As emphasized in this chapter, reserves are an insurance company�s principal liability. The company�s financial statement is filed annually with regulators to report on the company�s solvency. With solvency as the focus, the legal requirements for reserves provide a minimum below which the reserve cannot go. A company is free to incorporate safety margins (through more conservative assumptions or reserve methods, for example) and to provide higher reserve values.

Until now the discussion of modified reserves in this chapter has assumed that gross premiums always exceed net premiums. However, when net premiums are defined by a conservative reserve valuation basis and gross premiums by a competitive nonparticipating basis, net premiums for reserve valuation purposes may exceed gross premiums actually charged for the policy. In such a case the reserve needs to be based on the lower gross premium rates. This is accomplished indirectly by requiring the company to establish a deficiency reserve in addition to the net premium reserve. The deficiency reserve is the present value of the future excesses of net premium over gross premium. The sum of this deficiency reserve and the net premium reserve is the amount that would be obtained if the reserve were calculated on the basis of gross premium income.