Statutory reserve

Last updated November 19, 2019

In the business of insurance, statutory reserves are those assets an insurance company is legally required to maintain on its balance sheet with respect to the unmatured obligations (i.e., expected future claims) of the company. Statutory reserves are a type of actuarial reserve.

Insurance is a means of protection from financial loss. It is a form of risk management, primarily used to hedge against the risk of a contingent or uncertain loss.

Balance sheet summary of the financial balances of a sole proprietorship, a business partnership, a corporation or other business organization

In financial accounting, a balance sheet or statement of financial position or statement of financial condition is a summary of the financial balances of an individual or organization, whether it be a sole proprietorship, a business partnership, a corporation, private limited company or other organization such as Government or not-for-profit entity. Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year. A balance sheet is often described as a "snapshot of a company's financial condition". Of the four basic financial statements, the balance sheet is the only statement which applies to a single point in time of a business' calendar year.

Purpose

Statutory reserves are intended to ensure that insurance companies are able to meet future obligations created by insurance policies. These reserves must be reported in statements filed with insurance regulatory bodies. They are calculated with a certain level of conservatism in order to protect policyholders and beneficiaries.^[1]

Methods

There are two types of methods for calculation of statutory reserves. Reserve methodology may be fully prescribed by law, which is often called formula-based reserving. This is in contrast to principles-based reserves, where actuaries are given latitude to use professional judgment in determining methodology and assumptions for reserve calculation.^[1] In the United States, where formula-based reserves are used, the National Association of Insurance Commissioners plans to implement principles-based reserves in 2017.^[2]

The National Association of Insurance Commissioners (NAIC) is the U.S. standard-setting and regulatory support organization created and governed by the chief insurance regulators from the 50 states, the District of Columbia and five U.S. territories. Through the NAIC, state insurance regulators establish standards and best practices, conduct peer review, and coordinate their regulatory oversight. NAIC staff supports these efforts and represents the collective views of state regulators domestically and internationally. NAIC members, together with the central resources of the NAIC, form the national system of state-based insurance regulation in the U.S. The NAIC is an Internal Revenue Code Section 501(c)(3) non-profit organization. The 2018 NAIC President is Julie Mix McPeak, insurance commissioner from the Tennessee Department of Commerce & Insurance.

Life insurance in the United States

In the U.S. life insurance industry, statutory reserves are most commonly computed using the Commissioner's Reserve Valuation Method, or CRVM, the method prescribed by law for computing minimum required reserves.

Life insurance is a contract between an insurance policy holder and an insurer or assurer, where the insurer promises to pay a designated beneficiary a sum of money in exchange for a premium, upon the death of an insured person. Depending on the contract, other events such as terminal illness or critical illness can also trigger payment. The policy holder typically pays a premium, either regularly or as one lump sum. Other expenses, such as funeral expenses, can also be included in the benefits.

The size of a CRVM reserve, as with most life reserves, is affected by the age and sex of the insured person, how long the policy for which it is computed has been in force, the plan of insurance offered by the policy, the rate of interest used in the calculation, and the mortality table with which the actuarial present values are computed.

The actuarial present value (APV) is the expected value of the present value of a contingent cash flow stream. Actuarial present values are typically calculated for the benefit-payment or series of payments associated with life insurance and life annuities. The probability of a future payment is based on assumptions about the person's future mortality which is typically estimated using a life table.

The Commissioner's Reserve Valuation Method was itself established by the Standard Valuation Law (SVL), which was created by the NAIC and adopted by the several states shortly after World War II. The first mortality table prescribed by the SVL was the 1941 CSO (Commissioner's Standard Ordinary) table,^[3] at a maximum interest rate of 3½%. Subsequent amendments to the Standard Valuation Law have permitted the use of more modern mortality tables and higher rates of interest. The effect of these changes has in general been to reduce the amount of the reserves which life insurance companies are legally required to hold.

Notes

1 2 Beckley, Jeffrey A.; Scahill, Patricia L.; Varitek, Matthew C.; White, Toby A. (2012). Klugman, Stuart A. (ed.). Understanding Actuarial Practice. Society of Actuaries. p. 295.
↑ "Principle-Based Reserving (PBR) Implementation Plan" (PDF). National Association of Insurance Commissioners. 23 March 2015.Cite journal requires |journal= (help)
↑ The 1941 CSO table was prescribed for policies of ordinary life insurance. For policies of industrial life insurance the SVL prescribed use of the 1941 CSI (Commissioner's Standard Industrial) table.

