Reserve adequacy is whether the amount held for claims is enough to pay them as they develop. It is judged by comparing past reserves with what claims eventually cost and how long they took.
Adequacy is tested after the fact. A reserve that proves too low produces adverse development and a charge to earnings. One that proves too high ties up capital that could be used elsewhere. Neither is a neutral error.
For litigated claims the tail of the duration distribution is where reserves are most exposed. A plan built on a median duration will be short when the matters that run long arrive, and the extra time carries extra cost.
Reserve adequacy is not a single ratio. It is a judgment supported by a defined method, a stated cohort and a comparison to realized development.
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