What is the Loss Reserve and Policyholder Surplus Loss Adjustment ratio?
The ratio of reserves for claims and loss adjustment to policyholder surplus is the ratio of an insurer’s reserves set aside for unpaid losses. It may also include the cost of investigating and adjusting for losses on its assets after recognition of liabilities.
Also called reserves at insured‘ surplus, the ratio indicates the degree of risk each dollar of surplus bears. The ratio is usually expressed as a percentage.
Key points to remember
- The ratio of claims and claims reserves to insured surplus is the amount of assets that an insurance company has set aside for unpaid losses.
- If an insurance company has a ratio that is too high, usually expressed as a percentage, it may indicate problems for the insurer. if the number and extent of claims filed exceeds the estimated amount set aside in the reserve, the insurer will have to draw on its profits to pay the claims.
- This ratio is in place to help regulators spot insurers who may rely too heavily on the use of reserves to cover losses.
Understand claims reserves and claims adjustment provisions in relation to the excess of insureds
Insurance companies set aside a reserve to cover potential liabilities from claims made on the policies they underwrite. Reserves are based on an estimate of the losses an insurer may face over a period of time; this means that the reserves could be adequate, or the reserves could not cover its debts. Estimating the amount of necessary reserves requires actuarial projections depending on the types of policies taken out.
Insurers have several objectives when handling a claim: to ensure that they respect the contractual benefits described in the policies they underwrite, to limit the prevalence and impact of fraudulent claims and to profit from the premiums they receive. Insurers must maintain a sufficiently high reserve to meet expected obligations. The higher the loss ratio and loss adjustment provisions policyholders’ surplus, the more the insurer depends on the policyholders’ surplus to cover its potential liabilities (and the more it runs the risk of becoming insolvent). If the number and extent of claims filed exceeds the estimated amount set aside in the reserve, the insurer will have to draw on its profits to pay the claims.
Regulators pay attention to claims reserves and claims adjustment provisions relative to the policyholder surplus ratio, as this is an indicator of potential solvency problems, particularly if the ratio is high. According to National Association of Insurance Commissioners (NAIC), a ratio of less than 200% is considered acceptable. If a number of insurers have ratios that are higher than what is considered acceptable, this could indicate that insurers are tapping too deep into reserves to pay out profits.
The NAICs Regulatory information system (IRIS) is a collection of solvency analytical tools and databases designed to provide state insurance departments with analysis of the financial condition of insurers operating in their respective states. In many states, consumers can also access IRIS data from insurers operating there.
Note that these ratios can vary significantly from year to year; a high ratio is not necessarily a sign that an insurer is or will become insolvent.
Claims reserve ratio and policyholder excess loss adjustment in practice
At the end of the year, insurance companies are required to submit their financial information to insurance regulators. Part of the reports submitted include the development of claims reserves and claims settlement costs during the year. There may also be changes in the policyholder surplus (or the company’s policyholder surplus). If the gross claims reserves and claims adjustment expenses change, the company’s ratio of claims reserves to claims reserves and policyholder surplus would also be adjusted for that year.
Insurers set aside this reserve to pay for losses, including claims appraisal and assessment costs. Essentially, it’s like an insurance company’s rainy day fund. A government regulator may decide to shut down a business if it is unlikely to be able to deliver the services it has promised to its customers. By setting aside current earnings for future losses, insurance companies ensure that they can provide coverage over a long period of time. When an insurance company submits its financial information to insurance regulators, they evaluate it to ensure that they can pay future claims. The ratio of provisions for claims and provisions for regularization on policyholder surplus is a strong indicator of a company’s financial solvency.