What it is:
How it works (Example):
For example, let's assume that Company XYZ provides insurance to people on the East Coast. A big storm comes and flattens many of the houses. Company XYZ knows it is going to receive aof claims, so it creates a claims reserve on its to reflect the amount of the claims it thinks it is going to have to pay.
Big storms aren't the only thing that prompts claims reserves. Insurance companies often set up the reserves to ensure they have enough set aside to pay out claims in the normal course of business. The reserves often equal the value of claims that have been filed but not paid out yet.
Why it Matters:
Claims reserves are recorded as liabilities on the. In some industries, such as insurance, regulators set standards for how and when to set up reserves.