Unexpired risk reserve

From CEOpedia | Management online

Unexpired risk reserve (URR) "is defined as a prospective assessment of the amount that needs to be set aside in order to provide for the claims and expenses which will emerge from unexpired risk and which is ove and aboce the unearned premium reserve pertaining to the same risk as the same valuation date"[1]. URR is expressed as an sum of the values of anticipated future expenditures less "current claim reserve, current contract reserve, present value of future earned premiums, and the current balance sheet accrual for future expenses to the extent related to the future expenses that are included in the calculation of the deficiency" and the anticipated value of future claims[2]

Unexpired risk reserve in some sources is called also Additional Amount for Unexpired Risk or Premium Deficiency Reserve[3].

Unexpired risk reserve is an insurance accounting concept used to estimate the amount of unearned premiums that the insurer has yet to incur. It is the sum of the unexpired risk, which is the expected balance of insurance risk remaining from all policies, contracts and other obligations issued by an insurance company. The unexpired risk reserve is used to determine the amount of assets required by the insurer to cover its obligations.

The unexpired risk reserve is calculated as the difference between the total unexpired premiums and the total net premiums earned. The total unexpired premiums are the sum of the premiums paid on all policies, contracts and other obligations issued by the insurer. The total net premiums earned are the sum of the premiums received and the premiums paid out by the insurer.

In summary, the unexpired risk reserve is an insurance accounting concept used to estimate the amount of unearned premiums that the insurer has yet to incur and is calculated as the difference between the total unexpired premiums and the total net premiums earned.

Example of Unexpired risk reserve

To illustrate how the unexpired risk reserve is calculated, assume an insurer has issued five insurance policies with the following information:

  • Policy 1: Premium of $3,000, unexpired premium of $2,000
  • Policy 2: Premium of $2,000, unexpired premium of $1,500
  • Policy 3: Premium of $5,000, unexpired premium of $4,000
  • Policy 4: Premium of $1,500, unexpired premium of $1,000
  • Policy 5: Premium of $4,000, unexpired premium of $3,000

In this example, the total unexpired premiums are the sum of the premiums paid on all policies, or $12,500. The total net premiums earned are the sum of the premiums received and the premiums paid out by the insurer, or $15,000. The unexpired risk reserve is calculated by subtracting the total net premiums earned from the total unexpired premiums, resulting in an unexpired risk reserve of $2,500.

In summary, the unexpired risk reserve is calculated by subtracting the total net premiums earned from the total unexpired premiums. In this example, the unexpired risk reserve was calculated to be $2,500.

Elements of unexpired risk reserve

The basis of the URR calculation is to take into account the following factors that may affect the level of reserves[4]:

  • Forecast of future claims,
  • Forecast of future expenses,
  • Unearned premiums reserves.

Therefore, unexpired risk reserve is expressed by the formula:

Where:

  • URR - unexpired risk reserve,
  • E[clamins] - occurring after the date of valuation predicted claims in the remaining period of insurance,
  • E[expenses] - occurring after the date of valuation predicted administration expenses in the remaining period of insurance,
  • DAC - "deferred acquisition costs related to premiums that are being considered for calculation of unearned premium"[5],
  • UPR - unearned premiums reserves - retained at the end of the accounting period, a part of the income that is cover to take unexpired risk.

When to use Unexpired risk reserve

Unexpired risk reserve is used to measure the amount of exposure an insurer has to potential losses from outstanding policies. It is used to assess the adequacy of reserves and to ensure that the company is adequately protected against potential losses.

The unexpired risk reserve is also used to measure the potential future losses or liabilities that may arise from outstanding policies or contracts. This is important as it allows insurers to assess the adequacy of reserves and to plan for future liabilities or losses.

Types of Unexpired risk reserve

The unexpired risk reserve can be divided into two types:

  • Unearned Premium Reserve: This reserve is the amount of unearned premiums that have been paid to the insurer but not yet earned. It is calculated by subtracting the total earned premiums from the total premiums paid.
  • Unpaid Loss Reserve: This reserve is the amount of unpaid losses that have been incurred by the insurer but not yet paid. It is calculated by subtracting the total paid losses from the total losses incurred.

URR in accounting

"The treatment of reserve for unexpired risk in the final accounts of an insurance company is as follows[6]:

  • If it appears only in the trial balance, it should be taken to the liabilities side of the balance sheet.
  • If it appears as an adjustment, it should be charged to the revenue account and shown also on the liabilities side of the balance sheet.
  • If it appears in the trial balance and also as an adjustment, the difference of the two (i.e. Desired Reserve for Unexpired Risk at end less Reserve for Unexpired Risk in the beginning) should be taken to Revenue Account The Desired Reserve for unexpired Risk at end should be shown on the liabilities side of the balance sheet. The treatment for any additional reserve for unexpired risk, would also be on the same pattern"

Advantages of Unexpired risk reserve

  • The unexpired risk reserve provides a better understanding of the financial position of the insurer and helps to ensure that the insurer has sufficient assets to cover its obligations.
  • It enables the insurer to accurately assess the amount of risk remaining on its books.
  • It allows the insurer to set aside reserves to cover potential losses from unexpired policies.
  • It can help the insurer to better manage its capital reserves and liquidity.

Limitations of Unexpired risk reserve

Unexpired risk reserve has some limitations, which should be taken into consideration when calculating the reserve. These include:

  • Unexpired risk reserve is based on assumptions about the future, which may not be accurate. For example, there may be unexpected changes in the market that cause the assumptions to be incorrect.
  • Unexpired risk reserve does not take into account any changes in the insurer’s financial condition since the policies were issued.
  • Unexpired risk reserve does not take into account any changes in the policyholder’s risk profile since the policies were issued.

Other approaches related to Unexpired risk reserve

  • Loss Reserve: Loss reserve is an estimate of the amount of money an insurer will need to pay out to its policyholders due to losses. It is calculated by taking the total gross premiums earned and subtracting the estimated losses already incurred, as well as the estimated future losses that may occur.
  • Premium Reserve: Premium reserve is an estimate of the amount of money an insurer will need to pay out to its policyholders due to premiums. It is calculated by taking the total gross premiums earned and subtracting the estimated premiums already incurred, as well as the estimated future premiums that may occur.
  • Unearned Premium Reserve: Unearned premium reserve is an estimate of the amount of money an insurer will need to pay out to its policyholders due to unearned premiums. It is calculated by taking the total net premiums earned and subtracting the estimated unearned premiums already incurred, as well as the estimated future unearned premiums that may occur.

In summary, the other approaches related to the unexpired risk reserve include the Loss Reserve, Premium Reserve and Unearned Premium Reserve, which all estimate the amount of money an insurer will need to pay out to its policyholders.

Footnotes

  1. Pavlović B., (2012),
  2. Robbins E. L. & Bush R. N., (2015), p. 324,
  3. Hindley D., (2017), p. 5,
  4. Pavlović B., (2012),
  5. Pavlović B., (2012),
  6. Maheshwari S.N. & Maheswari S. K., (2009),


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References

Author: Wojciech Musiał