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Last Updated: 2/2/2023
Issue: Surplus notes, also known as surplus debentures and capital notes are securities issued by insurers interested in raising capital. Surplus notes are unsecured debt subordinated to all claims by policyholders and creditors, as such interest and principal payments on the notes are made only after approval has been granted by the commissioner of the state of domicile.  

Overview: Although surplus notes are debt instruments similar in some ways to issued corporate bonds offering a coupon, i.e. interest rate of return, and having a maturity date, under statutory accounting principles surplus notes are classified as equity.  The reason for this is because of the subordinate nature of the surplus notes and the restrictions for payment that requires approval by the domiciliary state commissioner.

Insurer Issuers of Surplus Notes

Under statutory accounting principles (SAP), issued surplus notes are treated as issued surplus, equity/capital. This treatment is different from U.S. generally accepted accounting principles (GAAP) where these instruments are treated as debt and reported as a liability.  (Under SAP, issued debt instruments that do not qualify as surplus notes are reported as liabilities similar to U.S. GAAP.) State insurance regulators treat surplus notes as statutory capital because they are unsecured and are at the bottom level of insurers' capital structure, which subordinate to policyholders, claimant and beneficiary claims, and to all other classes of creditors. If approval to make interest and principal payments on a surplus note is not given by the commissioner of the domiciliary state, the insurer is not necessarily considered to be in default. The accounting requirements for determining whether an issued debt instrument qualifies to be a surplus note is captured in paragraphs 2-7 of Statement of Statutory Accounting Principles (SSAP) No. 41R—Surplus Notes

Due to their treatment as regulatory capital, surplus notes are closely regulated to ensure the solvency of the insurer. Additionally, regulator approval is required for interest/principal repayment as well as initial issuance. Surplus notes being part of the insurer's total adjusted capital under Risk-Based Capital calculations are issued under the authority of the state of domicile insurance commissioner.

Insurer Holders of Surplus Notes

Insurer holders of surplus notes (those who have acquired surplus notes issued from other insurers) shall report the acquired surplus note in accordance with the measurement guidance specified in paragraphs 10 and 11 of SSAP No. 41R—Surplus Notes. The measurement method (either amortized cost or fair value) is determined based on whether a surplus note has been rated by a credit rating provider (CRP) and the quality of the CRP rating. Additionally, if the holders of surplus notes have not received interest and principal payments because the domiciliary state has not approved payment, the holder of the surplus note must consider whether the surplus note should be written down as being impaired.

Credit rating agencies tend to recognize the regulatory view in their assessment of the equity nature of surplus notes. According to A.M. Best, regulatory approval for the issuance and provisions for the interest and principal payments combined with the issuance amount of the surplus note are all key considerations in the agency's evaluation of surplus notes.

Surplus notes' credit ratings are notched from the issuer rating of the insurer to reflect the notes' deep subordination and the regulatory environment. The exercise of state insurance regulatory authority over surplus notes protecting insurers' capital position in times of stress is viewed as a credit positive for rating agencies. According to A.M. Best, for higher rated insurers, surplus note ratings are typically rated two notches below the issuers credit rating (ICR). However, for lower rated insurers the rating for surplus noted could be more than two notches lower than ICR.  

If a surplus note is rated by a CRP, then the holder shall report the equivalent NAIC designation when reporting the surplus note as an asset in Schedule BA – Other Long-Term Invested Assets. This designation is considered a filing exempt (FE) designation pursuant to Part Three, Section 5 (c) of the Purposes and Procedures Manual of the SVO. Surplus notes not rated by a CRP are considered "non-rated" surplus notes and are not reported with an NAIC designation. The SVO does not provide NAIC designations for surplus notes and does not compile information on ratings provided by CRPs.


Surplus notes are insurer-specific instruments issued to provide a source of capital for insurance entities. These debt-instruments are permitted to be reported as capital, and not as debt, due to the subordinate nature of the notes, and they require approval by the commissioner of the state of domicile before original issuance and before interest and principal repayments can be made.  Accounting guidance for surplus notes, for both issuers and holders, is provided in SSAP No. 41R. The Statutory Accounting Principles (E) Working Group monitors accounting and reporting guidance for surplus notes to ensure appropriate measurement and recognition in the statutory financial statements.


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