Incurred But Not Reported (IBNR)
Candlefocus EditorAn insurance company will set aside funds in an IBNR reserve to cover past policy periods in which losses occurred, but those losses have yet to be reported. The IBNR reserve is used to accrue for those future losses and it helps the company anticipate the cost of events that may have already occurred, but their respective claims have yet to be reported.
For instance, a policyholder may donate a car on January 1st, 2021 and the insurance company may not receive the actual claim until March 1st, 2021. The total loss incurred on January 1st, however, must be addressed and accounted for in the financial statements. Hence, in order to accurately report financial position, the insurance company must set aside funds in the IBNR reserve to account for the potential claims liability.
The IBNR calculation relies on historical trends and actuarial principles. It is an estimation of the future costs stemming from events that have already occurred but for which claims have yet to be reported. The higher the number of events that have occurred without a claim, the higher the IBNR reserves.
In other words, the larger the unpaid losses and exposures, the higher the IBNR reserves will tend to be. This makes it very important for insurance companies to maintain accurate and up-to-date records. Companies that inaccurately calculate their IBNR reserves may expose themselves to uncontrolled liabilities.
Just like all components of a company's balance sheet, an accurate IBNR calculation is crucial for adequate financial reporting. Companies that fail to properly estimate their IBNR reserves may be exposed to costs that exceed current claims reserves. As such, IBNR reserves that are regularly monitored and corrected can help ensure a company's financial health.