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| Outstanding Claims Reserve |
What Exactly Is a Claims Reserve?
A claims reserve is a fund established by an insurance company to pay policyholders who have filed or are expected to file legitimate claims under their policies. The fund is used by insurers to pay out incurred claims that have yet to be settled.
The balance sheet reserve is another name for the claims reserve.
Claims Reserve: An Overview
People purchase insurance to protect themselves against financial loss. The company providing the service charges its customers insurance premiums in exchange for taking on this risk. An insurance premium is the amount of money paid for an insurance policy by an individual or business; insurance premiums are either paid in installments—monthly or semi-annually—or in one upfront payment before coverage begins.
When an insurance company enters into a contract with a customer, it accepts any liability in the event that an adverse occurrence occurs that damages whatever it agreed to insure. Accepting liability entails paying the insured person when they file a valid claim.
Every year, insurance companies handle claims filed against the policies they sell. For example, if an auto insurance policyholder is involved in an accident, they will file a claim with their insurance provider to be reimbursed for any damages to their vehicle.
Some claims, such as fire-related property losses, are easily estimated and quickly settled. Others, such as product liability, are more complicated and may not be resolved until long after the policy has expired.
A claims reserve is money set aside for a claim that has been reported but has not been settled (RBNS) or incurred but has not been reported (IBNR). A claims reserve will be assigned to each file that fits those descriptions, reflecting the insurance company's best estimate of the eventual settlement amount. Because the amounts liable on any given claim are unknown until settlement, the outstanding claims reserve is an actuarial estimate.
A claims adjuster is in charge of calculating the payable amount. The monetary value of the claims reserve can be calculated subjectively, using the claims handler's discretion, or statistically, by analyzing past data to forecast future losses.
The claims reserve is funded by a portion of the premiums paid by policyholders over the course of their insurance contracts.
Actuarial estimates of the amounts to be paid on outstanding claims must be evaluated so that the insurer's profits can be calculated.
Particular Considerations
Insurance companies may struggle to accurately determine the amount to set aside for claims. Regular reviews are beneficial, but this does not guarantee that adequate funds are always allocated. Significant underestimations can be a nasty surprise for investors, eroding trust in accounting practices and weighing on stock prices.
Claims that have been incurred but not reported (IBNR) are especially difficult to evaluate. For example, workers may inhale asbestos while performing their jobs but may not file a claim until they are diagnosed with an illness 20 years later.
Recording of Claims Reserves
An outstanding claims reserve is an accounting provision that is recorded on a company's balance sheet as a liability. They are classified as liabilities because they must be paid at some point in the future. They are, in other words, potential financial obligations to policyholders.
As each case progresses and new information is obtained during the claims settlement process, the claims reserve is adjusted over time. The total amount 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 claims adjuster, investigator, and legal assistance fees.
Example of a Claims Reserve
Company A offers home insurance to people all over the United States. Unfortunately, a large storm destroys much of the property that it insures in Florida. Company A anticipates a large number of claims, even if they have not yet been reported, and establishes a claims reserve, putting money aside based on its estimates of how much it will likely have to pay out.
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