The nature of the automobile bodily injury liability loss reserve, its relation to financial statement valuations, and the techniques employed in its derivation are analyzed in this paper. The reserving practices of a sample of 224 nonlife insurers provide the research base for the study. A simulation approach to the selection of an optional reserving system is demonstrated at the end of the paper. A loss reserve is an estimate which is expected to reflect the value of the unpaid claims incurred as of the valuation date. In conjunction with the unearned premium reserve, it comprises the primary liability reported by a nonlife insurer. Its misstatement may lead to a significant misrepresentation of financial condition, resulting, in the extreme, in insolvency.' In addition to reducing the probability of insolvency, accurate reserving is necessary for the correct measurement of underwriting results. If a profit center is producing an underwriting loss, proper reserving will detect this condition at an early point in time so that corrective action may be taken by management to minimize the total loss incurred. If, on the other hand, the loss reserve is understated, the illusory underwriting Stephen Forbes, Ph.D., was a Huebner Fellow at the University of Pennsylvania. He joined the faculty of the University of Illinois at Urbana in September of 1967 where he is Assistant Professor of Finance. This paper was submitted in August, 1968. 1 For evidence indicating that insolvency is often accompanied by inadequate reserving, see the Hearings Before the Subcommittee on Antitrust and Monopoly of the Committee in the Judiciary United States Senate, 89th Congress, 1st Session, May 11 and 12, 1965, Part 12, High Risk Automobile Insurance, pp. 6745, 6749, 6809, 6811-6815, 6823-6825, 6833, 6843-6847. income (or understated loss) portrayed, prior to the adjustment of the reserve to its proper level, may result in management allocating additional resources to the unprofitable activity, thus compounding its total loss. Significant profit sacrifices may also result if the loss reserve and resulting incurred loss are overstated. This may discourage management from entering profitable underwriting activities which appear to be unprofitable. Financial stability is also enhanced by the maintenance of an accurate loss reserve. If the reserve is understated, surplus will be required to liquidate the deficiency at the time the necessary upward adjustments are made.2 This may take place during a period when assets are being drained by other factors (e.g., the payment of acquisition expenses). In the extreme situation, the total required adjustments may exceed the available surplus. An understated surplus, resulting from an overstated loss reserve, is also undesirable in that a true determination of financial condition is made impossible. The purpose of this paper is to study 2In addition to surplus, the liability excess of bodily injury liability and compensation statutory and voluntary over case basis and loss expense reserves is available to absorb deficiences.