Insurance Reserves and Accounting

A claims reserve is a reserve of money that is set aside by an insurance company in order to pay policyholders who have filed or are expected to file legitimate claims on their policies. Insurers use the fund to pay out incurred claims that have yet to be settled.

People pay for insurance coverage to protect themselves against financial loss. In exchange for taking on this risk, the company offering the service charges its customers insurance premiums. An insurance premium is the amount of money an individual or business pays for an insurance policy; insurance premiums are either paid in installments monthly or semi-annually or in one upfront payment before any coverage starts.

When entering a contract with customers, an insurance company accepts any liability in the event that an adverse occurrence takes place which damages whatever it agreed to insure. Accepting liability means making a payment to the insured person when they file a legitimate claim.

Every year, insurance companies deal with claims that are filed against the policies that they sell. For example, an auto insurance policyholder who gets involved in an accident will file a claim with their insurance provider to be reimbursed for any damages made to their car.

Some claims, such as property losses due to fire, are easily estimated and quickly settled. Others, such as product liability, are more complex and may be settled long after the policy has expired.

A claims reserve is money set aside for a claim that has been reported but not settled (RBNS) or incurred but not reported (IBNR). An insurance company will assign a claims reserve to each file that fit those descriptions, reflecting its best estimate of the eventual settlement amount. The outstanding claims reserve is an actuarial estimate, as the amounts liable on any given claim is not known until settlement.

A claims adjuster is responsible for estimating the payable amount. The monetary amount of the claims reserve can be calculated subjectively, using the claims handler’s judgment, or statistically, by evaluating past data to project future losses.

Money for the claims reserve is taken from a portion of the premium payments made by policyholders over the course of their insurance contracts.

It can be difficult for insurance companies to accurately determine the amount to set aside for claims. Regular reviews help, although that does not mean that adequate funds are always allocated. Significant underestimates can come as a nasty shock to investors, eroding trust in accounting practices and weighing on company share prices.

Claims that have been incurred but not reported (IBNR) are particularly tricky to assess. For example, workers may inhale asbestos while performing their jobs but might not file a claim until after being diagnosed with an illness 20 years after the adverse event occurred.

An outstanding claims reserve is an accounting provision that is recorded as a liability on a company’s balance sheet. They are classified as liabilities because they must be settled at a future date. In other words, they are potential financial obligations to policyholders.

The claims reserve is adjusted over time as each case develops and new information is retrieved during the claims settlement process. The total amount of funds set aside for a claim is the sum of the expected settlement amount and any expenses incurred by the insurer during the settlement process, such as fees for claims adjusters, investigators, and legal assistance.

When a business suffers a loss that is covered by an insurance policy, it recognizes a gain in the amount of the insurance proceeds received. The most reasonable approach to recording these proceeds is to wait until they have been received by the company. By doing so, there is no risk of recording a gain related to a payment that is never received. An alternative is to record the gain as soon as the payment is probable and the amount of the payment can be determined; however, this constitutes a form of accrued revenue, and so is discouraged unless there is a high degree of certainty regarding the payment. If the gain is recorded prior to cash receipt, the offsetting debit to the gain is a receivable for expected insurance recoveries.

A gain from insurance proceeds should be recorded in a separate account if the amount is material, thereby clearly labeling the gain as being non-operational in nature. For example, the title of such an account could be “Gain from Insurance Claims.” Though a gain is being recorded, the likely total outcome of an insurance claim is a net loss, since the amount of such a claim is offset against the actual loss incurred, net of an insurance deductible.

It may be necessary to disclose in the financial statement footnotes the nature of the events resulting in insurance proceeds, the amount of the proceeds, and the income statement line item in which the resulting gain is recorded.

In case of loss of Profit