Reserves: asset or liability?

[Phani Vasantarao]

Hi everyone,

Now, this may seem like a bit of a silly question at first. Reserves, as I understand, are supposed to be seen as liabilities. The assets an insurer or reinsurer holds *backs* the reserves. However, the terminology used with reserves often seems to address the concept of assets. For example, take deposited reserves (or deposit back). Here, the reinsurer is supposed to "deposit back" the "reserves" with the cedant. This is supposed to help the insurer gain all investment profit, and take investment risk away from the reinsurer. This is clearly talking about an asset - how could anyone "deposit back" a liability, and moreover, how does one earn investment returns on a liability?

It's a bit of a general question and may or may not help with the exam, but I think understanding the potential dual meaning (unless I am mistaken) of this word will generally help me wrap my head around insurance concepts.

Thanks,
Regards,
Phani

 

[Charlie]

I think it's more important to think about the context in which the term "reserves" is used. I think that depending on the context, it could be taken to refer to assets or liabilities.

You're right in the sense that an increase in reserves relates to an increase in expected future liabilities. And so there will need to be more assets "backing" them. But when the notes say that the reserves are deposited back, it is referring to the backing assets, rather than the underlying liabilities.

So I'd say that you have got a pretty good grasp of the insurance concepts but you just need to be flexible and interpret the term according to the context.

 

[Pede]

I agree with Charlie.
Suppose you're a proprietary company, and your shareholders give you £100 (rights issue or whatever). Then your assets will increase by £100. But so will your liabilities, as you 'owe' the shareholders more.
Also, don't forget that free assets are often also called free reserves. Says it all!

 

[Phani Vasantarao]

Thanks for your helpful replies!

 

[Sponge]

Also another general question.

What do they refer to when they say assets backing asset shares. And then sometimes in the same sentence refer to assets backing reserves.
In my understanding under a restropective valuation, asset shares form part of the reserves and/or are reflective of the reserve in some way.

How are the assets split to then back asset shares and reserves separately.

 

[Mark Willder]

Also another general question.

What do they refer to when they say assets backing asset shares. And then sometimes in the same sentence refer to assets backing reserves.
In my understanding under a restropective valuation, asset shares form part of the reserves and/or are reflective of the reserve in some way.

How are the assets split to then back asset shares and reserves separately.

Yes, you're right that the asset share is often used to set a reserve, although this would typically only be the case for with-profits policies. Depending on the regulations of the country concerned, reserves could also be higher or lower than asset shares.

The asset share is the retrospective accumulated cashflows concerning the policy.

The reserve is the amount of money we must hold to satisfy the regulator. It would normally be a prospective calculation.

An example may help. An insurer has assets of 100 and reserves of 80, so it is solvent. It's asset share is only 70, so not enough to cover the reserves on its own - the rest of the money comes from the capital of the insurer.

The insurer's assets can be broken down into three parts: 70 is backing the asset share (it is also backing the reserves), 10 is backing the rest of the reserves, 20 is backing the free assets.

I hope this clarifies what is going on.

Best wishes

Mark

 

[Sponge]

I think so, so whether asset shares are higher/lower than reserves. there will be a subset of capital that is backing asset shares, reserves and free surplus.

In a scenario where asset shares are greater than reserves, then there is more investment freedom with regard to this not sitting outside the regulatory capital (also assuming this is outside the SCR as well). This argument in the WP framework supports delaying bonus distributions on guarantees, as this creates a scenario where Asset Shares are higher than guarantees thus the investment strategy for the excess capital can be a bit more aggressive if this sits with the risk appetite of the company/fund.

 

[Mark Willder]

Yes, you're right that the asset share is often used to set a reserve, although this would typically only be the case for with-profits policies. Depending on the regulations of the country concerned, reserves could also be higher or lower than asset shares.

The asset share is the retrospective accumulated cashflows concerning the policy.

The reserve is the amount of money we must hold to satisfy the regulator. It would normally be a prospective calculation.

An example may help. An insurer has assets of 100 and reserves of 80, so it is solvent. It's asset share is only 70, so not enough to cover the reserves on its own - the rest of the money comes from the capital of the insurer.

The insurer's assets can be broken down into three parts: 70 is backing the asset share (it is also backing the reserves), 10 is backing the rest of the reserves, 20 is backing the free assets.

I hope this clarifies what is going on.

Best wishes

Mark

I think so, so whether asset shares are higher/lower than reserves. there will be a subset of capital that is backing asset shares, reserves and free surplus.

In a scenario where asset shares are greater than reserves, then there is more investment freedom with regard to this not sitting outside the regulatory capital (also assuming this is outside the SCR as well). This argument in the WP framework supports delaying bonus distributions on guarantees, as this creates a scenario where Asset Shares are higher than guarantees thus the investment strategy for the excess capital can be a bit more aggressive if this sits with the risk appetite of the company/fund.

Yes, that's exactly right.

Best wishes

Mark

 

[Sponge]

Thanks