What is Loss Reserve?

A loss reserve refers to an estimated amount of liability of an insurer that needs to pay for future claims. Generally, loss reserves permit an insurer to veil claims create in the opposition of insurance policies that it signed and accepted (underwrites). The insurance companies consider two figures while underwriting a new policy including an asset, the premium to be paid by the policyholder and liability, a future claim obligation.

Estimation of liabilities is a comprehensive undertaking. The insurers must take into consideration the types of insurance, contract’s duration and likelihood of a claim being made. The insurer must balance its calculations of loss reserve according to the circumstances change.

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Understanding Loss Reserve

The loss reserve defines as an approximated amount that has to be paid by an insurer for future claims on its underwritten insurance policies. The insurance companies generally make a loss reserve fund of liquid assets in order to cover the latter. The discounted loss reserve is smaller than the undiscounted loss reserve. The insurer considered a premium receivable and a claim obligation while underwriting a new policy. Claim obligation is a liability which is considered as a part of unpaid losses account that shows the loss reserve. The accounting of loss reserves is a comprehensive calculation as losses can occur at any time. Insurance companies may be in a good financial place to pay out claims by maintaining an appropriate level of loss reserves and can also to meet any long legal battles.

For instance, an insurance company may need funds for multi-year court battle for taking a legal action for final settlement with a claimant, which may evacuate funds of the company over a period of time. 

Frequently Asked Questions

What is the significance of Loss Reserve?

Loss reserve is important for the companies to be in a better place in terms of finance in order to fulfill the requirements of the claims and legal battles. Loss reserve is an estimated value of claims which are not yet paid. The insurance companies make the loss reserves by estimating an amount of claim which may need to be settled or adjudicated anytime. An insurance company also makes reserves for its entire books of business to estimate its future liabilities. The loss reserves may create for various reasons including pro tem amounts planned for known claims which are expected to pay but not yet paid, incurred losses yet to be announced, and claims which are known and yet to be due. It is very crucial for insurance companies to determine an adequate amount to set as a loss reserve because they probably incur liability at a time in the future.

How to calculate Loss Reserve?

Determining or estimating the right amount for loss reserve is decisive or critical for a company while maintaining its financial competence and profitability. The insurance company, which is very stable in its loss reserve calculation, it may allot too much amount in reserve which decease its income and ability of making investments in assets. On the other side, if the company is too forbearing with its calculation of loss reserve, it will not allot sufficient amount to its reserves, in result it may face the losses in future and there is possibility to become insolvent. The amount of loss reserve is calculated based on forecasting and estimation. A loss reserve also affects the tax liabilities of an insurance company as regulators calculate the taxable income of an insurer by deducting any rise in loss reserve and using the sum of annual premium that process is known as loss reserve deduction.

It is very comprehensive process to determine an adequate amount to set as a loss reserve because they probably incur liability at a time in the future. The insurance companies choose to use present value for the calculation of claims as it let them make a deduction in amount of future claim payments and estimate how much the companies required to reserve today. While determining the loss reserve, the years of interest earned on reserves prior to making the payments of claim is also considered because technically it decreases the amount of liability. Though, regulators need claims has to record with its real value of the loss which is called nominal value.