1. Why Life Insurance Needs Both GMM and VFA
Unlike general insurance, where PAA dominates, life insurers routinely need two of IND AS 117's three measurement models. Non-participating products (term, non-par endowment, most annuities) use the General Measurement Model (GMM) — the full Fulfilment Cash Flows + Contractual Service Margin building-block approach. Participating, with-profit products use the Variable Fee Approach (VFA) — a modified GMM specifically for contracts where policyholders share in the returns of a defined pool of underlying items. This article assumes familiarity with FCF, Risk Adjustment and CSM from our foundational IND AS 117 guide — read that first if these terms are new.
2. The Old Regime — Gross Premium Valuation & the Participating Fund
Indian life insurers currently value policy liabilities using actuarial valuation under IRDAI regulations, almost always via the Gross Premium Valuation (GPV) method — a prospective calculation: present value of future benefits and expenses, minus present value of future gross premiums, using assumptions that deliberately build in prudence through margins for adverse deviation (MADs). This is certified annually by the Appointed Actuary.
Financial statements follow a distinctive structure not found outside insurance:
- Policyholders' Account (Technical Account) — Form A-RA, the Revenue Account, segmented by fund (Participating, Non-Participating, Linked, etc.)
- Shareholders' Account (Non-Technical Account) — Form A-PL, receiving a transfer of surplus from the Policyholders' Account
- For participating business, the Insurance Act and IRDAI regulations mandate that shareholders can take at most 10% of the distributable surplus of the participating fund, with the remaining 90% allocated to policyholders
That 90% policyholder allocation is distributed through bonus declaration — the Board, on the Appointed Actuary's recommendation, declares a reversionary bonus once a year (added to the sum assured, guaranteed once declared, paid at claim or maturity), and potentially a terminal bonus (paid only on exit, not guaranteed in advance).
The core shift IND AS 117 makes: GPV produces one number — an actuarial liability — with profit emerging through the Policyholders'-to-Shareholders' account transfer, and policyholder participation recognised through a once-a-year discrete bonus declaration event. IND AS 117 instead splits the liability into FCF and CSM, releases the CSM continuously over the coverage period as insurance revenue, and — for participating business — embeds the policyholder's share of investment performance directly and continuously into the CSM via VFA, with no separate declaration event as such.
3. Worked Example 1 — Non-Par Term Life, Day 1 (GMM)
Facts: Suraksha Life issues a 10-year non-participating term policy on 1 April 2025. Annual premium: ₹8,000 (paid at the start of each year). Sum assured: ₹10,00,000. Locked-in discount rate: 7.5% p.a. PV of expected claims: ₹30,000. PV of expected expenses: ₹6,000. Risk Adjustment: ₹4,500. Acquisition cost: ₹2,500.
| Step | Amount |
|---|---|
| PV of future premiums (10-yr annuity-due, ₹8,000 @ 7.5%) | ₹59,032 |
| Less: PV of expected claims + expenses (₹30,000 + ₹6,000) | (₹36,000) |
| Net PVFCF (surplus) | ₹23,032 |
| Less: Risk Adjustment | (₹4,500) |
| Less: Acquisition cost (outflow) | (₹2,500) |
| CSM at inception (to bring net liability to zero) | ₹16,032 |
Net insurance contract liability on Day 1 is ₹0 (the FCF's negative ₹16,032 is exactly offset by the ₹16,032 CSM) — a profitable contract creates no day-one liability; the entire expected profit sits in the CSM, to be released as the insurer provides coverage over the next 10 years.
4. The CSM Roll-Forward Mechanics — Interest, Experience & Release
Unlike PAA, GMM requires the CSM to be actively rolled forward every reporting period:
| Step | What happens |
|---|---|
| 1. Opening CSM | Balance brought forward from the prior period |
| 2. + Interest accretion | Unwind of discount on the opening CSM, at the locked-in rate from inception |
| 3. ± Changes for future service | Favourable/unfavourable changes in expected future cash flows (e.g. updated mortality or lapse assumptions) adjust the CSM — not P&L |
| 4. − CSM release | The portion allocated to coverage units consumed in the period, recognised as insurance revenue |
| 5. = Closing CSM | Carried forward to the next period |
Coverage units quantify the insurance benefit provided in a period relative to the total expected over the remaining contract life — commonly the sum at risk multiplied by the probability of coverage continuing. A larger, longer-duration policy releases its CSM more slowly than a smaller or shorter one; the release pattern is not automatically straight-line.
5. Worked Example 1 Continued — Year 2 Roll-Forward
Continuing Suraksha's term policy. Assume, for simplicity, one coverage unit is consumed per policy year (10 total), so Year 1's CSM release = ₹16,032 ÷ 10 ≈ ₹1,603, leaving an opening CSM for Year 2 of ₹14,429.
