What is an evaluation reserve?
Valuation reserves are assets that insurance companies set aside in accordance with state law to mitigate the risk of decline in the value of the investments they hold. They work like a hedge to an investment portfolio and guarantee the solvency of an insurance company.
Because policies such as life insurance, health insuranceand various annuities may be in effect for long periods of time, valuation reserves protect the insurance company against losses resulting from investments that may not perform as expected. This helps ensure that policyholders are paid for claims and that annuity holders receive income even if an insurance company’s assets decline in value.
Key points to remember
- A valuation reserve is money set aside by an insurance company to protect against a decline in the value of its assets.
- Valuation reserves are required under state law to protect against natural fluctuations in the value of investments.
- Valuation reserves are calculated using an asset valuation reserve and an interest maintenance reserve to separate equity valuations from interest gains and losses.
- Regulators increasingly view risk-based capital requirements, such as valuation reserves, as a more prudent way to ensure solvency.
- To ensure that an insurance company remains solvent so that it can pay insurance claims and annuities, it must maintain a certain amount of valuation reserves.
Understanding an evaluation reserve
Insurance companies receive premiums for the services they render. In return, when a customer files an insurance claim claim that needs to be paid, an insurance company needs to make sure it has the money on hand to honor that claim.
The same is true for annuities issued by an insurance company. He must ensure that he can meet the regular payments of an annuity. For these reasons, it is essential for an insurance company to monitor its reserves and investments in order to remain solvent. Valuation reserves help insurance companies do this.
Valuation reserves ensure that an insurance company holds sufficient assets to cover the risks arising from the contracts it has subscribed. Regulators focus on use risk-based capital requirements to measure the solvency levels of insurance companies, which is a view of a company’s assets relative to its obligations separately rather than its assets relative to its liabilities together.
History of evaluation reserves
Valuation reserve requirements have changed over the years. Prior to 1992, a mandatory securities valuation reserve was required by the National Association of Insurance Commissioners to protect against a decline in the value of securities held by an insurance company.
After 1992, however, mandatory valuation reserve requirements for securities were amended to include a asset valuation reserve and an interest maintenance reserve. This reflected the nature of the insurance business, with companies holding different asset classes and customers buying more annuity-related products.
Changes to valuation reserve requirements
Life insurance companies have an obligation to pay beneficiaries who purchase insurance and annuities. These companies must hold an appropriate level of assets in reserve to ensure that they can meet these obligations for the many years that the policies may be in effect.
Various state laws and standards require that this level be calculated on a actuarial base. This approach takes into account the expectations complaints among policyholders, as well as forecasts of future premiums the business will receive and the amount of interest a business can expect to earn.
Yet the market for insurance and annuity products had evolved by the 1980s. American Council of Life Insurers report that in 1980, life insurance represented 51% of the reserves held by companies while the reserves held for individual annuities only represented 8%. Then, in 1990, reserves for life insurance fell to 29% of all reserves while the percentage held for individual annuities soared to 23%. This reflects the growing popularity of pension plans administered by insurance companies.
A change interest rate the climate can create a risk that has more impact on the reserves needed for current annuity payments than on life insurance benefits that are paid in a single payment. In recommending regulatory changes to separate asset valuation reserves from interest maintenance reserves, the National Association of Insurance Commissioners recognized the need to protect against fluctuations in the value of stocks and credit-linked obligations. capital gains and losses differently from interest-related gains and losses.