Related Research Articles

An actuary is a business professional who deals with the measurement and management of risk and uncertainty. The name of the corresponding field is actuarial science. These risks can affect both sides of the balance sheet and require asset management, liability management, and valuation skills. Actuaries provide assessments of financial security systems, with a focus on their complexity, their mathematics, and their mechanisms.

Actuarial science is the discipline that applies mathematical and statistical methods to assess risk in insurance, finance and other industries and professions. More generally, actuaries apply rigorous mathematics to model matters of uncertainty.

A life settlement is the "legal" sale of an existing life insurance policy for more than its cash surrender value, but less than its net death benefit ). There are a number of reasons that a policy owner may choose to sell his or her life insurance policy. The policy owner may no longer need or want his or her policy, he or she may wish to purchase a different kind of life insurance policy, or premium payments may no longer be affordable.

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In actuarial science and demography, a life table is a table which shows, for each age, what the probability is that a person of that age will die before his or her next birthday. In other words, it represents the survivorship of people from a certain population. They can also be explained as a long-term mathematical way to measure a population's longevity. Tables have been created by demographers including Graunt, Reed and Merrell, Keyfitz, and Greville.

In the United States, a minimum municipal obligation (MMO) is the state-mandated smallest amount a municipality must contribute to any pension plan established for its employees.

The following outline is provided as an overview of and topical guide to actuarial science:

The American Academy of Actuaries, also known as the Academy, is the body that represents and unites United States actuaries in all practice areas. Established in 1965, the Academy serves as the profession’s voice on public policy and professionalism issues.

Under European Union law, an annuity is a financial contract which provides an income stream in return for an initial payment with specific parameters. It is the opposite of a settlement funding. A Swiss annuity is not considered a European annuity for tax reasons.

A net premium valuation is an actuarial calculation, used to place a value on the liabilities of a life insurer.

An actuarial reserve is a liability equal to the actuarial present value of the future cash flows of a contingent event. In the insurance context an actuarial reserve is the present value of the future cash flows of an insurance policy and the total liability of the insurer is the sum of the actuarial reserves for every individual policy. Regulated insurers are required to keep offsetting assets to pay off this future liability.

The statutory accounting principles are a set of accounting rules for insurance companies set forth by the National Association of Insurance Commissioners. They are used to prepare the statutory financial statements of insurance companies. Statutory Accounting Principles are designed to assist state insurance departments in the regulation of the solvency of insurance companies. Although there are minor state-by-state variations, they are the basis for state regulation throughout the United States.

Loss reserving refers to the calculation of the required reserves for a tranche of general insurance business. It includes outstanding claims reserves.

Anders Lindstedt was a Swedish mathematician, astronomer, and actuarial scientist, known for the Lindstedt-Poincaré method.

Joshua Milne (1776–1851), was an English actuary.

The Institute and Faculty of Actuaries is the professional body which represents and regulates actuaries in the United Kingdom.

Sir George Francis Hardy was a British actuary, Egyptologist and amateur astronomer. He became a Fellow of the Royal Astronomical Society in 1877 and was President of the Institute of Actuaries from 1908 to 1910.

References

N. L. Bowers, H. U. Gerber, J. C. Hickman, D. A. Jones, & C. J. Nesbitt, Actuarial Mathematics, Society of Actuaries (1986). ISBN 0-938959-10-7

External links

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[Klugman295-1] 1 2 Beckley, Jeffrey A.; Scahill, Patricia L.; Varitek, Matthew C.; White, Toby A. (2012). Klugman, Stuart A. (ed.). Understanding Actuarial Practice. Society of Actuaries. p. 295.

[2] "Principle-Based Reserving (PBR) Implementation Plan" (PDF). National Association of Insurance Commissioners. 23 March 2015.Cite journal requires |journal= (help)

[3] The 1941 CSO table was prescribed for policies of ordinary life insurance. For policies of industrial life insurance the SVL prescribed use of the 1941 CSI (Commissioner's Standard Industrial) table.