At the start of Year 2 (1 April 2026), Suraksha's actuaries update mortality assumptions based on emerging experience — expected future claims fall by ₹1,000 (favourable, and it relates to future service, so it adjusts the CSM rather than hitting P&L immediately).
| Year 2 CSM roll-forward | Amount |
|---|---|
| Opening CSM (after Year 1 release) | ₹14,429 |
| + Interest accretion (7.5% locked-in rate) | ₹1,082 |
| + Favourable future-service assumption change | ₹1,000 |
| CSM before Year 2 release | ₹16,511 |
| − Year 2 release (1 of 9 remaining coverage units) | (₹1,835) |
| Closing CSM (start of Year 3) | ₹14,676 |
The key contrast with GPV: under the old regime, this favourable mortality experience would simply reduce the actuarial liability, flow through as a larger valuation surplus, and eventually inform next year's bonus recommendation — a single aggregated number. Under IND AS 117, you can see exactly how much of the change came from discounting (interest accretion), how much from genuinely better-than-expected future experience, and how much represents earned profit for the year — three separately visible, separately auditable figures instead of one.
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The VFA applies where the policyholder's benefits are contractually tied to a defined pool of underlying items (e.g. the participating fund's investment portfolio), and the insurer's own compensation is, in substance, a variable fee for managing that pool and providing insurance coverage. The critical mechanical difference from GMM: changes in the insurer's share of the underlying items' fair value adjust the CSM rather than hitting P&L directly.
Why this matters: if the par fund earns a strong return and 90% of it is contractually owed to policyholders, the insurer's liability rises almost in lockstep with the fund's value. Routing both the asset gain and the matching liability increase through the CSM means the insurer's reported profit reflects only its own genuine fee for the service — not a gross-up of investment market movements it was always going to pass through.
7. Worked Example 2 — Par Endowment, Fund Performance Through the CSM
Facts: Suraksha issues a 15-year participating endowment on 1 April 2025, annual premium ₹50,000, sum assured ₹10,00,000. The policy shares in the participating fund's investment performance, with policyholders entitled to 90% of the fund's return and Suraksha retaining a 10% variable fee. In Year 3, the underlying par fund investments backing this cohort earn a return of ₹5,00,000.
| Item | Amount |
|---|---|
| Fund investment return, Year 3 | ₹5,00,000 |
| Policyholders' contractual share (90%) | ₹4,50,000 |
| Insurer's variable fee (10%) | ₹50,000 |
Vs old regime: under GPV, this ₹4,50,000 becomes part of the participating fund's valuation surplus, and would be recommended by the Appointed Actuary as a reversionary bonus addition to the policyholder's sum assured — a discrete, once-a-year Board-approved event, disconnected in timing from when the underlying return was actually earned. Under VFA, the ₹4,50,000 is recognised as an adjustment to the CSM in the same period the fund performance occurs — continuously, not as an annual declared event. Only Suraksha's own 10% fee ultimately emerges as profit through CSM release over the remaining coverage period.
8. A Note on ULIPs
Unit-Linked Insurance Plans raise a genuinely unsettled implementation question. If a ULIP's investment (fund-value) component is distinct — separately identifiable and capable of being measured independently of the insurance component — that investment component is unbundled and accounted for separately (typically under IND AS 109), leaving only the mortality and morbidity rider charges within IND AS 117's scope. Where the components are too interrelated to separate, the whole contract is treated as a single insurance contract, generally under VFA if there is significant sharing of underlying item returns. This is a judgement each insurer needs to work through product by product — it is not a sector-wide default either way, and is one of the areas Indian insurers and their auditors are still actively working through as implementation approaches.
9. Onerous Contract Testing for Life Products
Facts: A competitively-priced non-par product cohort has PV of expected premiums of ₹40,00,000, against PV of expected claims and expenses of ₹43,00,000 and a Risk Adjustment of ₹2,00,000.
| Item | Amount |
|---|---|
| PV of expected claims + expenses | ₹43,00,000 |
| Risk Adjustment | ₹2,00,000 |
| Less: PV of expected premiums | (₹40,00,000) |
| Net loss at inception (onerous) | ₹5,00,000 |
This ₹5,00,000 is recognised immediately in P&L at inception. Vs old regime: GPV's margins for adverse deviation, applied assumption-by-assumption across an entire product line, tend to obscure a specific loss-making cohort within an otherwise-profitable book — IND AS 117's per-cohort Day 1 test surfaces it immediately and specifically.
