Question

Explain how a regulator uses deficiency reserves to make up for shortages if they occur when reserves for a life insurance contract are calculated using an insurer’s gross premium

Answer 1

Deficiency Reserve is the amount needed by an insurer if the premiums not earned are not sufficient to meet the future expenses and claims. It is expressed as a liability in the financial statement. For a particular company deficiency reserve doesn’t mean that the company is operating at loss, but it means that it is charging a premium lower than expected. It can also act as a strategy for a company where they know how much money to keep aside and not following the actuarial mode.

Deficiency Reserves: Reserve Calculation – Valuation Net premium exceeding the gross premium charged

Let us suppose we have net premium reserve X

And let us suppose the gross premium is x. So again we calculate new reserve value as (X-x). Let us call this (X-x) as Y. We must hold this Y as reserve.

Therefore our (Y-X) calculation will be the deficiency reserve. Let us call this value as A.

Deficiency reserves, if any, are calculated for each policy as the excess, if greater than 0, of the quantity A over the basic reserve. The quantity A is obtained by recalculating the basic reserve for the policy using guaranteed gross premiums instead of net premiums when the guaranteed gross premiums are less than the corresponding net premiums. At the election of the insurer for any one or more specified plans of insurance, the quantity A and the corresponding net premiums used in the determination of quantity A may be based upon the valuation tables with selected mortality factors.

This rule stands for both basic reserves and deficiency reserves. In calculation of basic reserves or deficiency reserves, guaranteed gross premiums without policy fees may be used where the calculation involves the guaranteed gross premium but only if the policy fee is a level dollar amount after the first year. In determining deficiency reserves, policy fees may be included in guaranteed gross premiums, even if not included in the actual calculation of basic reserves. Reserves for policies that have changes to guaranteed gross premiums, guaranteed benefits, guaranteed charges, or guaranteed credits that are unilaterally made by the insurer after issue and that are effective for more than one year after the date of the change shall be the greatest of the following:

(a) Reserves calculated ignoring the guarantee.

(b) Reserves assuming the guarantee was made at issue

(c) Reserves assuming that the policy was issued on the date of the guarantee.

Hence, acting as the potential risk of the company being not able to cover risks in the future, premium deficiency is listed as a liability in a company's accounting books