Section 01
What Is the LRC?
The LRC represents the insurer's obligation to provide coverage and services for the unexpired portion of the insurance contract. It sits on the liability side of the balance sheet and is updated at every reporting date.
Under PSAK 117 (Indonesia's adoption of IFRS 17), the LRC under the General Measurement Model (GMM/BBA) is built from three building blocks: PVFCF, RA, and CSM.
IFRS 17, Para 32 — IASB (2023) · PSAK 117 (OJK/IAI)
Section 02
The 3 Building Blocks of LRC
Building Block 1
Present Value of Future Cash Flows
PVFCF
Discounted best-estimate of all future cash inflows (premiums) and outflows (claims, expenses, acquisition costs), using IFRS 17 discount rates that reflect the time value of money and the characteristics of the liability.
Building Block 2
Risk Adjustment for Non-Financial Risk
RA
Compensation required for bearing uncertainty in the amount and timing of non-financial risks — including mortality, morbidity, lapse, and expense risk — beyond the best-estimate cash flows.
Building Block 3
Contractual Service Margin
CSM
Unearned profit deferred on the balance sheet at inception — set so that day-one P&L impact equals zero. Released to profit or loss over time as insurance coverage services are provided to policyholders.
IFRS 17 Para 32–38 · LRC = PVFCF + RA + CSM
Step 01
Calculate the PVFCF
The PVFCF is the net present value of all future cash flows within the contract boundary. Cash inflows are premiums receivable from policyholders; cash outflows include claims, benefits, directly attributable expenses, and allocated acquisition costs.
Two approaches exist for the discount rate: Top-down (asset yield minus illiquidity premium) and Bottom-up (risk-free rate plus illiquidity premium).
IFRS 17 Para 36–37, B72–B85 · IFoA CSM Working Paper (Sept 2019) · PSAK 117 (OJK/IAI)
Step 02
Calculate the Risk Adjustment
The RA is compensation for bearing non-financial risk uncertainty. IFRS 17 prescribes no single method — three approaches are commonly used in practice:
Most Common
VaR / Confidence Level
70th – 90th percentile
Composite insurers: ~75th pct. (EY 2023). Life & Health: typically above 80th pct. P&C: 80th–90th range common.
Widely Used
Cost of Capital (CoC)
CoC Rate: 4% – 6%
Analogous to Solvency II Risk Margin. RA = CoC rate × SCR capital over coverage period. Preferred by composite insurers.
Least Common
TVaR / CTE
Stochastic · High complexity
Average loss beyond a chosen confidence level. Requires full stochastic scenario modelling. More conservative; rarely adopted.
Disclosure Requirement: Regardless of method chosen, IFRS 17 requires the RA to be disclosed as an equivalent confidence level to enable comparability across entities.
IFRS 17 Para 37, B86–B92 · EY Research (2023) · Addactis (May 2025)
Step 03
Calculate the CSM
⚠️
Cannot Be Negative — Onerous Contract
If the CSM calculation yields a negative value, the contract is onerous and a Loss Component is recognised immediately in P&L at inception. No deferral is permitted.
IFRS 17 Para 38 & 47–52
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Locked-In at Inception
The CSM is measured using the discount rate at the date of initial recognition. This locked-in rate is fixed and does not change with subsequent market movements.
IFRS 17 Para 44
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Accretion of Interest Each Period
The CSM balance accretes interest at the locked-in inception discount rate each reporting period, reflecting the time value of money over the coverage period.
IFRS 17 Para 44(B)
📊
Release to P&L via Coverage Units
The CSM is released to profit or loss over the coverage period based on coverage units — reflecting the pattern of insurance contract services provided to policyholders.
IFRS 17 Para 44–45
Numerical Example
20-Year Whole Life Policy
| # |
Component |
What It Represents |
Amount |
| 1 |
PV Inflows |
PV of 1,000 × $2,000 annual premiums over 20 yrs |
+$1,500,000 |
| 2 |
PV Outflows |
PV claims $1,200k + PV expenses $150k |
−$1,350,000 |
| 3 |
PVFCF |
PV(Outflows) − PV(Inflows) = $1,350k − $1,500k |
−$150,000 |
| 4 |
Risk Adjustment (RA) |
Mortality & longevity uncertainty (75th pct. VaR) |
+$30,000 |
| 5 |
Cash Flows at Recognition |
No acquisition costs paid at inception date |
$0 |
| 6 |
CSM |
−(PVFCF + RA + $0) = −(−$150k + $30k) |
+$120,000 |
| ✓ |
LRC at Inception |
PVFCF + RA + CSM = −$150k + $30k + $120k |
$0 Net |
Why GMM applies here: The 20-year coverage period means cash flows must be discounted and updated each year. The CSM ($120k) locks in the expected profit at inception — released over 20 years as coverage units are provided, not recognised upfront.
Special Case
Onerous Contracts: When CSM < 0
When Fulfilment Cash Flows are positive (net liability before CSM), the group is onerous — expected losses exceed expected profits. IFRS 17 prohibits a negative CSM. The CSM floor is zero — it can only defer profits, never absorb losses.
IFRS 17 / PSAK 117 Para 38, 47–52 · IASB (2017/2023)
Episode 1 — Key Takeaways
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LRC = FCF + CSM — The Liability for Remaining Coverage has three building blocks: PVFCF, Risk Adjustment (RA), and the Contractual Service Margin (CSM).
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CSM is the Profit Buffer — The CSM is the balancing item that ensures zero net P&L at inception for profitable contract groups. Expected profit is deferred and released over the coverage period.
📊
Three RA Methods — VaR/confidence level (most common), cost of capital, or TVaR. The RA reflects compensation for non-financial risk uncertainty.
⚠️
Onerous Contracts Rule — The CSM cannot be negative. When FCF exceeds zero at inception, a Loss Component is established and losses are recognised immediately in P&L — no deferral allowed.
Coming Next · Episode 02
How Does the CSM Unwind?
Coverage Units & CSM Release Explained
Read Episode 2