Voluntary Reserve

Key Takeaways

• Voluntary reserves are cash held by insurers above government-required minimums.
• These reserves ensure company solvency during financial strains or disasters.
• Standard reserve levels in the industry typically range from 8% to 12% of revenue.
• Changes in state regulations now consider factors like client demographics and financial strength.
• Principle-based reserving allows for tailored reserve requirements in life insurance.

Voluntary Reserve: An Overview

A voluntary reserve is a sum of cash held by an insurance company above any minimum required by government regulators, which supports solvency and overall financial health. For both regulators and the company, these additionally held liquid assets signal stability and provide flexibility in stress periods, and they support long-term risk management. Unlike claim reserves, voluntary reserves are not set aside for specific expected payouts.

How a Voluntary Reserve Works

State regulators use tools provided by the Insurance Regulatory Information System (IRIS), which is managed by the National Association of Insurance Commissioners (NAIC), to determine the solvency of insurance companies in their jurisdictions, and the appropriate amount of cash they should have in reserve.1

IRIS mines financial information filed by each insurance company in order to determine which insurance companies may face solvency issues. The regulatory body determines a range of liquidity ratio values that are considered acceptable for each company. Outlying values indicate that an insurer should be examined more closely by regulators.1

Factors Influencing Voluntary Reserve Levels

Insurance companies have competing considerations when deciding on the size of a voluntary reserve.

A large amount of cash on hand is a sign of the company's stability and its ability to meet the demands of any catastrophe. But it also decreases the amount available to reinvest in the business or reward shareholders.

There are few restrictions on the use of a voluntary reserve, however. The company could choose to pay any unexpected expense from it or, for that matter, use it to fund a shareholder dividend.

Various tax laws and accounting practices discourage property and casualty insurers, in particular, from setting aside excess money even for catastrophes.

An insurance company's voluntary reserve is separate from its claim reserve, which is an amount of money budgeted for policyholder claims that have not yet been filed.

Industry Standards for Reserves

Standard levels of reserves in the industry range from 8% to 12% of the company's total revenues. The requirements vary depending on the type of risks a company assumes.

Reserve requirements are a shifting field for regulators. In 2016, an NAIC report concluded that the existing formulas for reserves were excessive in some cases and inadequate in others, depending on the circumstances and clientele of the company. The standards, it found, did not reflect the growing variety and complexity of financial products that are now sold by life insurance companies.

Principle-Based Reserving in Life Insurance

The report recommended “principle-based reserving” for life insurance companies. This departure from past practice bases reserve requirements on a highly individualized mix of factors that include the demographics of the company's clients, the company's financial performance, and its financial strength.2