Voluntary Reserve: An Overview
Let me explain what a voluntary reserve is—it's simply a sum of cash that an insurance company holds beyond any minimum required by government regulators.
You should know that state regulations establish these minimum reserve requirements for insurance companies to make sure they stay solvent. These voluntary reserves, which you might also hear called additionally held liquid assets, show up as such in the company's financial statements.
It's similar for financial institutions; state regulators impose reserve requirements on them too, and those institutions can also maintain voluntary reserves.
Key Takeaways
- An insurance company's voluntary reserve is its cash on hand that exceeds the minimums set by state regulators.
- The minimums are intended to guarantee that the company remains solvent.
- The standards for reserve accounts range from 8% to 12% of revenue.
How a Voluntary Reserve Works
State regulators rely on tools from the Insurance Regulatory Information System (IRIS), managed by the National Association of Insurance Commissioners (NAIC), to assess the solvency of insurance companies in their areas and decide the right amount of cash they should keep in reserve.
IRIS pulls financial data filed by each insurance company to spot which ones might have solvency problems. The regulators set a range of acceptable liquidity ratio values for each company, and if values fall outside that range, it signals that the insurer needs closer examination.
Determining the Reserve Amount
When insurance companies decide on the size of a voluntary reserve, they face competing priorities.
Having a large amount of cash on hand signals the company's stability and its readiness to handle any catastrophe, but it also reduces what's available to reinvest in the business or distribute to shareholders.
There are few restrictions on how you can use a voluntary reserve; the company might tap it for unexpected expenses or even to fund a shareholder dividend.
Various tax laws and accounting practices particularly discourage property and casualty insurers from setting aside excess money, even for potential catastrophes.
Remember, an insurance company's voluntary reserve is distinct from its claim reserve, which is money set aside for policyholder claims that haven't been filed yet.
The Standard
In the industry, standard reserve levels range from 8% to 12% of the company's total revenues, and these requirements vary based on the types of risks the company takes on.
Reserve requirements are an evolving area for regulators. Back in 2016, an NAIC report found that existing reserve formulas were excessive in some cases and inadequate in others, depending on the company's situation and clients. The standards didn't account for the increasing variety and complexity of financial products sold by life insurance companies.
Life Insurance Reserves
The report suggested moving to 'principle-based reserving' for life insurance companies. This approach shifts from old practices by basing reserve requirements on a customized mix of factors, including the demographics of the company's clients, its financial performance, and its overall financial strength.
As a result, at least 46 states have updated their formulas for determining reserve requirements.
Other articles for you
The United States Aircraft Insurance Group (USAIG) is the oldest aviation insurer in the nation, founded in 1928, known for insuring historic events and promoting flight safety.
A distress sale involves quickly selling an asset at a loss due to urgent financial needs like debts or emergencies.
Commercialization is the process of introducing new products or services to the market to achieve commercial success.
Residual income refers to ongoing earnings from initial investments, often overlapping with passive income, and is used in personal, corporate, and investment contexts.
A safe harbor is a legal provision that reduces or eliminates liability in specific situations if certain conditions are met, with applications in finance, real estate, law, and accounting.
A Life Income Fund (LIF) is a Canadian retirement tool for holding locked-in pension funds to provide ongoing retirement income without lump-sum withdrawals.
An offering circular is a condensed prospectus that informs potential investors about new securities, including finances, risks, and fund usage.
IRS Form 8606 is used to report nondeductible contributions to IRAs and handle related tax implications like distributions and conversions.
A guaranteed bond is a debt security backed by a third party to ensure interest and principal payments if the issuer defaults.
The Jarrow Turnbull Model is a reduced-form credit risk model that incorporates fluctuating interest rates to calculate default probabilities.