{“text”:"### What is a Valuation Reserve?
Valuation reserves are assets that insurance companies set aside as required by state law to mitigate the risk of declines in the value of investments they hold. These reserves function as a hedge to an investment portfolio, ensuring that an insurance company remains solvent.
Because policies such as life insurance, health insurance, and various annuities may be in effect for extended periods, valuation reserves protect the insurance company from investment losses. This ensures that policyholders are paid for claims and annuity holders receive income even if an insurance company’s assets lose value.
Key Insights about Valuation Reserves
- Confirmation of Financial Health: A valuation reserve is money set aside by an insurance company to hedge against a decline in the value of its assets.
- Legal Requirements: Valuation reserves are mandated by state law to protect against the natural fluctuations in the value of investments.
- Precision in Measurement: Valuation reserves are calculated using an asset valuation reserve and an interest maintenance reserve to separate valuations in equity versus interest gains and losses.
- Risk Management Focus: Regulators are increasingly emphasizing risk-based capital requirements, such as valuation reserves, to ensure solvency prudently.
- State Regulations Compliance: To ensure an insurance company remains solvent enough to pay insurance claims and annuities, it must maintain a certain level of valuation reserves.
Understanding a Valuation Reserve
Insurance companies receive premiums for the services they provide. When a client files an insurance claim that needs to be paid out, the company must have money on hand to fulfill this obligation. The same conditions apply to annuities that require regular payments.
Valuation reserves help ensure that insurance companies can honor their obligations by maintaining adequate assets to manage the risks from the contracts they have underwritten. Regulators focus on risk-based capital requirements to measure the solvency levels of insurance companies\u2014this looks at a company’s assets versus obligations separately.
Evolution of Valuation Reserve Requirements
Prior to 1992, the mandatory securities valuation reserve required by the National Association of Insurance Commissioners (NAIC) protected against declines in securities’ value. However, post-1992 regulations, reflecting the diversified nature of insurance business holdings, introduced distinct asset valuation reserves and interest maintenance reserves.
Adjusting to Market and Regulatory Changes
Life insurance companies need to secure sufficient asset reserves to settle obligations from long-term policies. State laws and actuarial standards guide these requirements, forecasting expected claims, future premiums, and anticipated interest earnings.
Throughout the 1980s, the market for insurance and annuity products saw substantial shifts, with the reserves for life insurance and annuities variably adjusting. Recognizing these market changes and the implications of a volatile interest rate climate led the NAIC to update the regulatory framework to balance asset valuation and interest maintenance reserves reliably.
Related Terms: Asset Valuation Reserve, Risk-Based Capital Requirements, Interest Maintenance Reserve.
References
- National Association of Insurance Commissioners. “Financial Condition Examiners Handbook”, Page 114, 235.
- American Council of Life Insurers. “2019 Life Insurers Fact Book”, Pages 23, 31.
