What Is a Claims Reserve?
A claims reserve is a reserve of money that is set aside by an insurance company in order to pay policyholders who have filed or are expected to file legitimate claims on their policies. Insurers use the fund to pay out incurred claims that have yet to be settled.
The claims reserve is also known as the balance sheet reserve.
- The claims reserve is funds set aside for the future payment of incurred claims that have not yet been settled.
- The outstanding claims reserve is an actuarial estimate, as the amounts liable on any given claim is not known until settlement.
- Money for the claims reserve is taken from a portion of the premium payments made by policyholders over the course of their insurance contracts.
- An outstanding claims reserve is recorded as a liability on a company’s balance sheet.
Understanding Claims Reserve
People pay for insurance coverage to protect themselves against financial loss. In exchange for taking on this risk, the company offering the service charges its customers insurance premiums. An insurance premium is the amount of money an individual or business pays for an insurance policy; insurance premiums are either paid in installments—monthly or semi-annually—or in one upfront payment before any coverage starts.
When entering a contract with customers, an insurance company accepts any liability in the event that an adverse occurrence takes place which damages whatever it agreed to insure. Accepting liability means making a payment to the insured person when they file a legitimate claim.
Every year, insurance companies deal with claims that are filed against the policies that they sell. For example, an auto insurance policyholder who gets involved in an accident will file a claim with their insurance provider to be reimbursed for any damages made to their car.
Some claims, such as property losses due to fire, are easily estimated and quickly settled. Others, such as product liability, are more complex and may be settled long after the policy has expired.
A claims reserve is money set aside for a claim that has been reported but not settled (RBNS) or incurred but not reported (IBNR). An insurance company will assign a claims reserve to each file that fit those descriptions, reflecting its best estimate of the eventual settlement amount. The outstanding claims reserve is an actuarial estimate, as the amounts liable on any given claim is not known until settlement.
A claims adjuster is responsible for estimating the payable amount. The monetary amount of the claims reserve can be calculated subjectively, using the claims handler's judgment, or statistically, by evaluating past data to project future losses.
Money for the claims reserve is taken from a portion of the premium payments made by policyholders over the course of their insurance contracts.
Actuarial estimates of the amounts that will be paid on outstanding claims must be evaluated so that the insurer can calculate its profits.
It can be difficult for insurance companies to accurately determine the amount to set aside for claims. Regular reviews help, although that does not mean that adequate funds are always allocated. Significant underestimates can come as a nasty shock to investors, eroding trust in accounting practices and weighing on company share prices.
Claims that have been incurred but not reported (IBNR) are particularly tricky to assess. For example, workers may inhale asbestos while performing their jobs but might not file a claim until after being diagnosed with an illness 20 years after the adverse event occurred.
Claims Reserve Recording
An outstanding claims reserve is an accounting provision that is recorded as a liability on a company’s balance sheet. They are classified as liabilities because they must be settled at a future date. In other words, they are potential financial obligations to policyholders.
The claims reserve is adjusted over time as each case develops and new information is retrieved during the claims settlement process. The total amount of funds set aside for a claim is the sum of the expected settlement amount and any expenses incurred by the insurer during the settlement process, such as fees for claims adjusters, investigators, and legal assistance.
Claims Reserve Example
Company A provides home insurance to people living across the U.S. Unfortunately, a big storm ends up destroying a lot of the property it insures in Florida. Company A knows it will receive a lot of claims even if they have not been reported yet and, as a result, creates a claims reserve, putting money aside based on its estimates of how much it thinks it will likely have to pay out.