Voluntary Reserve
Candlefocus EditorVoluntary reserve accounts are cash assets that are held by an insurance company to provide additional protection to its policyholders. Not to be confused with the company's required levels of capital, or reserves, voluntary reserves go beyond the minimum state regulatory requirements, intended to provide both a financial cushion and increased policyholder security.
The exact percentage that an insurance company should aim for in its voluntary reserve account is determined by many factors, such as an insurer's assets, liabilities, and the type of insurance products offered. Generally, insurers should aim for a reserve between 8-12% of their overall revenue. A larger voluntary reserve indicates a stronger financial foundation and a higher level of financial stability.
Insurance companies are required by law to maintain specific levels of reserves, regardless of the total amount of their assets, liabilities or total premiums written. Keeping a reserve account at the legally required minimum is not the same as maintaining a healthy reserve account. The majority of states, such as Michigan, require that insurers maintain a certain percentage of reserves based on their premiums, ranging anywhere from 8 to 12 percent. In Michigan, the required reserve percentage increases each year, beginning at 8 percent and slowly increasing to 10 percent.
By creating a voluntary reserve, which is determined and managed solely by company management, insurers can boost their financial strength and create an additional barrier for policyholders. It is an important component of risk management for any insurance company. With a higher reserve level, the burden of risk associated with unforeseen circumstances can be more easily managed and the policyholders enjoy more security when the company has higher financial strength.
In addition to its risk management benefits, a voluntary reserve also can boost an insurance company’s investment strategy. By placing more capital in higher yield investments, the insurance company can maintain more flexibility in managing its investments and build more diversity across its portfolio.
Overall, voluntary reserves are one of the key elements of strong risk management strategies that insure both the financial stability of the insurer and the security of its policyholders. Maintaining a high level of reserves helps the insurer remain solvent, regardless of the type of claims presented or the amount of premiums written. It also serves as an additional barrier against potential risk.