In return for the promise to cover losses covered by an insurance contract, insurance companies receive premiums. Insurance is the concept that shares risk between people or organizations. This is done by insurance companies to make a profit. An insured files a claim with the insurer to file a claim. The insurance company then investigates the claim to determine the damages and coverage. Most insurance claims are not paid on the same day that they are filed. Insurance companies that cover property and casualty insurance recognize that there is a potential liability and document this exposure through a process known reserving, which estimates the payout for covered claims. Insurance companies use funds to quantify this liability. They set aside funds that represent the future value of a claim payout. To prove a company’s solvency and ability to pay open claims, these funds are put into liquid asset accounts.
Insurance companies must report all financial transactions, including reserving, to ensure public safety from insolvent companies. Publicly traded companies are required to establish internal controls that ensure accurate financial reporting to regulatory authorities. The largest liability for an insurance company is its outstanding debts due on unpaid claims. Insurance companies must have reserves to meet regulations. Reserves are assets that are used to pay for outstanding claims. Based on the information gathered during the claim investigation, employees of claims set reserves. The reserves are then filtered through accounting, underwriting, actuarial, and other departments. Actuaries are highly skilled in risk analysis, mathematics, and statistics. Accurate reserve data is used to calculate insurance premiums and create financial reports for the accounting department.
Although reserve practices are regulated by the Internal Control Board, companies have the right to vary their level of checks and balances. A strong internal control system can eliminate inaccuracies in the reserving process. Companies need to review their reserving procedures in order for them to be solvent and profitable. One must identify the causes of reserve inaccuracies when reviewing the reserving procedures of an insurance company. These are the questions to ask if you have concerns about reserve inaccuracies.
– Have employees been properly trained?
Is there documentation for reserve analysis?
– Does management review employee reserve analyses?
– Does there exist a separation of control or are there only a few who have all the authority?
– Is there any discrepancy in the technology systems that track financial data?
Are the external audits of the reserving procedure impartial and reliable?
Insurance companies that have strong internal control procedures can increase their reserve accuracy and allow upper management to maximize profits. Two key ways that accurate reserving practices can increase profits are: Accurate reserves allow cash to be freed up that would otherwise be kept in liquid accounts as outstanding loss reserves. Because these accounts are low-risk and have a shorter investment period, they often yield lower returns. These additional funds can be invested by management in bonds and stocks to improve income. A company that reports its reserves are lower than its liabilities can become insolvent and face penalties from regulatory agencies. Profits can be affected by penalties and fines.
A competitive premium setting by actuaries is another avenue to profit from accurate reserving. This will result in increased sales. Actuaries review the loss ratio every year.
