Final answer:
The policyholders' surplus is the difference between an insurer's assets and liabilities, providing a financial cushion for potential high claims. It's fundamental to an insurance company's financial health and is impacted by their management of reserves and investment income.
Step-by-step explanation:
The policyholders' surplus of an insurer is defined as the difference between its assets and liabilities. This is a critical measure of an insurance company's financial health, as it signifies the financial cushion that protects policyholders in case of unusually high claims.
The surplus is akin to the equity that a company has, which would be the remaining funds after all debts and other obligations are paid. In the context of insurance, this surplus is used to pay claims that exceed the expected amount, which might occur during major events or disasters.
If we look at the concept of coinsurance, where an insurance policyholder pays a percentage of a loss and the insurance company pays the remaining cost, we can see how this affects insurance operations.
The idea behind coinsurance is that it helps prevent over-utilization of insurance coverage by involving the policyholder in paying part of the claim, hence promoting more responsible behavior.
Insurance companies must manage their funds wisely, adding premiums they collect to their reserves and often investing them to generate income. These investments need to be fairly liquid as the company needs to have sufficient funds available to cover claims, especially in the event of a disaster.