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Internal:Training/IFRS17/The contractual service margin: Difference between revisions

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Created page with "{{Internal:Training/IFRS17/nav-dropdown}} 🔗 '''Recall.''' In the previous page, you learned how the risk adjustment compensates the insurer for bearing uncertainty, and how it releases gradually as risk expires. Now we turn to the final building block, the one that captures the profit the insurer expects to earn from a group of contracts: the contractual service margin. 🎯 '''Objective.''' In this page, you will learn: * What the con..."
 
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⚠️ '''Common misconception.''' A frequent error is believing that the CSM can absorb all changes in estimates, regardless of direction or magnitude. In fact, the CSM cannot go below zero. If unfavourable changes exceed the remaining CSM, the excess is recognised immediately as a loss in the [[Definition:Income statement|income statement]]. At that point, the group of contracts has become [[Definition:Onerous contract|onerous]], meaning the insurer now expects to lose money. Once onerous, any further deterioration also goes directly to profit or loss. The CSM is a one-way floor at zero: it can absorb bad news only up to the point where expected profit runs out.
 
📐 '''A concrete illustration.''' Imagine AXA holds a group of threefive-year [[Definition:MotorEmployers' liability insurance|motoremployers' insuranceliability]] contracts in Germany with an initial CSM of €5 million. At the end of year one, updated [[Definition:Claims|claims]] data suggests that future claims will be €2 million lower than expected. The CSM rises to €7 million (before any release). At the end of year two, however, a new court ruling on [[Definition:Bodily injury|bodily injury]] compensation increases expected future claims by €9 million. The CSM, which stood at roughly €7 million before release, cannot absorb the full €9 million. It drops to zero, and the remaining shortfall, approximately €2 million, flows straight into the income statement as a loss. This example shows the CSM acting as a shock absorber: it smooths out moderate swings, but it cannot hide genuine losses.
 
🤔 '''Think about it.''' The CSM stores unearned profit and releases it as coverage is provided. But how does the insurer decide how much to release each period? If a five-year contract provides more coverage in some years than others, should the release be equal each year, or should it follow the pattern of service?
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