What is Voluntary Reserve?
A voluntary reserve is an additional sum of cash held by insurance companies over and above the minimum required by regulators—demonstrating financial prudence beyond legal mandates.
State regulations set minimum reserve requirements for insurance companies to ensure their solvency. Voluntary reserves, often termed additionally held liquid assets, appear prominently in the company’s financial reports. Financial institutions also maintain voluntary reserves as a further safety measure.
Key Takeaways
- A voluntary reserve signifies an insurance company’s financial security over and above state-mandated requirements.
- These reserves aim to guarantee company solvency and operational longevity.
- Regulatory reserve amounts typically range from 8% to 12% of total revenue.
How Do Voluntary Reserves Function?
State regulators employ tools provided by the Insurance Regulatory Information System (IRIS), governed by the National Association of Insurance Commissioners (NAIC), to assess solvency and determine appropriate reserve levels for insurance companies.
IRIS analyzes financial data from each insurer to flag companies that might face solvency issues. This regulatory framework allows for a range of liquidity ratio values deemed acceptable. Lower or higher valuations necessitate closer scrutiny by the authorities.
Determining the Reserve Amount
Insurance companies face a dual challenge when deciding on their voluntary reserve size. While a significant cash reserve underscores a company’s stability and disaster-readiness, it could limit the funds available for reinvestment or shareholder rewards.
The voluntary reserve can be used flexibly, covering unexpected expenses or financing a shareholder dividend. However, tax policies and accounting norms often discourage excessive reserve funds, especially for property and casualty insurers.
It’s important to differentiate a company’s voluntary reserve from its claim reserve, allocated for pending policyholder claims.
Industry Standards
The industry standard for reserves ranges between 8% to 12% of company revenues, dependent on the risk profile and nature of the assumed risks. Regulatory requirements evolve, with reports indicating variable effectiveness—sometimes showing reserves are either excessive or insufficient relative to modern industry complexities.
Life Insurance Reserves
In recent regulatory changes, the NAIC endorsed ‘principle-based reserving’ for life insurance, tailored more finely to specific company factors like demographic data and financial performance. This new approach inspired at least 46 states to modify their respective reserve formulas.
Related Terms: claim reserve, required reserves, liquidity ratios.
References
- National Association of Insurance Commissioners. “Insurance Regulatory Information System (IRIS) Ratios Manual 2020 Edition”, Page 1.
- National Association of Insurance Commissioners. “Principle-Based Reserving (PBR)”.
- National Association of Insurance Commissioners. “How Principle-Based Reserving Will Affect Life Insurers”, Page 2.
