Statutory Legal Reserve
Insurance companies are required by statute to comply with the legal reserve requirements established by the state insurance laws. Life companies that comply with the legal reserve requirements established by the state insurance laws are known as Legal Reserve Life Insurance Companies.
Generally speaking, life insurance companies must keep reserves in stable investments, for example in cash, or in government bonds. This ensures that the reserves are sufficiently protected from loss.
The State Insurance Department
Most state insurance departments mandate a conservative “statutory” accounting system that will insure company solvency. This “statutory” system has been successful for decades in minimizing insurance company failures and preventing policyholder losses. The state insurance department does review and measure the insurance companies’ cash flow and liabilities to ensure that they have the cash to meet policyholder obligations. They are audited by state insurance departments at least every 3 years. Life insurance companies also file quarterly and annual statements.
Required Reserves Ensure Payment of Policyholder Benefits
A large percentage of each premium dollar calculated by actuaries for each company goes into the policy owner’s reserve fund. This policy reserve (Legal Reserve) fund is a liability to the life insurance company. The fund is established as a way of determining or measuring the assets the company must maintain in order to be able to meet its future commitments under the policies it has issued.
If an insurance company’s reserve levels fall short, and it goes into what is called receivership, the remaining insurance companies in the state legal reserve pool must assume the liabilities and obligations of the insurer. The amount they are required to accept are based on the amount of insurance and annuities they have issued in that state. If one company has issued 10% of all insurance and annuities in that state, then they must accept 10% of any bankrupt insurer’s obligations for that state.
The reserve liabilities are established as financial safeguards to ensure the company will have sufficient assets to pay its claims and other commitments when they fall due. These assets are kept intact for payment of living and death benefits to the insured’s. The reserve pool protects annuity investors as well as those who purchase other life insurance products or policies.
Additional Security Safeguards
Nearly every legal reserve life insurance company further protects its policyholders by reinsuring part of the coverage with a life reinsurance company. This is done when the company will not or cannot undertake a risk alone. Reinsurance prevents relatively sizable claims from depleting a company’s policyholder reserves. The amount reinsured depends on many factors such as the size of the individual claim and the number of claims a company can expect.
Produce additional operating capital
Sell its business to another life company
Merge into another financially stable life company
A legal reserve life insurance company simply does not close its doors and go out of business. Legal reserve life policyholders enjoy personal security safeguards unknown by other types of business. Legal reserve life insurance companies have established a public responsibility to respect both the letter and the spirit of laws and regulation so the interests of their policyholders are always protected.