Do insurance companies have to have liquid assets for EVERY dollar they insure?

Question

Like how casinos have to have cash on hand for every chip in play on there floor...even though 100% of customers would never cash out at the same time, nor would every insured driver get in an accident on the same day, are insurance companies still required to have that backing or is a percentage? Who governs this?

Answer 1

There is no way possible an insurance company could have enough cash sitting around to pay off every claim if all their insureds had a claim at the same time.

Think about it. If you buy auto insurance for your car, you don't pay in premium, anywhere near what the insurance company is going to have to pay out if you wreck it.

I pay about $1000 a year for auto coverage. That includes liability in case I cause the accident and my insurance has to pay for the other guy. But just consider the collision coverage only.

Say you've got 5000 people insuring their cars and they each pay 1000 for collision coverage. You'd collect $5,000,000. in premium. But, all those cars are worth $20,000 each. If they all crashed at once, you'd need $100,000,000. to pay off all the claims.

Answer 2

It's not a straight "dollar for dollar". I don't know what the ratio is, but the reserves (cash set aside to pay future claims) are taken into account when AM Best rates financial strength.

Insurance companies are "governed" by the states they are licensed to do business in. Each state has an Insurance Department, which reviews and regulates the companies they license. If the reserves get too low, the state insurance department can either make the insurance company stop writing new business, or put it under one of several levels of supervision, where they have an outside manager come in to fix the problems, manage the company, or worst case, liquidate it.

Answer 3

As was stated before, the federal/state governments have regulations governing how much should be set aside at all times (reserves) and are reported to the IRS and states. Generally it is a percentage. You are correct that not all policy-holders are likely to cash out at the same time, however that's what reinsurance is for. Insurance companies buy reinsurance in order to reduce total liability in a catastrophic, major claim kind of event. Lastly some companies circumvent pooled risks by releasing arms of business into separate entities. For instance after the 4 hurricanes or whatever hit Florida 2 years ago, I believe State Farm spun off it's FL homeowner's insurance business into a separate entity as to not be liable in the case of another major event. My company has a separate legal entity in NY to handle the regulations and policies of the state. This way, their liabilities are separate and we can still do business there with a minimal amount of total risk enterprise wide.

Answer 4

what a great question, one i have never seen asked before but that is extremely important nonetheless.

first off, each state establishes minimum guidelines on the amount an ins company must set aside to be able to cover claims. now, the most stringent state is NY. interestingly, when you see advertisements on TV, internet, print, or radio ... pay attention to the disclaimer. the disclaimer states something to the effect of "not available to residents of the state of new york". this is because if you do business in NY you have to have an amazing amount put aside to cover these claims.

finally, contrary to what some other posters have stated, there are some companies that do in fact have these reserves ON HAND and IN CASH. usually these are the larger mutual companies (not stock companies) and ones that have been around for more than a century.

good luck and again ... great question!

Answer 5

Have you ever played craps??

That is the best analogy I have ever heard to explain an insurance company and their financial strategy. They constantly bet the COME line.

If they have a good run... more premiums than losses that year, then they put the money into the fund that will cover the losses, when they throw snake eyes and crap out.

when you have some time google Mission Ins,, Company.

the beginning of the year maybe 17 years ago.. they were rated Bests a++ a very good rating... I think it was 8 months later they were belly up. obviously.. they crapped out

Answer 6

No, insurance companies dont have to have liquid assets for every dollar they insure.

They do have reserve requirements for the policies they issue. These reserve requirments are set by statute and state insurance regulation. They reflect actuarial calculations of the magnitude of probable claims, and are adjusted annually based on the insurer's experience in its pool of insureds. Insurers have to issue actuarial reports and analyses to their industry regulators, including calculations of their capitalization versus liabilities using risk based capital techniques.

Answer 7

Short answer: no. Insurance companies are fascinating when you really look into them, most of them on-sell most of the risk they have and make their money by investing in shares etc all the cash they get. It would be a good industry to get into.