Computation of actuarial reserves

The Computation of Actuarial Reserves generally refers to the process of calculating the amount which an insurance company must hold in reserve for expected future liabilities, or Actuarial reserves.

The calculation process often involves a number of assumptions, particularly in relation to future claims experience, and investment earnings potentia. Generally, the compuation involves calculating the expected claims for each future time period. These expected future cash outflows are then discounted to reflect interest to the date of the expected cash flow.

For example, if we expect to pay $300,000 in Year 1, $200,000 in year 2 and $150,000 in Year 3, and we are able to invest reserves to earn 8%p.a., Their respective contributions to Actuarial Reserves are:

• Year 1: $300,000 x (1.08)^-1 = $277,777.78
• Year 2: $200,000 x (1.08)^-2 = $171,467.76
• Year 3: $150,000 x (1.08)^-3 = $119,074.84

If we sum the discounted expected claims over all years in which a claim could be experienced, we have completed the compuation of Actuarial Reserves. In the above example, if there were no expected future claims after year 3, our computation would give Actuarial Reserves of $568,320.38.