Insurance companies sometimes issue instruments that have the characteristics of both debt and equity; these instruments are commonly referred to as:

Question

Options

• AGeneral notes
• BDomiciliary notes
• CLong-term bond notes
• Dsurplus notes

• A
  2% (1)
• B
  4% (2)
• C
  11% (5)
• D
  83% (38)

Explanation

Surplus notes (D) are hybrid instruments unique to the insurance industry that carry features of both debt (they pay periodic interest and have a stated maturity) and equity (they are subordinate to all policyholder and creditor claims, and interest/principal payments require regulatory approval). Because they bolster an insurer's surplus - the equity buffer protecting policyholders - they are counted as capital rather than pure liabilities under state insurance accounting rules.

Why the distractors are wrong:

• A. General notes - not a recognized insurance industry term; "general" signals a made-up distractor.
• B. Domiciliary notes - "domiciliary" relates to an insurer's state of incorporation/regulation, not to a class of hybrid securities.
• C. Long-term bond notes - a generic debt concept with no hybrid equity characteristic; standard bonds give holders no ownership-like standing.

Memory tip: Think surplus = surplus line of capital. Surplus notes literally add to surplus (equity) on the balance sheet while still obligating the issuer to pay interest like a note - the word "surplus" is the direct clue that these instruments shore up an insurer's capital base.

No community discussion yet for this question.