Large Product-Liability Claim: Case Reserve, IBNR, Reinsurance Recovery and Salvage
Sagar Insurance is lead insurer with a 30% share in a co-insurance product liability programme for a pharmaceutical manufacturer. A contaminated batch has produced 240 claimants. Sagar's share of the policy limit is ₹6 crore. The insured has admitted liability for 60 claimants; 30 have settled at ₹40,000 each; 90 are in litigation; 60 are unreported but the actuary estimates IBNR. The claims team has booked a case reserve of ₹3.2 crore. The actuary's central estimate is ₹4.6 crore, with a range of ₹3.8 crore to ₹5.4 crore. The claims team has also recorded a ₹1.1 crore recovery from a facultative reinsurer, but the reinsurer has disputed coverage and has not confirmed. Salvage from the insured's supplier is probable at ₹25 lakh but is not admitted. The CFO asks how much claim liability to recognize at year-end and how to present the reinsurance and salvage.
1. What gross claim liability should Sagar recognize at year-end? Explain how the case reserve, actuarial estimate, paid claims and IBNR interact.
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Start from the actuary's central estimate, not the claims team's case reserve, because the case reserve omits IBNR and may understate the litigated claims. The gross liability should be Sagar's share of the ultimate cost.
If ₹4.6 crore is the central estimate of Sagar's share of ultimate claims, paid claims are 30 × ₹40,000 = ₹12,00,000, and the outstanding claim reserve = ₹4.6 crore − ₹0.12 crore = ₹4.48 crore. If the central estimate is already an outstanding estimate, book ₹4.6 crore. The distinction should be documented so the reserve is not double-counted.
The range ₹3.8 crore to ₹5.4 crore should be disclosed as estimation uncertainty; do not book the low end merely to protect profit. The 60 admitted claims, 90 litigated claims and 60 IBNR claims should be grouped by status, but the total must reconcile to the actuarial estimate. The case reserve of ₹3.2 crore is not sufficient evidence to override the actuary.
2. How should the disputed facultative reinsurance recovery and the probable salvage be treated in the financial statements?
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Do not net the disputed facultative recovery against the gross claim. Recognize a reinsurance asset only when the recovery is probable, measurable and the cover is confirmed. Here the reinsurer has disputed coverage, so the asset is at best a contingent asset; disclose it and do not credit the revenue account.
If a recovery is later confirmed, recognize it separately as a reinsurance recovery, not as a reduction in the gross claim. Salvage of ₹25 lakh is probable but not admitted. If it is probable and measurable, it may be recognized as a reduction of the claim, but the safer treatment is a disclosed contingent asset until admitted. The balance sheet should therefore show the gross liability and, separately, any confirmed reinsurance asset. Netting a disputed recovery against the claim would hide both the gross exposure and the coverage dispute.
3. Should the claim be discounted? What disclosures are needed?
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General-insurance claim liabilities are normally carried undiscounted unless the company has a documented policy, the claim is long-tail and the effect is material. For this product-liability claim, litigation may take years, so a discounted figure could be relevant, but it would need a risk-free rate, a settlement pattern and disclosure of the undiscounted amount.
The exam point is that discounting is a policy choice that must not be used to reduce the reserve without evidence. Recommend carrying the undiscounted central estimate, disclosing the range and the discounting policy, and testing the reserve at each reporting date. Also disclose the co-insurance share, the policy limit and the fact that the insured's liability admissions do not bind Sagar on quantum. That gives users the information to judge the uncertainty.