Download Policy Reserve Purpose

Policy Reserve
• Policy reserve also known as legal reserve are
major liability of insurance company
• Under the level-premium method , premiums
are overpaid during the early years of policy
(higher than necessary to pay the death
claims).
• The excess premiums must be held for future
payment to the policyownwer’s beneficiaries.
• Policy reserves are liability item in the balance
sheet of insurance companies that have to
offset by assets equal to the amount.
• Policy reserve are also called legal reserves
because state law specifies the basis for
calculating the policy reserve required by law.
Purpose of Policy Reserve
• 1- It is a formal recognition of the insurer’s
obligation to pay future claims. The policy reserve
plus future premiums add interest earnings
must be sufficient to pay all future policy
reserves.
• 2-The reserve is a legal test of insurer’s solvency.
The insurance must hold assets at least equal to
its legal reserves and other liabilities. Policy
reserves should not be viewed as a fund. Rather,
they are a liability item that must be offset by
assets.
Definition of Reserve
• The policy reserve can be defined as the
difference between the present value of
future benefits and the present value of future
net premiums.
• The net single premium is equal to the present
value of future net benefits at the inception of
the policy.
• The net single premium can be converted into
a series of net level premiums without
changing the relationship.
• After the first installment is paid ,the present
value of future benefits and the present value
of future net premiums are no longer equal to
each other.
• Present value of future benefits will increase
over time while the present value of future
net premiums will decline because the
premiums are lower the amount that is
needed to pay for death benefit.
Type of Reserves
• The reserve can be viewed either
retrospectively or prospectively.
• If we refer to the past experience, the reserve
is known as a retrospective reserve.
Retrospective reserve calculation method
Reserve on Valuation date=
Sum of the past net premiums with interest
added minus Sum of the past mortality cost
with interest added
• Prospective reserve is the difference between
the preset value of future benefits and the
present value of future net premiums.
• Prospective reserve calculation method
Reserve on the valuation date=
Present value of future benefits under the
contract – Present value of future premiums
• The retrospective and prospective methods
are the mathematical equivalent of each
other.
• Both methods will produce the same level of
reserves at the end of any given year if the
same set of actuarial assumption is used.
Classification of Reserve
• Reserve can be classified based on the time of valuation.
1- Terminal reserve: is the reserve at the end
of any given policy year used by
companies to determine the cash surrender
value a well as amount of risk.
2- Initial reserve: is the reserve at the
beginning of any policy year used by companies to
determine dividends.
3- Mean reserve: is the average of the terminal and initial
reserves used by insurers to determine dividends.