New Jersey Life and Health State Practice Exam

What is defined as an insurer's ability to make unpredictable payouts to policyowners?

1. Capital reserve

2. Liquidity

3. Investment return

4. Claims ratio

The correct answer is: Liquidity

The concept of liquidity pertains to an insurer's ability to meet its short-term obligations, specifically the requirement to make payments to policyholders when claims arise. This ability is crucial for an insurance company, as it ensures that the firm can respond promptly and effectively to unpredictable claims, which can vary significantly in size and timing. Liquidity measures how quickly an insurer can convert its assets into cash to cover these obligations, making it a vital component of financial stability in the insurance industry. In times of unexpected losses or high claim volumes, a liquid insurer can fulfill its promises to policyholders without delay, maintaining trust and operational integrity. While the other options relate to the financial operations of an insurance company, they do not directly address the immediate capability to handle unpredictable payouts to policyholders. Capital reserves are more focused on long-term financial health, investment returns relate to the growth of the insurer’s assets, and claims ratio pertains to the proportion of claims paid relative to premiums collected, which is more about efficiency rather than immediate liquidity.