A worldwide insurance company could generate 50000 new policies in a day. In what way do they manage this mountain of paper? Imagine a big supermarket putting everything in the right aisle. The creation of a "Portfolio" is the first step in the IFRS 17 grouping process.
A portfolio forms the topmost level of grouping. You cannot just throw all your customers in a big bucket. According to IFRS 17, a portfolio refers to a group of contracts that must satisfy two specific and strict conditions:
Let's break down exactly what these two rules mean in the real world.
This rule focuses on the nature of the hazard. Visualize an organization that sells car insurance as well as life insurance. Is it possible for them to include these policies in one portfolio? No way. The likelihood that someone will have an accident in their car (risk of property and casualty) is fundamentally different from the likelihood that someone will die (mortality risk). Actuaries must use separate portfolios for high-risk and low-risk events as the underlying math and stats used by actuaries to calculate these events are completely different.
What if the company sells the “Whole Life Insurance” and the “Term Life Insurance”? Though the commercial products differ, the underlying hazard — mortality — is the exact same risk. Therefore, they pass the first test.
Having similar risks is a requirement, but it is not enough on its own. The company must also operate those policies as a single business line.
Suppose a company sells basic Term Life Insurance. In other words, they sell some policies directly to individual families. By contrast, they sell other policies in bulk to massive corporations, to cover their employees. Although identical in risk (mortality), the company probably has two entirely separate management teams, sales strategies, and internal reporting of the “Retail” division as opposed to the “Corporates” division. Since they cannot be managed together, they must be segregated into a Retail Life Portfolio and a Corporate Life Portfolio.
Putting similar risks and internal management structure together is a powerful first step towards organizing the chaos of policies. However, a portfolio is still much too broad. An individual Corporate Life Portfolio could contain great policies worth millions of dollars alongside terrible policies worth millions of losses. To uncover the actual accounting numbers, we require a further disaggregation of the portfolio.