Tennessee Insurance Practice Exam

The amount of liquid assets an insurer must have on hand to meet future obligations to policyholders is referred to as what?

1. Liquidity ratio

2. Surplus

3. Reserves

4. Capital adequacy

The correct answer is: Reserves

The correct choice refers to the amount of liquid assets that an insurer is required to maintain in order to ensure it can fulfill its future obligations to policyholders. This concept is fundamental in the insurance industry as it ensures that the insurer has sufficient funds available to pay claims as they arise. Reserves are specifically set aside for this purpose, representing the estimated amount that will be needed to pay out claims that have occurred but have not yet been reported (known as incurred but not reported claims) along with claims that are known and waiting to be settled. This financial strategy is crucial to the stability and reliability of an insurance company, as it allows them to meet their contractual commitments without relying on incoming premium payments. Other terms provided in the options have distinct meanings that do not accurately represent this requirement. Liquidity ratio measures the insurer's ability to meet short-term obligations, but does not directly refer to the actual funds set aside for claims. Surplus is related to the excess of assets over liabilities but does not specifically indicate the liquid assets intended for immediate claims. Capital adequacy refers to a company's capital in relation to its risk, indicating overall financial health rather than the liquid assets specifically earmarked for meeting future insurance claims.