Washington State Insurance Practice Exam

Why are insurance companies required to maintain "reserves"?

1. To pay for operational expenses

2. To ensure funds are available for future claims payouts

3. To invest in profitable ventures

4. To reduce customer premiums

The correct answer is: To ensure funds are available for future claims payouts

Insurance companies are required to maintain reserves primarily to ensure that they have adequate funds available for future claims payouts. This is a fundamental aspect of how insurance operates, as these reserves act as a safety net for the insurer, guaranteeing that they can meet their obligations to policyholders when claims are made. Maintaining reserves is crucial for the financial stability of an insurance company. It demonstrates the insurer's ability to cover not only anticipated claims based on statistical predictions but also unexpected losses that may arise. This practice helps build trust with policyholders, as they can have confidence that the insurance company will fulfill its commitments when needed. The other options focus on aspects that are important to an insurance company but do not directly pertain to the necessity of maintaining reserves. For example, operational expenses, while critical to running an insurance business, are funded from different sources and not directly tied to the claims-paying abilities. Investments can enhance the funding for reserves but are not a reason to maintain them. Lastly, while managing reserves can impact premiums indirectly, the primary function of reserves is to cover future claims, not to manipulate pricing strategies.