This article provides a brief introduction to loss reserves for self-insured organizations.
Many organizations self-insure liability exposures such as workers compensation, general liability, automobile liability, or medical malpractice. Self-insurance can assume various forms, such as liability retained through a high deductible policy or an excess policy. Regardless of the self-insurance mechanism it employs, the organization must recognize the resulting obligation for future loss1 payments as a liability on its balance sheet. This liability is commonly referred to as a loss reserve or “loss accrual”. In short, the purpose of a loss reserve is to help ensure that an organization has sufficient assets available to make any necessary payments related to it self-insured exposure.
It is important to recognize that a loss reserve is an estimate of future uncertain events. In order to better understand the nature of loss reserve liabilities, it helps to examine the characteristics of the underlying insurance obligations. For a self-insured, potential liabilities arise from insurable accidents. A significant period of time often elapses between the date of the accident and the date of any loss payments. This lag gives rise to the need for loss reserves. Typically, a loss reserve established at a specified date is required to provide for all future expected loss payments related to accidents that have occurred through that point in time. Since the magnitude of future loss payments are rarely known with certainty, it is necessary to estimate these amounts.
Organizations that purchase guaranteed cost insurance transfer the liability for insurable accidents to the insurance carrier. These organizations generally have no need to establish loss reserves. Also, some organizations may choose not to carry loss reserves if the magnitude of the liability is considered immaterial or cannot be reasonably estimated. In such cases, the organization should be careful to comply with all applicable accounting and state-specific regulatory requirements. Organizations that do carry loss reserves often rely on the services of an actuary to determine the appropriate amount. In addition to accurately quantifying loss reserves, a good actuary can help an organization better understand and manage its risks.
Learn more about the components of loss reserves in this article.
Disclaimer: Information presented in this article should not be relied upon as actuarial or accounting advice, which should be provided by a credentialed actuary or accountant familiar with the details of your organization’s risk management program.
1. In this article, the term “loss” is used in a general sense to refer to loss and expense payments. This article provides more information on the types of claim payments and claim expenses commonly considered in the reserving process.