What Are Balance Sheet Reserves?
Balance sheet reserves refer to the amount expressed as a liability on the insurance company's balance sheet for benefits owed to policy owners. Balance sheet reserves represent the amount of money insurance companies set aside for future insurance claims or claims that have been filed but not yet reported to the insurance company or settled. The levels of balance sheet reserves to be maintained are regulated by law.
Also known as "claim reserves."
Understanding Balance Sheet Reserves
Balance sheet reserves are required of insurance companies by law to guarantee that an insurance company can pay any claims, losses, or benefits promised to claimants.
Property and Casualty (P&C) insurers carry three types of reserves:
- Unearned premium reserves, the balance of the premium that has not yet been "earned" during the policy period;
- Loss and loss adjustment reserves or obligations that have been incurred from claims filed or soon to be filed;
- "Incurred but not reported" (IBNR) reserves, which are set aside for hard-to-estimate claims such as workers' compensation and product liabilities.
Balance Sheet Reserves and Profitability
Reserving policy by an insurer can significantly impact its profitability. Over-reserving can result in an opportunity cost to the insurer, as it has less amount of funds to deploy for investments; conversely, under-reserving can boost profitability, as more funds are freed up to invest. Regulators, however, closely watch the reserving policies of the insurance companies to make sure adequate reserves are set aside on the balance sheet.