Many of us begin the new year with a resolution to save money, and a logical first step to achieving this goal is to create (and stick to) a budget. Insurance companies use a similar approach to estimate what claims will cost for the year. Throughout the year they collect premiums, but for planning purposes they need to estimate how much of that they will pay out for claims. The “reserve” is an estimate of what an individual claim will cost, and that amount of money is set aside (or reserved) in order to pay that claim. By adding all the reserves together for all of the individual claims, the company can estimate what they will pay out on pending claims. Then they estimate what they will pay out on claims that have not yet been filed, and add that to the total of the pending claims to get an estimate of what they will pay out during a period of time.
How do insurance companies decide what future claims will cost?
Claim reserves are in part based on both the past history of the company and the losses they have paid in the past. Additionally, the individual adjusters that handle the payment of claims must use their own experience and knowledge to adjust the reserve based on the individual claim.
For example, based on statistical data, a company may have paid an “average” of $5,000 per claim in years past. Each new claim that is reported may get an initial value (reserve) of $5,000. But, once it is discovered that a serious injury or death has occurred, the adjuster will raise the amount of reserve so the company sets aside enough money to be sure they can pay the claim. Some companies keep separate reserves for anticipated expenses such as fees for ordering medical records, cost of appraisals, or legal fees. Other companies include an estimated amount for expenses in their “average” or “standard” reserve.
Sometimes, there is a gap in time between the loss and when it gets reported to the insurance company. When setting claim reserves, the insurance company also includes “Incurred But Not Reported” claims (IBNR). By doing this, a company can include reserves for claims that have occurred but have not yet been reported.
Why it matters
Establishing accurate claims reserves allows the insurance company to meet its future financial obligations on behalf of insured individuals. The reserves are considered a company’s liabilities (money that is owed and will be paid in the future).
In order to establish accurate reserves, insurance companies require their adjusters to make regular adjustments to the value of claims. Usually an adjuster is required to make a preliminary adjustment within 24 or 48 hours of the claim being reported. After that, the adjuster is expected to adjust the reserve as additional information becomes available, and also to seek out updated information as the claim is pending in order to increase or decrease the reserve as appropriate.
Why is this important to a person with a claim? If an adjuster has kept a low reserve on a case for a long period of time, and suddenly finds out the claim is much more serious, they will have to make a significant increase to the reserve. Insurance companies don’t like surprises, and the adjuster will have to justify why they weren’t aware earlier that the claim was likely to be much larger. That claim will often be scrutinized more closely to determine if the increase is really appropriate. This justification and closer scrutiny usually means a delay in the review and evaluation of the claim; that means a longer time until an offer is made, and that the initial offer may be lower. For this reason, we try to keep the insurance company adjuster aware of developments in the case while the case is pending and before we are prepared to discuss settlement. This allows the adjuster to change the reserve on the claim to accurately reflect the value and thus avoid the need for any dramatic changes in the reserve on that claim. In turn, this helps prevent delay in negotiations and settlement.