Washington State Insurance Practice Exam

What are "insurance reserves"?

1. Funds available for operational costs of an insurer

2. Funds set aside to pay future claims

3. Investments made by the insurance company

4. Funds reserved for marketing expenses

The correct answer is: Funds set aside to pay future claims

Insurance reserves are essential to the financial health of an insurance company, as they represent the funds set aside specifically to pay future claims. This is a crucial aspect of insurance operations because it ensures that the insurer can meet its obligations to policyholders when claims arise. By accumulating reserves, the insurance company can assess and predict its future liabilities resulting from the policies it has underwritten. Setting aside these reserves is not only a regulatory requirement but also a best practice in risk management. It helps the insurer maintain financial stability and assures policyholders that the company has the necessary funds to cover potential claims. The accuracy of determining reserves is vital, as it must reflect the estimated future payouts based on statistical data and actuarial science. This includes considering factors like claim frequency, severity, and the time value of money. In contrast, operational costs, investments, and marketing expenses do not directly pertain to the purpose of reserves. Operational funds might cover day-to-day costs, investments represent the insurer's financial assets, and marketing expenses are allocated for promoting the business rather than fulfilling contractual obligations to policyholders. Therefore, the focus of insurance reserves is explicitly on future claim payments, making the identification in the context of the provided question particularly clear and relevant.