Ratio Stock to surplus

CFA Level III Portfolio Management
#1

Hi guys,

I’ve got a question regarding the stock to surplus ratio for non-insurance company? What is it? Why does it have an influence on the risk of the company?

I really don’t get what they mean… Many thanks for your help.

#2

The value of common stock in their investment portfolio divided by the amount of surplus (assets less liabilities).

#3

Magician,

How it would affect the risk tolerance?

Thanks.

#4

Equity is an investment which shouldn’t affect risk tolerance.

However, higher surplus increases risk tolerance, so I’d say a lower ratio means you have space to invest in equity, getting the ratio back to baseline.

#5

Let me bump this question as I’m confused here as well.

I’m looking at question 7 from Schweser Mocks Volume 2, AM Session of Mock 2.

For the risk tolerance answer, all it says is “There are two important factors affecting the risk tolerance of A1 in this case: the uncertain cash flow characteristics of their claims and the stock-to-surplus ratio. The primary objective is to meet policyholder claims, and the overall level of risk tolerance is low. An ALM approach focused on surplus volatility is appropriate.”

I don’t know what to make of this. The case says they want to take their stock to surplus ratio from 90% to close to 100%. I get that a high stock to surplus ratio would increase portfolio risk, but I don’t understand how it’s an important factor affecting risk tolerance in the context of a casualty insurerer.

Thanks!

#6

bump

#7

The CFAI mentions stock-to-surplus as an reflection of the lower risk tolerances of casualty insurance companies, rather than saying that stock-to-surplus ratios affect risk tolerances. Specifically, it notes that prior to the 1970s, insurance companies sometimes had a stock-to-surplus ratio greater than 1, but when the financial crisis hit int he 1970s, some of these companies saw their surpluses suddenly disappear, which impaired their ability to issue new products and support existing products. Nowadays, the stock-to-surplus ratio is usually limited to 1/2 to 3/4.

Practically, if there’s a question on this topic, you should probably mention that unpredictable cash flows leads to unpredictable liquidity which primarily drives low risk tolerance. However, the company should also be mindful of their stock-to-surplus ratio to make sure that their surplus is resilient to stock market fluctuations.

The Schweser question, specifically, just seems like just a very poorly written question.

#8

Thanks for your input!