Skip to main content
diversification.com
← Back to A Definitions

Adjusted future premium

What Is Adjusted Future Premium?

Adjusted Future Premium refers to the dynamic re-estimation and modification of anticipated premiums and related cash flows within an insurance contracts portfolio. This concept is central to modern insurance accounting standards, particularly International Financial Reporting Standard 17 (IFRS 17), where it impacts the reported financial performance and overall liabilities of an insurer. Unlike a fixed premium, an Adjusted Future Premium acknowledges that future assumptions about factors like mortality, policyholder behavior, and economic conditions can change, necessitating adjustments to the financial representation of the contract.

History and Origin

The evolution of insurance accounting has historically grappled with the long-term nature of insurance contracts and the uncertainty of future events. Early accounting practices for insurance were often tied to national requirements, leading to diverse methodologies that made cross-border comparisons difficult33, 34, 35. The development of specialized insurance accounting standards, like statutory accounting principles (SAP) in the United States, emerged to protect policyholders and ensure insurer solvency, often focusing on conservative reserve calculations31, 32.

A significant shift occurred with the introduction of International Financial Reporting Standard 17 (IFRS 17) by the International Accounting Standards Board (IASB) in May 2017, replacing the interim IFRS 428, 29, 30. IFRS 17 aimed to provide a comprehensive, globally consistent framework for reporting insurance contracts, emphasizing a current measurement model for future cash flows and the recognition of profit over the service period25, 26, 27. This standard inherently mandates the continuous adjustment of future premium expectations, reflecting changes in estimates and providing a more faithful representation of the financial position and performance of insurance contracts over time23, 24. The historical journey of accounting and insurance reflects their intertwined evolution as commerce expanded, necessitating robust systems for risk management and reliable record-keeping.22

Key Takeaways

  • Adjusted Future Premium refers to the ongoing re-evaluation and modification of expected premiums and associated cash flows for insurance contracts.
  • It is a core component of modern insurance accounting standards, especially IFRS 17, ensuring that financial reporting reflects current estimates of future obligations and revenues.
  • The concept aims to provide a more accurate and transparent view of an insurer's profitability and solvency over the long term.
  • Adjustments are driven by changes in actuarial assumptions such as mortality rates, lapse rates, expenses, and investment returns.
  • It differs from a static "adjusted premium" which typically relates to a fixed adjustment made to a premium calculation at a point in time, often for cash surrender value.

Formula and Calculation

While "Adjusted Future Premium" is not represented by a single, universal formula, its essence is captured within the measurement models of IFRS 17, primarily through the adjustments made to the Contractual Service Margin (CSM) and the overall liability for remaining coverage. The CSM represents the unearned profit an insurer expects to recognize as it provides services under the insurance contracts21.

Under IFRS 17's General Measurement Model, the liability for remaining coverage (LRC) is initially recognized as:

LRC=Fulfilment Cash Flows (FCF)+CSM\text{LRC} = \text{Fulfilment Cash Flows (FCF)} + \text{CSM}

Where:

  • (\text{Fulfilment Cash Flows (FCF)}) = Explicit, unbiased, and probability-weighted estimate of the present value of future cash outflows (e.g., claims, expenses) less the present value of future cash inflows (e.g., premiums), including a risk adjustment for non-financial risk20.
  • (\text{CSM}) = An amount representing the unearned profit in the group of contracts19.

Adjusted Future Premium arises when actual premium receipts for future coverage differ from expected premiums (e.g., due to unexpected lapses or changes in policyholder behavior). These differences, known as "premium experience adjustments," relating to future service, lead to a prospective recalibration of the CSM. Positive changes that increase future expected cash flows (e.g., higher-than-expected future premiums) adjust the CSM upwards. Negative changes that reduce future expected cash flows (e.g., lower-than-expected future premiums) adjust the CSM downwards, but cannot create a CSM asset (i.e., the CSM cannot become negative for a profitable group of contracts, in which case a loss is recognized)18.

Interpreting the Adjusted Future Premium

The interpretation of an Adjusted Future Premium is crucial for understanding an insurer's underlying profitability and its ability to meet long-term obligations. When an insurer updates its estimates for future premiums and makes corresponding adjustments, it signals how well the initial pricing and actuarial assumptions align with unfolding reality.

A positive adjustment to future premiums (or the CSM) suggests that the insurer anticipates collecting more revenue or incurring fewer costs than initially projected for future coverage, potentially indicating better-than-expected policyholder persistency or favorable risk experience. Conversely, a negative adjustment implies that future expected revenues are lower, or costs are higher, than originally foreseen, which could lead to a reduction in the CSM or even the recognition of a loss if the contracts become onerous.

This ongoing adjustment provides a dynamic view of an insurance company's financial performance, moving away from "locked-in" assumptions to reflect current best estimates. For stakeholders, understanding these adjustments provides insight into the long-term viability of specific product lines and the overall health of the insurer's balance sheet.

