Case Reserve

A case reserve is an insurance company's estimate of the total cost it will ultimately pay for a single, specific claim that has been reported but is not yet settled. Think of it as a financial placeholder. When a policyholder reports a car accident or a fire, the insurer can't know the final cost immediately. Medical treatments, repairs, and legal disputes can take months or years to resolve. So, the company's claims adjuster sets up a case reserve based on the initial facts and their professional judgment. This reserve is a liability on the insurer's balance sheet, representing money it owes but hasn't paid yet. It's a crucial number because the sum of all these individual case reserves, along with another estimate for claims that have happened but haven't been reported yet (IBNR), forms the company's total loss reserves. Getting this estimate right is one of the most important jobs in the insurance business.

For investors, understanding reserves is like having X-ray vision into an insurance company's health and honesty. Since these reserves are estimates, they can be manipulated, either intentionally or through incompetence.

• Aggressive Reserving: If management sets reserves too low, its current earnings will look artificially high. The company appears more profitable than it really is. But reality always catches up. When the true, higher costs of the claims become known, the company will have to add to its reserves, which hammers future profits. This is a huge red flag.
• Conservative Reserving: On the other hand, a prudent insurer might consistently set reserves a little higher than they expect to pay. This is called “redundant” or “conservative” reserving. It understates current profits, but as the claims are settled for less than the reserved amount, the excess is released back into earnings in future years. For a value investor, this can be a beautiful thing—it's a hidden source of future profits that the market might not be pricing in.

The money set aside in reserves doesn't just sit in a vault. The insurance company invests it in stocks, bonds, and other assets until the claims are actually paid. This pool of investable money is the famous insurance float, a concept championed by Warren Buffett. A company with disciplined reserving and underwriting can generate substantial investment income from its float, sometimes even earning enough to make a profit when its core insurance business breaks even or loses a little money (a combined ratio just over 100%). Therefore, the size and stability of the reserves directly fuel this powerful engine of value creation.

Digging into an insurer's reserving practices is a classic value investing move. It separates the well-managed, durable businesses from the short-sighted ones.

While you can't know the exact “correct” number for reserves, you can spot patterns that reveal a company's character and discipline.

• Look at the History: Review the company's annual reports (for US insurers, the “Schedule P” in regulatory filings is a goldmine) to see its reserving history. Does it consistently experience adverse development (meaning it had to increase reserves for old claims) or favorable development (meaning it released redundant reserves)? A consistent track record of modest favorable development is often the hallmark of a high-quality, conservative insurer.
• Check the Ratios: Track the loss ratio over many years. A company whose loss ratio suddenly drops without a good explanation might be under-reserving to make its numbers look good. Stability is your friend.

Ultimately, reserving is an art as much as a science. It reflects the culture and integrity of a company's management. A management team that reserves prudently is signaling that it is focused on long-term stability and profitability, not short-term tricks. For an investor, finding such a team is half the battle won.