What Is an Asset Valuation Reserve (AVR)?

An asset valuation reserve (AVR) is capital required to be set aside to cover a company against unexpected debt. The asset valuation reserve (AVR) serves as a backup for equity and credit losses. A reserve will have capital gains or losses credited or debited against the reserve account.

Key Takeaways

  • An asset valuation reserve (AVR) refers to capital that is set aside to cover any unexpected debt.
  • Equity and credit losses can be covered by an asset valuation reserve (AVR) to mitigate potential business risks.
  • The two components of an asset valuation reserve (AVR) are the default component and the equity component.
  • The insurance industry and the banking industry are two industries required to have asset valuation reserves (AVRs) set forth by their governing body.

Understanding an Asset Valuation Reserve (AVR)

The intent of an asset valuation reserve (AVR) is to function as a failsafe or safety net of capital that can be accessed in the event of credit or equity losses that might adversely affect an organization’s ability to meet and fulfill its obligations.

Usually, the asset valuation reserve (AVR) consists of two components, a default component, and an equity component. The default component protects against future credit-related losses related to credit products and the equity component against losses related to a company's assets.

Contributions are typically made at least annually toward an asset valuation reserve (AVR). There is a certain amount of risk when a company acquires an asset. For example, the cash flow expected from the asset could miss its anticipated targets or there might be an overall change in the value of an asset, such as depreciation, or there could be adverse effects of bad debt. To build up the asset valuation reserve (AVR), a company’s earnings may see a recurring charge to be put toward such an allowance.

The asset valuation reserve (AVR) is meant to mitigate the fallout of such potential risks along the lines of other types of reserves. As an asset valuation reserve (AVR) is amassed, especially among insurance companies, it typically reduces outstanding cash surpluses that could be used for other purposes, such as paying dividends.

Asset Valuation Reserves (AVRs) in Industries

The insurance industry is one industry in which an asset valuation reserve (AVR) is mandated. The National Association of Insurance Commissioners (NAIC) requires domestic insurers to maintain an asset valuation reserve (AVR) to cover policyholder claims in the event of financial issues at the insurer.

The NAIC also mandates a liability reserve be kept to cover claims in real estate and mortgages. The equity component has provisions for common stocks, real estate, and other invested assets, such as bonds.

Actuarial calculations are used to find the amount of asset valuation reserve (AVR) that is necessary to cover different assets. This might also be done by making estimates of future losses the company believes it will be exposed to. Credit and equity capital gains and losses, whether realized or unrealized, are factored as debits or credits towards such a reserve.

The banking sector is also subjected to asset valuation reserves (AVRs) in the form of reserve ratios, requiring them to keep a certain amount of deposits on hand. This is to ensure that in times of financial stress, clients will be able to withdraw their deposits and prevent a possible bank run.

The reserve ratios for banks in the U.S. are mandated by the Federal Reserve, which stipulates the details in Regulation D, which sets forth all of the requirements for depository institutions.