Statutory reserve is defined as the amount of monetary unit in any financial institution including insurance company, bank and the credit union, must have on hand in order to cater the liabilities and obligations vested through the paid premiums and the deposits made. In the bank and credit union industry, the required statutory reserves are set and mandated by the Central Bank of the nation while in the insurance industry, it is set and regulated by the state of national government or by the designated regulatory authority. Computed in different ways, the statutory reserves basically are required to give assurance that the financial institutions are able in terms of the payment of the claims even in the event of calamities.
Financial institutions such as insurance companies, banks and credit unions acquire profits from investments and loans they were able to make coming from the made deposits to them. In some type of financial institutions such as brokerages, acquire their profits through charging commissions to their clients in every transaction made though they do not have full access on the loan and investment of the clients thus they are not subject to the reserve of the requirements.
Insurance companies, banks and credit unions therefore must always take into account a balance among their varied obligations to the shareholders- to the premiums and deposits they received and accepted- to maximize the profits through lending and investing their numerous assets and their liability to their clients and depositors to maintain a good enough liquidity that will meet the rising demands.
Aside from fact that the statutory reserve requirements is one of the factors that will provide information in liquidity issues, it also reflects the perception of how stable the banking industry in the nation is and also pictures on how the economy of the nation be moderated. If in the event the requirement of the reserve is intensely raised, the particular amount of money that is made available for lending will subsequently be reduced that will adversely affect the nation’s economic activity. On the other hand, a reduction of the requirement can possibly increase the available amount of money for lending. While the statutory reserve requirements are in a stable state in many countries, there are some nations which include United States, United Kingdom, Turkey and Germany reduced the reserve requirements on the 20th century and worst cases fall out dramatically.
In terms of statutory reserves in the insurance industry, the requirements are usually set and promulgated by the state. The very common formula used in the setting of the reserves is through the Commissioner’s Reserve Valuation Method which is a very complex formula that includes several factors such as the holder’s sex and age, the mortality table and the type of policy one acquired. Thus in order to meet the reserve requirements, the company should utilize the values as a result of the complex formula bestowed to every policy and keep aside enough liquid reserve that will be used in the policy’s sum reserves.