Statutory Reserves

Statutory Reserves

Statutory reserves are the minimum amounts of cash and readily marketable securities that insurance companies are required to hold by state insurance regulators. Their purpose is to ensure insurers have sufficient liquidity to pay legitimate policyholder claims when they arise.

Why they exist

• U.S. states regulate insurance (authority affirmed by the McCarran–Ferguson Act of 1945). Insurers must be licensed in each state where they do business and comply with that state’s reserve requirements.
• Without reserve requirements, insurers might over-invest premiums to boost returns and risk running short of cash to pay claims.
• Reserves protect policyholders and help maintain confidence in the insurance market, especially during economic stress.

What counts as statutory reserves

• Cash and readily marketable securities that can be converted to cash quickly.
• Requirements vary by state and by product type (life, health, property and casualty, long‑term care, annuities, etc.).

How reserves are calculated

States use two basic approaches to set reserve levels:

• Rules-based approach
• Standardized formulas and assumptions prescribe minimum reserve amounts.
• Principles-based approach
• Insurers may set reserves using their own actuarial experience and company-specific data, as long as reserves are at least as large as those under the rules-based standards (and often are larger).

When an insurer voluntarily holds reserves above the required minimum, those are called non-statutory or voluntary reserves.

Trade-offs

• Holding statutory reserves reduces the amount available for investment, which can lower short-term profits.
• The benefit is greater financial stability and stronger policyholder protection, which supports consumer confidence and the insurer’s long-term reputation.

Example

XYZ Insurance faces a rules-based minimum reserve requirement of $50 million. After reviewing its claims history and competitive position, the company adopts the principles-based approach and sets a higher reserve level. This conservatism reduces potential investment income but enhances solvency and market trust, helping XYZ better withstand economic downturns.

Key takeaways

• Statutory reserves are mandated by state regulators to ensure insurers can meet future claims.
• They may be held in cash or liquid securities and apply across many insurance product lines.
• Regulators use rules-based or principles-based methods to determine required reserves.
• Insurers can hold additional voluntary reserves for added conservatism, trading off higher liquidity for lower immediate returns.