Definition of Contract Reserves
Contract Reserves are specific financial reserves set up by insurance companies to ensure they have sufficient funds to cover future policy benefits, which exceed the expected future premiums upon calculation at the time of underwriting. These reserves are part of the intrinsic safety nets implored to uphold the companies reporting, financial security, and regulatory duties. These are particularly important in life insurance and annuities where coverage extends over long durations, and the payment structure and insured risk can be significantly complex.
Purpose of Contract Reserves
Stabilization: The primary reason for contract reserves is to balance the expected influx of future net premiums with the projected outflow of payments for claims.
Regulatory Requirements: Contract reserves are not only a measure for security, but also mandated under various insurance legislations and regulations to maintain solvency and transparency in operations. Tools and guidelines such as those promulgated by the National Association of Insurance Commissioners (NAIC) Guide to Understanding Contracts Reserves ensures systematic follow-up.
Distinguishing Contract Reserves from Other Types
Premium Reserves: These are established for future unearned premiums, distinct as it pertains more directly to the proportional premium income not yet earned but received.
Claim Reserves: Set up to cover the expected cost of future claims related to incidents that have already transpired or anticipated as liabilities under certain policies.
Functioning Mechanism
Actuarial principles are key to guiding proper ALM (Asset Liability Management) strategies where accurate and predictive financial modeling helps in managing assets compared with the liabilities and thus ensuring adequate reserves have been held under the Contract Reserves.
References and Resources
- National Association of Insurance Commissioners (NAIC)
- Government publications on insurance regulations
Conclusion
Contract Reserves represent a vital financial preparation for insurance companies to meet projected future commitments against underwritten policies where the claims expected, based upon maturity or claims engaged, may exceed the totaling premium payments anticipated over the period.
