Why are loss reserves significant for insurance companies?

Loss reserves are crucial for insurance companies because they are the funds set aside to cover anticipated claims that have been reported but not yet settled, as well as claims that are incurred but not yet reported. This financial preparation allows the insurance company to maintain adequate liquidity and ensure that it can fulfill its obligations to policyholders when claims arise. By properly estimating and setting aside these reserves, an insurance company effectively manages its risk and ensures stability, which is essential for long-term sustainability.

The significance of loss reserves is especially pronounced because they provide a safety net for the company, allowing it to meet both current and future claims obligations without jeopardizing its financial health. This is vital not just for compliance with regulatory requirements but also for maintaining trust and reliability with customers. Therefore, the establishment of loss reserves is a key function within the risk management framework of an insurance company, ensuring that they are prepared to meet their commitments and providing confidence to stakeholders.