Legal Definitions - loss reserve

A loss reserve is an estimated amount of money that an insurance company sets aside to cover the future costs of claims that have already occurred but have not yet been fully paid out. This financial provision accounts for claims that have been reported but are still being processed, as well as claims that have occurred but haven't even been reported to the insurer yet (often called "incurred but not reported" or IBNR claims). Establishing a loss reserve is a crucial accounting measure to ensure the insurer has sufficient funds to meet its obligations to policyholders.

• Example 1: Automobile Accident Claims

  Imagine a large commercial trucking company that insures its fleet of delivery vehicles with a particular insurer. One month, several trucks are involved in separate accidents, resulting in significant vehicle damage and some driver injuries. While these claims have been reported, the full extent of the repair costs, medical bills, and potential legal settlements is still being assessed. The insurance company would establish a loss reserve for these specific incidents, estimating the total amount it expects to pay out once all repairs are completed, medical treatments concluded, and any liability disputes resolved.

  This example illustrates a loss reserve because the insurer is setting aside funds for claims that are known to have occurred (the reported accidents) but whose final payment amount is still uncertain and will be disbursed in the future.

• Example 2: Long-Term Disability Benefits

  Consider a life and disability insurance provider that covers an individual who has become permanently disabled and is now receiving monthly long-term disability payments. Based on actuarial tables and the individual's age, the insurer can estimate the total future payments it will likely make over the policyholder's lifetime. Even though these payments will be made incrementally over many years, the company establishes a loss reserve to account for the present value of these projected future benefit payouts, ensuring it has the financial capacity to fulfill its long-term commitment.

  Here, the loss reserve is for an ongoing claim where future costs are highly probable and predictable over a long period, demonstrating the forward-looking nature of the reserve for sustained obligations.

• Example 3: Widespread Property Damage from a Storm

  After a severe hailstorm sweeps through a metropolitan area, a property insurance company receives thousands of claims for damaged roofs, windows, and vehicles. Many policyholders have reported damage, but the process of inspecting each property, estimating repair costs, and settling claims will take months, if not years. Furthermore, some policyholders might not have reported their damage yet, or the full extent of hidden damage might not be immediately apparent. The insurer would establish a substantial loss reserve to cover the estimated total cost of all these claims – both reported and those expected to be reported – arising from the hailstorm.

  This example highlights how a loss reserve accounts for a large volume of claims, including those that are "incurred but not reported" (IBNR), following a widespread event, emphasizing the need for robust financial planning by insurers to handle significant future liabilities.