The Correct Answer for the CTFA Exam

A

The reserve-to-surplus ratio is a financial metric that measures the amount of reserves that an entity has relative to its surplus. The reserve represents the funds that are set aside by the entity to cover potential losses that may arise in the future. The surplus, on the other hand, represents the excess of assets over liabilities that the entity has on its balance sheet. The reserve-to-surplus ratio is calculated by dividing the reserve by the surplus.

The reserve-to-surplus ratio is an important metric for entities that operate in industries where losses are common. For example, insurance companies are required to maintain reserves to cover potential claims from policyholders. The reserve-to-surplus ratio is used to evaluate the financial strength of an entity and its ability to withstand unexpected losses.

Option A states that the financial position of an entity with a 2-to-1 reserve-to-surplus ratio is less affected by variability in its loss reserves than is an entity operating at a 4-to-1 ratio. This statement is incorrect. A lower reserve-to-surplus ratio indicates that the entity has fewer reserves relative to its surplus. This means that the entity has less cushion to absorb unexpected losses. Therefore, a 2-to-1 reserve-to-surplus ratio is more affected by variability in its loss reserves than is an entity operating at a 4-to-1 ratio.

Option B states that the financial position of an entity with a 2-to-1 reserve-to-surplus ratio is more affected by variability in its loss reserves than is an entity operating at a 4-to-1 ratio. This statement is correct. As explained above, a lower reserve-to-surplus ratio means that the entity has less cushion to absorb unexpected losses. Therefore, the financial position of an entity with a 2-to-1 reserve-to-surplus ratio is more affected by variability in its loss reserves than is an entity operating at a 4-to-1 ratio.

Option C states that the financial position of an entity with a 4-to-1 reserve-to-surplus ratio is less affected by variability in its loss reserves than is an entity operating at a 2-to-1 ratio. This statement is incorrect. A higher reserve-to-surplus ratio indicates that the entity has more reserves relative to its surplus. This means that the entity has a greater cushion to absorb unexpected losses. Therefore, the financial position of an entity with a 4-to-1 reserve-to-surplus ratio is less affected by variability in its loss reserves than is an entity operating at a 2-to-1 ratio.

Option D states that the financial position of an entity with a 4-to-1 reserve-to-surplus ratio is more affected by variability in its loss reserves than is an entity operating at a 2-to-1 ratio. This statement is incorrect. As explained above, a higher reserve-to-surplus ratio means that the entity has a greater cushion to absorb unexpected losses. Therefore, the financial position of an entity with a 4-to-1 reserve-to-surplus ratio is less affected by variability in its loss reserves than is an entity operating at a 2-to-1 ratio.

Therefore, the correct answer is option B: the financial position of an entity with a 2-to-1 reserve-to-surplus ratio is more affected by variability in its loss reserves than is an entity operating at a 4-to-1 ratio.