Reserve is a type of liability of the insurer for its policyholders. Insurers made reserves in order to ensure their ability to pay future claims to the policyholders. The amount of reserves depends upon the nature and the duration of the policy. The reserves in any group of policies originate in the excess of premium receipts over payment of claims. It is accumulated on the assured mortality and interest.
Things which are taken into consideration while calculating reserve for a particular policy.
- Nature of Policy
- Assumed Mortality Rate
- Assumed Rate of Interest
- Period of Premium Payment
- Duration of Policy etc.
Sources of Reserve:
- First source of reserve is premium paid by the policyholder
- Second source is interest, as the premium is invested by the insurance companies to the equity, government securities etc. and in this way they get return from the invested fund.
Need for Reserve
- To meet the amount of claims : Insurer might receive a claim from its policyholder any time when an given event takes place with them and the insurer must have enough balance at that time to meet that claim. Reserve helps the insurer to meet the claim of the policyholder at any time.
- To build up fund: Reserve is also helpful to build up fund for the insurer as it can be invested by them for the long period to earn at least assumed rate of return.
- To give benefit to the policyholder at any cost: The main purpose of creating reserve to make payment to the claim of the policyholder whenever it is made.