Balance Sheet Reserves
What Are Balance Sheet Reserves?
Balance sheet reserves, otherwise called claims reserves, are accounting passages that show money set to the side to pay future obligations. Balance sheet reserves show up as liabilities on a company's balance sheet, one of the three principal financial statements. Balance sheet reserves are especially important in the insurance industry since companies must have adequate funds to pay any claims recorded by clients. There are set standards for setting up balance sheet reserves relying upon the state where the company is based.
Understanding Balance Sheet Reserves
Balance sheet reserves are placed as liabilities on the balance sheet and address funds that are set to the side to pay future obligations. For insurance companies, balance sheet reserves address the amount of money insurance companies set to the side for future insurance claims or claims that have been recorded however not yet reported to the insurance company or settled. The levels of balance sheet reserves to be kept up with are regulated by law. Balance sheet reserves are otherwise called claim reserves.
Balance sheet reserves are required of insurance companies by law to guarantee that an insurance company can pay any claims, losses, or benefits vowed to claimants.
Types of Insurance Reserves
Property and casualty (P&C) insurers carry three types of reserves:
- Unearned premium reserves, the balance of the premium that has not yet been "procured" during the policy period.
- Loss and loss adjustment reserves or obligations that have been incurred from claims recorded or destined to be documented;
- Incurred yet not reported (IBNR) reserves, which are set to the side for hard-to-gauge claims, for example, [workers' compensation](/laborers compensation) and product liabilities.
Illustration of Balance Sheet Reserves
To act as an illustration of balance sheet reserves for a company not in the insurance company, Company XYZ must recall one of its products and issue refunds to customers. Customer refund claims are expected to come in at a consistent rate for the next six months. To cover the refunds, the company sets to the side a balance sheet reserve of $15,000. As the customers demands show up and the amounts are refunded, Company XYZ decreases the $15,000 reserve on the balance sheet appropriately.
Insurance companies will frequently set up balance sheet reserves that equivalent the value of the claims that have been documented yet have not yet been distributed.
Balance Sheet Reserves and Profitability
The holding policy of an insurer can fundamentally influence its profits. Over-holding can bring about an opportunity cost to the insurer as it there are less funds accessible for investments. Alternately, under-saving can support profitability as additional funds are freed up to invest. Regulators, be that as it may, closely watch the holding policies of insurance companies to ensure adequate reserves are set to the side on the balance sheet.
Features
- The balance sheet reserves of insurance companies are regulated so these companies have adequate reserves to pay client claims.
- Insurance companies will frequently set up balance sheet reserves that equivalent the value of claims documented however not yet paid.
- The reserves are funds set to the side to pay future obligations.
- Balance sheet reserves are liabilities that show up on the balance sheet.
