Statutory Reserves

Statutory reserves are state-mandated reserve requirements for insurance companies. By law, insurers must hold a portion of their assets as either cash or readily marketable securities so that they will be able to make good on their claims in a timely manner.

The McCarran-Ferguson Act, passed by Congress in 1945, gave the states, rather than the federal government, the authority to regulate insurance companies. To do business in a state, each insurer must be licensed by the state's insurance department and abide by its rules. Among those rules is how much money an insurer must keep in reserve (that is, have readily available) to make sure that it will be able to pay its future claims. Statutory reserves apply to a range of insurance products, including life insurance, health insurance, property and casualty insurance, long-term care insurance, and annuity contracts. The requirements can vary from one state to another and according to the type of insurance product.

Statutory reserves for insurance companies are calculated in two different ways: a rule-based approach or a principle-based approach. Traditionally states have used the rule-based approach, basically telling insurers how much money they must keep on reserve based on standardized formulas and sets of assumptions. More recently, many states have been moving toward a principle-based approach, which gives insurers greater leeway in setting their reserves.

In explaining the reason for the transition, the National Association of Insurance Commissioners (NAIC) noted in 2019 that, "sometimes this rule-based approach leaves an insurer with excessive reserves for certain insurance products and inadequate reserves for others." The insurance industry also maintained that the old approach hadn't kept up with the introduction of new and often more complex insurance products.

Under a principle-based approach, the NAIC said, "insurers will be required to hold the higher of (a) reserves using prescribed factors or (b) reserves which consider a wide range of future economic conditions and [are] computed using justified insurer experience factors specific to an insurer, such as mortality, policyholder behavior and expenses."

Because insurers are restricted in how they can invest or otherwise use the money they must set aside for their reserves, they lose out on some potential profits. However, holding reserves can also make investors more confident that an insurer is in a solid position to withstand a bear market or other financial calamity. Some insurance companies go beyond their statutory reserve requirements and set aside additional capital, often referred to as non-statutory reserves or voluntary reserves.

Other financial institutions, such as banks, are also subject to reserve requirements, which may be set on the federal level.