GIM2170 - Accounting framework: Equalisation Reserves

An equalisation reserve is created where an amount is set aside out of past or current underwriting profits to meet future underwriting losses. The function of the reserve may simply be to smooth the flow of profit. More commonly the intention is to recognise that in some classes of business there may only be claims made at extended intervals, far longer than a single year. So even though premiums may look like pure profit in the absence of claims, once a claim is made it may be in an amount equal to many years’ premiums. In such a case, to recognise the premium as pure profit could be seen as imprudent, so that the reserve should only be drawn down when there are very heavy claims arising from the occurrence of events of an exceptional nature, that is events not normally occurring every year. Under EC Directive 87/343/EEC equalisation reserves were required for companies carrying on a substantial amount of credit insurance business from 1990 onwards. The Insurance Companies (Reserves) Act 1995 made equalisation reserves a mandatory regulatory requirement for certain categories of business, including credit insurance business, from 1996 onwards (see GIM7000+).