Insurance Reserves: The Strength to Keep Promises

Insurance is a product that sells a ‘promise’ to pay benefits when an accident occurs. To fulfill this promise reliably, insurance companies do not spend all the premiums they receive from customers; instead, they set aside a specific amount for future payouts, known as Insurance Reserves.

1. Why Are Reserves Necessary?

There is a long time gap between when premiums are paid and when benefits are received. In life or long-term non-life insurance, the premiums paid in the early years often exceed the risk cost, but as policyholders age, the probability of accidents increases and premiums alone become insufficient.

2. Accumulation of Policy Reserves

In the early stages, voluntary savings occur because leveled premiums are higher than the immediate risk rate. This saved amount is then used later when the risk rate surpasses the premium.

3. Main Types of Reserves

Actuarially, they are broadly classified as follows:

• Policy Reserve: The core funds accumulated for future benefit payments.
• Outstanding Claims: Amounts for accidents that have already occurred but have not yet been paid.
• Unearned Premiums: The portion of premiums received for which the accounting liability period hasn’t ended.

💡 Professor’s Tip

Insurance reserves are the largest ‘liability’ item on an insurance company’s balance sheet. If reserves are too low, the company may fail; if they are too high, profits decrease. Finding this equilibrium is where an actuary’s advanced mathematical skills are truly needed.

🔗 Next Step

• Ch6: Mortality Modeling