10. Old IGAAP vs IND AS 117 — Side-by-Side Comparison
| Aspect | Old IRDAI regime | IND AS 117 |
|---|---|---|
| Liability basis | Gross Premium Valuation, prospective, with margins for adverse deviation | Fulfilment cash flows + explicit Risk Adjustment + CSM |
| Profit emergence | Actuarial valuation surplus, 90:10 transfer (par business) | CSM released systematically as insurance revenue over coverage |
| Participation mechanism | Discrete annual reversionary/terminal bonus declaration | Continuous CSM adjustment for policyholder's share of returns (VFA) |
| Accounts structure | Separate Policyholders' (Technical) & Shareholders' (Non-Technical) Accounts | Single set of financial statements; insurance revenue / service expense / finance income-expense |
| Prudence margins | Implicit — margins for adverse deviation built into assumptions | Explicit, separately disclosed Risk Adjustment |
| Loss recognition | Can be masked by portfolio-wide margins, often not immediate | Mandatory Day 1 onerous contract loss per annual cohort |
| Discount rates | Valuation-basis rates set with prudence | Market-consistent discount rates required |
11. Disclosures Required
- Full CSM reconciliation table — opening, new business added, interest accretion, changes for future/current/past service, release, closing
- Risk Adjustment — the confidence level used
- Expected pattern of future CSM release (a maturity-style analysis by future period)
- Onerous contracts — loss components created and reversed
- Sensitivity analysis to key actuarial assumptions (mortality, lapse, discount rate)
- Transition disclosures — which transition approach (modified retrospective, fair value, or full retrospective) was used for existing back-book policies, since full retrospective is often impracticable for long-duration business written years ago
12. Common Mistakes CAs Make
Error 1 — Applying GMM instead of VFA to a participating product. Missing the "significant sharing of underlying item returns" test pushes market-driven investment volatility straight into P&L instead of the CSM — materially misstating both profit and its volatility.
Error 2 — Treating "bonus" as a discrete annual event for accounting purposes. Under VFA, policyholder participation in fund performance is recognised continuously in the CSM as it emerges — waiting for the annual Board bonus declaration to record it is a timing error, even though the product-level bonus communication to customers is unaffected.
Error 3 — Ignoring the annual cohort requirement. Policies issued more than a year apart cannot sit in the same group of contracts — this affects CSM tracking, onerous contract testing, and disclosure granularity.
Error 4 — Crediting the CSM past zero. Favourable changes must first reverse any existing loss component before increasing a positive CSM — the CSM itself can never go negative, and getting this sequencing wrong overstates unearned profit.
Error 5 — Not assessing whether a ULIP's investment component should be unbundled. Defaulting every ULIP into a single VFA treatment (or, conversely, always unbundling) without a genuine distinctness assessment risks a systematically wrong scope conclusion across an entire product line.
13. FAQs
Why do life insurers need both GMM and VFA?
GMM is the default model for long-duration contracts and applies to non-participating products like term and non-par endowment, where the insurer's obligation doesn't vary with the performance of an underlying pool of assets. VFA is a modified version of GMM used specifically for participating (with-profit) contracts, where policyholders share in investment returns from a defined pool of underlying items — the insurer's variable fee. Using GMM for a participating product would force market-driven investment swings straight into profit or loss, even though the insurer merely passes most of that return through to policyholders; VFA routes those swings through the CSM instead, which is the more faithful representation.
How does the CSM roll-forward work year to year?
Each period, the opening CSM is increased for interest accretion at the locked-in discount rate and for favourable changes in estimated future cash flows (relating to future service), and decreased for unfavourable changes in future-service cash flows and for the amount of CSM released to profit or loss as insurance revenue for coverage provided in that period. The release amount is based on coverage units — a measure of the quantity of insurance benefits provided in the period relative to the remaining expected total, so a larger, longer-duration policy releases CSM more slowly than a smaller, shorter one.
What happens to the old system of reversionary and terminal bonus under IND AS 117?
The policyholder communication and product mechanics of bonus declaration are unaffected — reversionary and terminal bonuses continue to exist as product features governed by IRDAI regulations and the participating fund's actuarial surplus. What changes is the accounting: under VFA, the policyholder's share of underlying item returns is recognised continuously within the CSM as investment performance emerges, rather than being recognised as a discrete expense only when the Board formally declares a bonus each year.
How are ULIPs accounted for under IND AS 117?
This is one of the more actively-debated implementation questions. If a ULIP's investment component is distinct and can be measured separately from its insurance component, the investment component is unbundled and accounted for separately (typically under IND AS 109), leaving only the mortality/morbidity rider charges within IND AS 117. If the components are highly interrelated and cannot be measured independently, the whole contract is treated as a single insurance contract, generally under VFA where there is significant sharing of underlying item returns. Each product's specific terms need individual assessment rather than a blanket sector-wide answer.
What is the difference between Gross Premium Valuation and the IND AS 117 fulfilment cash flow approach?
Both are prospective, discounted valuations of future cash flows — in that sense they're conceptually similar. The key differences are in the margins: GPV builds prudence into individual assumptions (margins for adverse deviation, or MADs) that are not separately visible, whereas IND AS 117 requires a best-estimate (unbiased) projection of cash flows plus one explicit, separately disclosed Risk Adjustment. IND AS 117 also separates the resulting number into a liability component (FCF) and an unearned-profit component (CSM), released systematically over the coverage period — GPV simply produces a single actuarial liability figure, with profit emerging through the policyholders'/shareholders' account transfer mechanism instead.
Can the CSM become negative?
No. The CSM is capped at zero. If unfavourable changes in future-service cash flows would otherwise push the CSM negative, the excess beyond zero is instead recognised immediately as a loss in profit or loss, creating (or adding to) a loss component — the same onerous-contract mechanism used at initial recognition. Correspondingly, favourable subsequent changes must first reverse any existing loss component before any amount can be credited back to a positive CSM.