Onerous contracts

jaip04

Hi, an onerous contract is defined as a net OUTFLOW for sum of : FCF + Acquisition cash flows + cash flows arising from contract . FCF in one of these IFRS papers is also defined as being NEGATIVE if there's a profit (which the CSM offsets). How does that tie into onerous contracts? Is a profit for acquisition cash flows + cash flows arising from contract also negative ?

graham

I'm not quite sure if I understand your question so let's break it down:

• If FCF < 0 then the contract is likely profitable so there is a net inflow of cash to the insurer (this would be a non-onerous contract)
• In this case, the insurer establishes as CSM (Contractual Service Margin) and this CSM amount is gradually released into profit as services and coverage are provided
• But an onerous contract is one that is not likely to be profitable, so there is a net outflow of cash
• Here, you do not need to establish a CSM for an onerous/unprofitable contract since we would have FCF > 0. (Actually you have to be slightly more careful because I suppose an onerous contract cold still have FCF < 0 and require a CSM even if the the total outflow is positive, although that doesn't seem likely)

So the "tie-in", very roughly speaking, is that onerous contracts probably never need to have a CSM established (because it's unlikely that FCF < 0 for onerous contracts)

jaip04

Thanks that makes sense