What is the purpose of an equalisation reserve?

The purpose of an equalisation reserve is to smooth out fluctuations in loss ratios for certain classes of business. In the insurance industry, loss ratios can vary significantly from year to year due to factors like changes in the economy, natural disasters, or variations in claims frequency and severity. An equalisation reserve acts as a financial buffer that helps insurers balance these fluctuations over time.

By setting aside a portion of premiums collected into this reserve, insurers can manage the impact of particularly high or low claims in any given period. This ensures that the insurer remains solvent and can pay claims even in adverse years, while also providing stability in premium pricing for policyholders. As a result, the equalisation reserve contributes to the overall financial health of an insurance company and helps maintain competitive and fair pricing for policyholders.