Statutory Reserves
Candlefocus EditorDepending on the insurance company’s legal jurisdiction, statutory reserves can come in the form of cash and cash equivalents (like U.S. Treasury bonds or money market funds) or other short-term investments.
The insurance industry is highly regulated, and the amount of the statutory reserve requirement for an insurance company is determined by the applicable state insurance regulations. In the United States, for example, the amount of the required reserve must be sufficient to pay out any outstanding claims and to cover any upcoming policy renewals. It's calculated by the company's actuary at least once every three years, and must be re-calculated whenever a dramatic change occurs in the company’s operations.
Sometimes, insurance companies choose to set their statutory reserves above the minimum level, using a principles-based approach. By taking a more proactive approach to statutory reserves, companies may be able to better manage their gains, losses and expenses.
When an insurance company has more statutory reserves than it needs to cover claims and expenses, the extra money can be used to pay dividends to its shareholders. This is why insurance companies often prioritize reserving amounts — they understand the competitive impact of having excess reserves that can potentially be returned to shareholders.
Overall, statutory reserves are a critical part of the insurance industry, ensuring that companies have enough money to cover unexpected claims and policy renewals. By preventing companies from being financially overwhelmed by a single large claim, statutory reserves help to ensure that the industry remains solvent, secure and healthy.