Understanding Insurance Reserve Requirements: How They're Calculated

Reserve requirements for an insurance company are determined by the state in which the company is doing business. The purpose of the reserve requirement is to ensure that if a catastrophic event were to happen, with a large percentage of policyholders affected, the company would have enough money to meet the claims.

Factors Determining Reserve Requirements

To determine reserve requirements, each state considers factors such as the number of policyholders in the state, the amount of their potential benefits and the amount of revenue generated.

In New York, for example, reserve requirement amounts are determined in the following manner. Insurers file a report with the Department of Insurance that provides information concerning the valuation of the insurer’s general and separate accounts. In keeping with Securities and Exchange Commission (SEC) requirements, an insurance company's general account holds assets for its fixed products, while the separate account must hold assets for variable insurance products, such as variable life and universal life insurance policies and variable annuities.

Reserve Valuation Basis

The valuation is based on all products sold, including these:

• ordinary life insurance, including all traditional life, individual stop-loss (ISL) and flexible premium life insurance
• group life insurance, permanent plans and unearned premiums
• industrial life insurance
• credit life insurance
• fixed income annuities and structured settlement annuities
• accumulation type annuities
• company retirement annuities
• supplementary contracts with life contingencies
• disability—disabled lives, for approved and pending and resisted claims
• deficiency reserves
• substandard extra premium reserves
• accident and health unearned premium reserve
• accident and health additional contract reserves   
• accident and health reinsurance ceded (active life reserves)    
• accident and health present value of amounts not yet due on claims
• accident and health reinsurance ceded (claim reserves)
• guaranteed interest contracts (balance before reinsurance)     
• guaranteed interest contracts (reinsurance balance)
• supplementary contracts and annuities certain (balance before reinsurance)
• supplementary contracts and annuities certain (reinsurance balance)
• dividend accumulations or refunds (balance before reinsurance)
• dividend accumulations or refunds (reinsurance balance)        
• premium and other deposit funds (balance before reinsurance)          
• premium and other deposit funds (reinsurance balance)          
• other (balance before reinsurance)         
• other (reinsurance balance)

The basis of the reserve requirements takes into account these balances and separate account amounts and determines a percentage that the insurer needs to keep on hand. Usually, the reserve requirement amounts to 10 to 12 percent of the insurer’s revenue.