Valuation of Reinsurance Assets and Insurance Contract Liabilities under Ind AS 117 — Technical Framework for Indian Insurers

Ind AS 117, India’s adoption of the IFRS 17 Insurance Contracts standard, represents the most significant change to insurance accounting since the sector’s liberalisation — and it introduces a measurement model for insurance contract liabilities that is fundamentally a valuation framework, requiring insurers to measure their obligations using current estimates of future cash flows, a risk adjustment for non-financial risk, and a contractual service margin that represents the unearned profit in the insurance contract portfolio. For Mumbai-based insurers — including the large life insurance companies, general insurers, and reinsurers that have their head offices in the city — implementing Ind AS 117 is a multi-year actuarial, financial reporting, and systems transformation challenge. For the valuers, auditors, and financial advisors who support these institutions, understanding the measurement framework deeply enough to provide useful professional input is a prerequisite.

The General Measurement Model (GMM) — also called the Building Block Approach — is the default measurement model under Ind AS 117, applicable to most long-duration life insurance contracts. It measures the insurance contract liability as the sum of three components: the fulfilment cash flows (comprising the probability-weighted present value of future cash outflows less future cash inflows, discounted at a current market-consistent discount rate), the risk adjustment for non-financial risk (a margin that compensates the insurer for bearing the uncertainty inherent in the amount and timing of the cash flows from contracts), and the Contractual Service Margin (a deferred profit margin that is recognised in profit or loss over the service period as the insurer provides coverage). The interaction between these three components — particularly the CSM release pattern and the risk adjustment quantification — requires both actuarial expertise and accounting judgment that goes well beyond conventional insurance reserving.

Why Ind AS 117 Insurance Contract Liability Valuation Is Fundamentally a Discounted Cash Flow Exercise

The discount rate applied to fulfilment cash flows under the GMM is a current market-consistent rate that reflects the time value of money and the characteristics of the insurance contract cash flows — but excludes credit risk of the insurer itself. For Indian rupee-denominated contracts, the discount rate is derived from the Indian Government Securities yield curve, adjusted for illiquidity premium differences between government bonds and insurance contract cash flows. The illiquidity premium adjustment — which increases the discount rate for contracts with illiquid liabilities, thereby reducing the present value of the liability — is one of the most significant and contested valuation judgments in Ind AS 117 implementation, because it directly affects the size of the insurance contract liability and therefore the reported solvency position of the insurer.

The Premium Allocation Approach (PAA) is a simplified model available for short-duration contracts where the coverage period is one year or less, or where the PAA produces a measurement that is not materially different from the GMM. Most general insurance contracts — motor, property, health, and liability policies — qualify for the PAA, which is analytically similar to the unearned premium reserve approach used under previous Indian GAAP. The PAA measures the liability for remaining coverage as a portion of the premium received, with adjustments for acquisition costs and expected losses.

The Variable Fee Approach (VFA) is a modification of the GMM applicable to participating life insurance contracts — policies where the insurer shares investment returns with policyholders, as is common in Indian unit-linked and participating whole life products. Under the VFA, the insurer’s obligation is a variable fee for its asset management service, and changes in the fair value of the underlying assets affect the CSM rather than profit or loss, reducing the P&L volatility that would otherwise result from marking insurance liabilities to current interest rates while holding assets at amortised cost. For Indian life insurers with large participating policy books — including several of Mumbai’s major life insurance companies — the VFA’s asset-liability matching treatment is a significant determinant of reported earnings stability.

Reinsurance assets — representing the reinsurer’s share of the cedant’s insurance contract liabilities — are measured separately under Ind AS 117 using a modified version of the GMM. The measurement must reflect the expected recoveries from the reinsurer, adjusted for the risk of reinsurer default (the credit risk of the reinsurer, which is explicitly recognised in the reinsurance asset measurement unlike in the direct insurance liability). For Mumbai-based general insurers with significant catastrophe reinsurance programmes and treaty arrangements with international reinsurers, the credit quality of the reinsurer counterparty portfolio is a material input to the reinsurance asset valuation. A reinsurance asset that is fully secured by highly rated reinsurers is measured very differently — with minimal default adjustment — from one where a material portion of the recovery exposure is with lower-rated or unrated cedants. The independent assessment of reinsurance counterparty credit quality, and its translation into the Ind AS 117 default adjustment, is a specialised valuation sub-task that requires familiarity with both the reinsurance market and the accounting standard’s measurement requirements.

The discount rate used in Ind AS 117’s General Measurement Model deserves focused attention because it is one of the most consequential and most technically contested inputs in the entire insurance accounting framework. The standard requires a current rate that reflects the time value of money and the characteristics of the insurance contract cash flows — specifically, their liquidity characteristics. Unlike a corporate bond discount rate, which must reflect the issuer’s credit risk, the Ind AS 117 discount rate must exclude credit risk of the insurer itself. This creates a disconnect from observable market rates — there is no market instrument that pays the same cash flows as an insurance contract liability at zero credit spread — and the insurer must therefore construct the discount rate analytically rather than simply reading it from a market yield curve.

The bottom-up approach constructs the discount rate by starting from a risk-free yield curve — typically the government securities yield curve, adjusted for the currency of the insurance contracts — and adding an illiquidity premium that reflects the difference in liquidity between risk-free government bonds and the insurance contract liabilities. Insurance contract liabilities are inherently illiquid — policyholders cannot withdraw their funds on demand in the same way that bond investors can sell their holdings — and this illiquidity allows the insurer to hold less liquid assets to match those liabilities, earning a higher yield. The illiquidity premium adjustment captures this economic reality and produces a discount rate that is higher than the risk-free rate, lower than the insurer’s own borrowing cost. Determining the appropriate illiquidity premium requires empirical analysis of corporate bond spreads net of default expectations — a technically demanding exercise that requires data from Indian credit markets that is less transparent than in developed market contexts.

For Mumbai-based life insurance companies with large participating policy books — where the policyholders share in the investment returns on assets backing their policies — the Variable Fee Approach under Ind AS 117 provides a measurement model that reduces artificial P&L volatility by allowing changes in the fair value of underlying assets to flow through the CSM rather than through profit or loss. The practical implementation of VFA for Indian participating policies requires careful analysis of the contractual terms — specifically, the degree to which the insurer has discretion in how it determines the participating returns, and whether the contracts meet the direct participation feature criteria prescribed by the standard. Policies with guaranteed minimum returns that limit the insurer’s discretion may not qualify for VFA, falling instead under the GMM with its direct P&L exposure to interest rate movements.

Our professional practice at Harshul Mangal & Associates covers valuation engagements for financial institutions including insurance companies, where our IBBI Registered Valuer credential (Reg. No. IBBI/RV/16/2025/16044) and financial due diligence experience provide the analytical foundation for Ind AS 117 measurement support and reinsurance asset valuation.

For further reading on the regulatory framework governing this area, refer to the ICAI guidance on Ind AS 117 — Insurance Contracts, which provides the primary regulatory foundation for the analysis discussed here.

Our valuation services cover the full range of SFA assignments described in this post — from regulatory compliance to transaction support. If you need professional valuation assistance, we would be pleased to assist. You can reach out to us here or write to harshulmangal.ca@gmail.com.