Reserves ***

(You'll need to know this for other chapters)

MR. WATSON: Reserves . Contrary to what most people think, insurance companies usually do not lose money by paying life insurance claims or health insurance claims. How do we they what they are going to pay out to the insured? Based upon what?

MR. WATSON: Mortality tables and morbidity tables. Mortality tables tell us how many men or women of a certain age are going to die. Morbidity tables tell us how many of them are going to what?

STUDENT: Get sick or become disabled.

MR. WATSON: Does that make sense? So the states regulate insurance. So each state will tell insurance companies, “If you are operating in our state, you must take a piece of that premium that's paid to you and set it aside”, and that money that's set aside guarantees payment for future claims. These are reserves.

MR. WATSON: So we already know what our losses are going to be - what we will have to pay out each year. We already have the money that's set aside to pay for those losses. Does that make sense?

STUDENTS: Um-hmm.

MR. WATSON: That money that is set aside, is it an asset or liability to the insurance company?

STUDENTS: Liability.

MR. WATSON: It's a liability. Let me explain it this way.

MR. WATSON: It is the same as having a $100 electric bill. You take $25 a week and set it in the cookie jar. Theoretically, you can't spend that money that is in the cookie jar on anything else. It's owed money. It's a liability. Everybody understand that?

STUDENTS: Yes.

MR. WATSON: So very seldom will insurance companies go broke by paying claims. So reserves are monies that are set aside to guarantee payment for future claims, future obligations, and they are a liability. Does that make sense?

STUDENTS: Um-hmm.