Hypothetical Example

Consider an insurance company, "SecureFuture Life," which issues a group of long-term life insurance policies.
Initially, in Year 1, SecureFuture Life estimates the future premiums and claims for this group of policies. Based on these estimates, and considering discounting and risk adjustment, they calculate an initial Contractual Service Margin (CSM) of $10 million, representing the expected unearned profit for these contracts.

In Year 3, a significant industry-wide trend emerges: Policyholder lapse rates for this type of product are lower than previously assumed. This means more policyholders are expected to continue paying premiums for longer into the future than SecureFuture Life initially projected.

SecureFuture Life's actuaries reassess their actuarial assumptions. The recalculation shows that the expected future premium inflows are now higher for the remaining coverage period. This change in expected future cash flows, related to future service, results in an upward "Adjusted Future Premium" impact. The CSM is adjusted upwards to reflect this increased expected profitability from the future premiums. If the initial CSM was $10 million and the impact of the lower lapse rates (higher future premiums) translated to an additional $1 million in expected future profit for the remaining coverage, the CSM would increase to $11 million (before any release to profit or loss for services provided in Year 3). This adjustment ensures SecureFuture Life's financial statements reflect a more current and accurate view of the profitability embedded in this group of insurance contracts.

Practical Applications

The concept of Adjusted Future Premium, largely driven by principles similar to those found in IFRS 17, has several practical applications in the insurance industry and financial reporting:

  • Financial Reporting and Transparency: It allows for a more accurate and current representation of an insurer's financial position. Instead of "locking in" assumptions, the ongoing adjustments to future expected cash flows and the Contractual Service Margin (CSM) provide stakeholders with a clearer view of an insurer's actual financial health over the life of its insurance contracts16, 17. This improved transparency aids investors and regulators in assessing an insurer's long-term viability14, 15.
  • Pricing and Product Development: Insurers can use the insights gained from Adjusted Future Premium calculations to refine their pricing strategies for new products. Understanding how deviations from initial actuarial assumptions impact future profitability enables them to design products that are more sustainable and accurately priced for various risk adjustment factors.
  • Risk Management: By continuously monitoring and adjusting for changes in expected future premiums and cash flows, insurers can better manage their exposure to various financial and non-financial risks. This includes assessing the impact of changing economic conditions, such as fluctuations in interest rates, on their liabilities and investment strategies12, 13. The National Association of Insurance Commissioners (NAIC) highlights how interest rate changes significantly impact insurers' balance sheets and profitability, especially for life insurers11.
  • Regulatory Compliance and Solvency: Regulatory frameworks, such as Principle-Based Reserving (PBR) in the United States and Solvency II in Europe, require insurers to maintain adequate reserves that reflect their actual risk profiles and future obligations9, 10. The principles behind Adjusted Future Premium align with these requirements by providing a more dynamic and realistic valuation of future policy obligations and earnings. PBR, for instance, requires insurers to hold reserves based on a wide range of future economic conditions and insurer-specific experience factors8.

Limitations and Criticisms

While providing enhanced transparency, the application of concepts leading to Adjusted Future Premium, particularly under IFRS 17, is not without limitations or criticisms:

  • Complexity and Implementation Challenges: The detailed requirements for measuring and adjusting the contractual service margin (CSM) and fulfilment cash flows can be highly complex. This complexity often necessitates significant changes to actuarial systems and general ledger systems, requiring substantial investment in technology and human resources for implementation7.
  • Reliance on Assumptions: Despite the dynamic nature of adjustments, the calculation of future premiums and cash flows heavily relies on complex actuarial assumptions (e.g., mortality, morbidity, lapses, expenses, investment returns) that are inherently uncertain5, 6. While these assumptions are updated, significant deviations can still lead to volatility in reported earnings. For long-term insurance products like Long-Term Care (LTC) insurance, estimating future results is particularly challenging due to limited historical data and dynamic underlying forces3, 4.
  • Volatility in Reported Earnings: The "unlocking" of the CSM for changes in future cash flows that relate to future service means that changes in estimates can directly impact reported earnings. This can introduce more volatility into an insurer's stated financial performance compared to older accounting standards where assumptions were often "locked in" or only changed under specific conditions like premium deficiencies2.
  • Comparability Issues During Transition: During the transition period to new accounting standards like IFRS 17, comparing the financial statements of companies that have adopted the new standard with those still reporting under older regimes can be challenging1.

Adjusted Future Premium vs. Adjusted Premium

While both terms relate to how insurance premiums are determined or modified, "Adjusted Future Premium" and "Adjusted Premium" refer to distinct concepts in insurance and financial accounting.

| Feature | Adjusted Future Premium | Adjusted Premium