The reserve is the sum of all assets or funds that a company must have at any time. It includes interest and premiums as they accrue. This will cover all insurance claims. The net premiums are used to calculate the reserve, which is always considered a liability. A business creating a “Reserve” is basically setting aside money for a particular purpose. Reserves are money that is set aside to protect against future losses.
Reserves are a key aspect of business management. Because it is reflected in an insurance company’s balance sheet, it is a fundamental requirement. The income statement includes a significant line item, the change in reserves. A company’s income statement can be affected by even a small adjustment or change in reserves. The reserves are calculated by actuaries.
We will show you an example to illustrate the importance of Reserve.
Reserves of Insurance Company “X”, 1,34,6059,480
Change in Reserves — 7,2169,080
Net Income — 13,28.303
In this case, a 0.1% error would wipe out net income.
It is evident that both the profitability and solvency of a business are highly dependent upon the reserve value. The reserve value is a key determinant of many of the key performance indicators used by analysts at insurance companies.
The reserving process gives great insight into past claims performance and policy exposures. These can impact the terms and conditions of future business. This includes the basis for decisions to stop underwriting certain classes of insurance or withdraw completely from it entirely to support other enterprises with better capital returns or capital rates.
Insurance premiums are usually used to pay claims that arise during the year. It is evident that claims may not be paid upon account closing. These claims will be resolved in the next year.
The Insurer must keep aside a certain amount of money to pay these claims. The Reserve for Outstanding Claims is the amount that’s set aside to pay out claims.
This could explain why claims settlements are so flooded.
1. Some claims could be under investigation, survey or arbitration.
2. Other claims may be surveyed, but not paid.
These reserves usually include the amount of liability for claims that have been classified as:
a) Reported and surveyed, but not yet paid
b) Reported but not yet surveyed.
Reserve for outstanding claims also includes provisions for Incurred but unreported (also known as IBNR claims). These claims can arise in the year of account, but could be reported during the next year.
The majority of General Insurance policies are issued every year and are usually annual contracts. These contracts usually end at different times. They can end at different dates or claim can be made after the accounting date. The closing date of accounts will determine whether there is any unpaid liability. Therefore, the Insurance Company must make provisions to cover losses that may arise during the policy’s unexpired term. These provisions are known as the Reserves for the Unearned Premium Reserve or Reserves for Expired Risk.
It is possible to calculate the unexpired premium under each policy. However, this would require a lot of data. There are many ways to calculate the unexpired premium portion. The most common methods are Pro-rata, 1/365, 1/24 and 1/8. There is also a blanket method that uses a set percentage. A simple calculation is made by dividing premium income into a percentage that can be used to reserve unexpired risk.
