intuitively there is no switch. But per novelty the closing balances have opposite signs: in force is always negative, new business always positive. In force is larger in magnitude, so the combined margin is negative, and the combined steps after CL are too small to change that.

Single switch. No loss component is ever recognised, because the opening and the closing are both negative. The new-business contributions are forced onto the CSM side, with a negative sign to show that they reduce it. In the LRC view they cancel the corresponding fulfilment-cash-flow steps, and the CL step is zero — there is nothing to balance.
Multiple switches. New business is recognised in the loss component — it is liability-like on its own — while in force sits in the CSM. The combined liabilities step CL resolves the discrepancy: it adds the two novelties, releases the liability-like amount and allocates the same amount to the CSM.

Both approaches give the same opening and closing LRC; only the AoC steps between differ. In the financial performance the total comprehensive income is the same, and so is the OCI. The insurance service result and the insurance finance income/expense differ, and the differences cancel in profit and loss. The multiple-switch logic shows an explicit loss-component contribution and larger CSM changes, financial and non-financial.

Splitting every figure of the financial performance into financial and non-financial parts creates extra rows that cancel in aggregate. Some find that confusing; others find it transparent. Without that split for the loss component, the financial performance would show no loss-component rows and the same totals. KPIs built on the CSM or the loss component, however, can look very different under the two logics even though the financial performance agrees.

In the MeshWeaver port

The port implements the multiple-switch logic, per novelty: AllocateTechnicalMargin classifies the accumulated margin before and after every step and switches whenever the class changes. There is no single-switch option. How the port treats the CL step, and what is not established there, is on Technical margin. The financial performance, in which the original's comparison shows its differences, is not ported (see Reports and financial performance).