What is a valuation reserve?

State laws require insurance companies to set aside resources known as valuation reserves to lower the risk of decreases in the value of their investments. They guarantee the continued viability of an insurance firm and act as a hedge for an investment portfolio.

Valuation reserves shield the insurance firm against losses from underperforming assets since policies like life, health, and variable annuities may be in force for long periods. This helps guarantee that annuity holders get income even if an insurance company’s assets decrease in value and that policyholders are compensated for their claims.

Understanding a Valuation Reserve

For the services they provide, insurance firms are compensated with premiums. In exchange, an insurance firm must guarantee sufficient funds to fulfill a client’s request to pay an insurance claim.

This also holds for any annuities that insurance providers issue. It has to be sure it can afford the annuity’s monthly payments. These factors make it essential for an insurance business to keep an eye on its investments and reserves to be viable. Valuation reserves help insurance companies with this.

An insurance company’s valuation reserves ensure sufficient assets to cover any risks associated with its underwritten contracts. The primary tool regulators use to assess the solvency levels of insurance businesses is risk-based capital requirements, which present a company’s assets and liabilities individually rather than jointly.

Valuation Reserves’ Past

Over time, the criteria for valuing reserves have evolved. The National Association of Insurance Commissioners mandated the establishment of an obligatory securities valuation reserve before 1992 to guard against a decrease in the value of the securities that an insurance company had.

However, an asset valuation reserve and an interest maintenance reserve were added to the statutory securities valuation reserve requirements in 1992. This was in line with the structure of the insurance industry, whereby clients were buying more annuity-related products and businesses owned a variety of asset classes.1. Modifying requirements for Valuation Reserves

Paying beneficiaries who buy insurance and annuities is the responsibility of life insurance companies. These firms must have sufficient reserve assets to ensure they can fulfill their responsibilities during the many years that the policies may be in force.

Several state laws and guidelines require the actuarial determination of this threshold. This method considers the anticipated claims from policyholders and projections for the company’s future premium income and interest earnings.

However, throughout the 1980s, the insurance and annuity product markets had been changing. According to the American Council of Life Insurers, individual annuity reserves comprised just 8% of corporate funds in 1980, compared to life insurance’s 51% share. Subsequently, by 1990, life insurance reserves accounted for only 29% of total resources, while individual annuity reserves increased to 23%. This was a reflection of the rising popularity of insurance company-managed retirement programs.

The risk associated with fluctuating interest rates might affect the reserves required for continuous annuity payments more than lump-sum life insurance payouts. The National Association of Insurance Commissioners agreed upon that changes in the value of equity and credit-related capital gains and losses should be protected against differently from changes in the value of interest-related gains and losses. To do this, they want to separate asset valuation reserves from interest maintenance reserves in the regulations.

Conclusion

• An insurance firm puts aside money as a valuation reserve to protect itself against a decline in the value of its assets.
• State legislation mandates valuation reserves as a safeguard against the inherent volatility of investment values.
• To distinguish between valuations of equity gains and losses and those of interest, valuation reserves are computed using an asset valuation reserve and an interest maintenance reserve.
• Regulators often examine risk-based capital requirements, such as valuation reserves, as a more sensible means of guaranteeing solvency.
• An insurance company must keep a specific level of valuation reserves to ensure it stays solvent and can pay claims and annuities.