Equalization Reserve

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Equalization Reserve

An account where an insurance company deposits funds to use in an emergency. That is, if an insurer finds itself in a position where it needs to pay more claims than it had anticipated, it may use funds from the equalization reserve to ensure that it fulfills its contractual obligations. An equalization reserve helps prevent any potential cash flow problems for the insurance company. It is especially useful in the event of an act of God, such as a flood or fire, where many policyholders live in the affected area. See also: Rainy day fund, Emergency fund.
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Equalization reserves are for random fluctuations of claim expenses for some types of insurance contracts such as hail insurance, according to the GAO's February 2005 report.
Action by the International Accounting Standards Board, which is trying to establish a single set of global accounting standards, may by next year prohibit catastrophe and equalization reserves. In March 2004, the board issued International Financial Reporting Standard 4 Insurance Contracts, Phase I, which includes guidance that effectively prohibits the reserves, according to the GAO report.
To absorb the Sfr2.95 billion in 9/11 claims, Swiss Re says it will use about Sfrl billion from its equalization reserves. The insurer is currently tangled in a legal conflict with the leaseholder of the World Trade Center, larry Silverstein, who maintains the towers were destroyed by two separate attacks and that he is therefore entitled to $7.1 billion for two claims under the terms of his insurance policy.
Company spokesman Christophe Dufraux stressed that the loss figure was before accounting for any release from Axa's equalization reserves, which some European insurers maintain to smooth the effect major losses might otherwise have on earnings.
But some organizations have benefited from stable performance in their life reinsurance segments and favorable regulatory practices within their domiciles, which have allowed them build up equalization reserves to offset severe losses and smooth reported underwriting results.
He added that the trend in the United Kingdom has been to align the calculation of taxable profits with accounting standards, and he pointed to the government's agreement to let insurers create tax-deductible equalization reserves to help cushion the blow of unusually heavy losses.