Liability for Incurred Claims

Study guide: Exam 6C

The Liability for Incurred Claims (LIC) is the IFRS 17 liability for claims that have already occurred but are not yet fully paid — case reserves, IBNR, reopened claims and the associated adjustment expenses. It is measured as the present value of fulfilment cash flows plus a risk adjustment, and it is where nearly all of a P&C actuary's traditional reserving work now lives.

$\text{LIC} = \underbrace{\text{PV(Expected future cash flows)}}_{\text{fulfilment cash flows}} + \underbrace{\text{RA}}_{\text{risk adjustment}}$

No contractual service margin. The service under an incurred claim has already been provided, so there is no unearned profit to defer — the LIC is fulfilment cash flows plus risk adjustment and nothing else. This is a structural difference from the LRC under the GMM.
Discounting is mandatory, at current rates consistent with the characteristics of the liability cash flows. There is no PAA exemption for the LIC beyond claims expected to be paid within a year of being incurred.
The estimate is unbiased and probability-weighted — the mean of the distribution of outcomes, not a conservative or a modal estimate. Conservatism enters only through the explicit risk adjustment, which is the whole point of separating the two.
Cash flows within the Contract Boundary only, and only those directly attributable to fulfilling the contracts: claim payments, ALAE, directly attributable claims-handling overhead (ULAE), and claim-related salvage and subrogation recoveries as negative cash flows.
Changes in the LIC are split on the income statement: changes from claim experience and assumption revisions go to Insurance Service Expenses, while the unwinding of discount and the effect of changes in discount rates go to Insurance Finance Income or Expenses. Getting this split right is what makes the Insurance Service Result a clean measure of underwriting performance.
Reinsurance recoveries on incurred claims are not deducted here; they form part of the Reinsurance Contracts Held asset.

From Undiscounted Reserves to the LIC An actuary's undiscounted central estimate of unpaid claims and ALAE is $\$180$ million, expected to be paid over five years in the pattern $35\%$ , $25\%$ , $20\%$ , $12\%$ , $8\%$ (paid at mid-year). The current discount rate is $4\%$ . The risk adjustment is set at $6\%$ of the discounted fulfilment cash flows.

Compute the LIC.
Answer Discount each year's payment at $4\%$ from its mid-year point ( $t = 0.5, 1.5, \ldots$ ):
 $\begin{align*} \text{PV} &= \$180\text{M} \times \bigl[0.35 v^{0.5} + 0.25 v^{1.5} + 0.20 v^{2.5} \\ &\qquad\qquad + 0.12 v^{3.5} + 0.08 v^{4.5}\bigr] \end{align*}$ 
with $v = 1.04^{-1}$ . Evaluating the bracket:
 $\begin{align*} &0.35(0.98058) + 0.25(0.94287) + 0.20(0.90661) \\ &\quad + 0.12(0.87174) + 0.08(0.83821) \\ &= 0.34320 + 0.23572 + 0.18132 + 0.10461 + 0.06706 \\ &= 0.93191 \end{align*}$ 
 $\begin{align*} \text{PV} &= \$180\text{M} \times 0.93191 \\ &= \$167.7\text{M} \end{align*}$ 
Risk adjustment:

$0.06 \times \$167.7\text{M} = \$10.1\text{M}$

LIC:

$\$167.7\text{M} + \$10.1\text{M} = \$177.8\text{M}$

The discount saves $\$12.3$ million and the risk adjustment gives $\$10.1$ million back, so the LIC lands close to the undiscounted estimate — a coincidence of this payout pattern and these parameters, not a general result. On a long-tail line the discount would dominate; on a short-tail line the risk adjustment would.

In the following year, the $\$167.7$ million unwinds toward $\$180$ million as time passes; that unwind is insurance finance expense, not an underwriting loss, and separating it is exactly what the IFRS 17 income statement is designed to do.