Life insurance companies need to ensure that they have enough money to pay benefits when they are due, and they do this by holding reserves in cash. A cash reserve is a legal requirement mandated by state governments to ensure life insurance companies can pay stated claims. This acts to protect both policyholders and the insurer from default.
Generally speaking, life insurance companies must keep reserves in stable investments, for example in cash, or in government bonds (or bond-like investments). This ensures that the reserves are sufficiently protected from loss. While there are usually no specific investment recommendations, insurance companies are generally encouraged to invest in very conservative investments for their cash reserves.
States have individual requirements. For example, in New York, life insurance companies must separate their general account from their sub-account and treat each one differently. The general account is used for fixed investments for life and annuity contracts. The variable sub-account is used for variable life and annuity products.
States will also use a mathematical formula to calculate the reserve requirements of life insurance companies based on the assets that they hold, and a state defined reserve minimum. Any life insurance company that does not meet the state minimum must then sell assets or raise capital to meet the reserve minimum.
- "Practicing Financial Planning for Professionals, Practitioners' Version, 10th edition"; Sid Mittra, Anandi P. Sahu, Robert A Crane; 2007
- Financial Web: Life Insurance Company Reserves
- "Life & Health Insurance, License Exam Manual, 6th Edition"; Dearborn Financial; 2004
- Photo Credit dollars image by peter Hires Images from Fotolia.com
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