Legal Definitions - policy reserve

A policy reserve is a specific financial amount that an insurance company is legally mandated to set aside and hold. This reserve acts as a dedicated fund to ensure the company can meet its future financial obligations to policyholders, such as paying out claims, benefits, or maturity values as stipulated in their insurance policies. Essentially, it's a pool of money built up over time from premiums and investment earnings, guaranteeing that the company will have sufficient funds available when a policyholder's claim or benefit payment becomes due, even if that is many years in the future.

• Example 1: Life Insurance Policy

  Imagine a 35-year-old individual purchases a whole life insurance policy with a death benefit of $750,000. This policy guarantees that upon their death, their beneficiaries will receive this amount. The insurance company collects premiums from this policyholder over many years. A portion of these premiums, along with investment returns, is allocated to a policy reserve specifically for this policy and others like it. This reserve ensures that, whether the policyholder passes away in 5 years or 50 years, the company will have the $750,000 readily available to pay the beneficiaries, fulfilling its contractual promise.

• Example 2: Disability Income Insurance

  Consider a professional who buys a disability income insurance policy that promises to pay them a monthly income of $5,000 if they become unable to work due to illness or injury. If this individual suffers a debilitating accident and becomes permanently disabled, the insurance company will be obligated to pay them $5,000 every month for many years, potentially until retirement age. To guarantee these long-term payments, the insurer establishes a policy reserve funded by the premiums collected from this policyholder and others. This reserve ensures that the company has the financial capacity to make consistent monthly payments, even if the disability lasts for decades.

• Example 3: Fixed Annuity Contract

  A retired couple invests a substantial lump sum into a fixed annuity with an insurance company, which promises to pay them a guaranteed monthly income for the rest of their lives. Since the lifespan of the couple is uncertain, the insurance company faces a long-term, potentially decades-long, financial commitment. To secure these ongoing payments, the company is required to set aside a significant policy reserve. This reserve is built from the initial lump sum and its investment earnings, acting as a dedicated fund to ensure the company can reliably make the promised monthly income payments to the annuitants, regardless of how long they live.