Casualty Actuarial Society (CAS) Practice Exam

What type of financial arrangement allows a primary insurer to obtain funds through surplus notes?

1. Equity financing

2. Contingent surplus note

3. Line of credit

4. Collateralized loan

The correct answer is: Contingent surplus note

Surplus notes are a unique form of financial instrument utilized by primary insurers to raise capital. A contingent surplus note specifically allows insurers to raise funds while maintaining operational flexibility. It is essentially a debt instrument that can be converted to equity or has conditions under which repayment is deferred, allowing the insurer to manage its capital more fluidly. This type of financing helps insurers to strengthen their surplus positions without immediately impacting cash flow. In contrast, equity financing involves raising funds through the sale of shares, which does not apply in this context since surplus notes do not represent ownership interests. A line of credit provides a source for immediate funds but does not relate specifically to surplus notes as it involves a loan arrangement and typically has collateral requirements. Similarly, a collateralized loan requires the borrower to provide collateral against the funds lent, which does not align with the core characteristic of surplus notes that typically remain unsecured, subject to repayment conditions that protect the financial interests of the insurer. Thus, the nature and function of a contingent surplus note distinguish it as the appropriate choice in this scenario.