If an insurer reduces its loss reserves in the year of adjustment, what is the effect on net income and policyholders' surplus?

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Multiple Choice

If an insurer reduces its loss reserves in the year of adjustment, what is the effect on net income and policyholders' surplus?

When an insurer reduces its loss reserves in the year of adjustment, it releases funds that were previously set aside to cover future claims. That release is recorded as income in the current year, so net income increases. Since loss reserves are a liability, reducing them lowers the insurer’s liabilities, which raises policyholders’ surplus (PHS) as assets minus liabilities grows. In short, a favorable reserve development boosts both net income and PHS. For example, reducing reserves by 10 million would increase net income by 10 million and simultaneously increase PHS by 10 million.

When an insurer reduces its loss reserves in the year of adjustment, it releases funds that were previously set aside to cover future claims. That release is recorded as income in the current year, so net income increases. Since loss reserves are a liability, reducing them lowers the insurer’s liabilities, which raises policyholders’ surplus (PHS) as assets minus liabilities grows. In short, a favorable reserve development boosts both net income and PHS. For example, reducing reserves by 10 million would increase net income by 10 million and simultaneously increase PHS by 10 million.

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