What is an Asset Valuation Reserve?

An asset valuation reserve (AVR) refers to the capital or financial resources kept aside by a company to cover unforeseen financial crises or unexpected debts. The asset valuation reserve is one of the required capital that companies must set aside to mitigate future risks and unexpected debt. AVR also serves as a capital backup for a company in terms of credit losses.

How Does an Asset Valuation Reserve Work?

Asset valuation reserve is a lump sum of capital set aside for future use and to cater for contingencies in a company. It serves as a backup for equity for a company as well as credit losses. An asset reserve has two components, these are the default and the equity components. While the default component serves as a backup for credit losses such as losses relating to debt securities, preferred stock, real estate, and mortgages, among others, the equity component serves as a backup for the company's equity. Asset reserve is used in different companies, industries, and sectors. In the insurance industry, for instance, domestic insurers are mandated to have an asset valuation reserve that covers the future claims that policyholders will make and other financial obligations that might arise for the insurer. The National Association of Insurance Commissioners (NAIC) also expects insurance companies to keep a liability reserve in addition to an asset valuation reserve.

Why Asset Valuation Reserve Is Required

Essentially, an asset valuation reserve is required to act as a backup or safety net for companies when unexpected future financial obligations arise. This reserve also provides a safe-landing for a company in the event of a future credit or equity loss. Different companies have a varying amount of asset valuation reserve they must keep, the amount of AVR needed to cover different assets is determined through actuarial calculations. Estimating future losses a company is likely to be exposed to can also be used in determining the required asset reserve. There are other factors that companies consider when determining the asset valuation reserve such as the risk of the assets. Companies make contributions to the asset valuation reserve annually in order to be able to mitigate potential risks and debts in the future.