bonds and equities in actuarial work

An insurer's investments mostly fall into two big families. A bond is a loan: you give a company or government money, and in return it promises fixed interest payments (coupons) on set dates and your money back at the end. An equity, or share of stock, is a slice of ownership in a company: there is no promise of fixed payments, but you share in its profits (dividends) and the rise or fall of its price. The first is a contract with a schedule; the second is a stake in an uncertain future.

What makes bonds so central to actuaries is that their cash flows are dated and predictable — 50 every June, say, plus 1,000 at maturity in year 10. That looks a lot like a liability turned around: where a liability is money you must pay on known dates, a bond is money you will receive on known dates. You can line them up. Equities, by contrast, pay no fixed schedule and swing in value, so they cannot be matched against a liability the way a bond can; what they offer is a higher expected return over the long run in exchange for that volatility. A typical insurer holds mostly bonds (to match obligations) with a smaller, carefully sized equity sleeve (to earn extra return on long-dated or surplus money).

In practice the choice between them is a trade between matching and reaching. Short, certain liabilities (a claim due next year, an annuity payment due next month) cry out for bonds whose cash flows arrive at the same time. Long, uncertain, or growing liabilities, and the surplus that backs the company itself, can tolerate some equity. A common misconception is that more equity is always better because stocks 'beat bonds in the long run' — true on average, but an insurer can be forced to sell at the worst moment to pay a claim, and regulators charge more capital for the volatility. The right mix is the one that backs the promises safely, not the one with the highest brochure return.