Which of the following describes the two ways commutations distort the financial statements?

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Multiple Choice

Which of the following describes the two ways commutations distort the financial statements?

Commutations can affect both the income statement and the balance sheet in a way that distorts reported results. When the reinsurer pays a settlement, that cash inflow is recorded as a reduction in losses paid in the period, which looks like a negative paid loss and acts like a one-time gain in earnings. At the same time, the way the loss obligations are carried on the books can change: the remaining gross loss reserves may be kept or adjusted in a way that appears larger on the balance sheet, because the transfer of risk to the reinsurer changes the net position but often leaves or increases the gross reserve to reflect future uncertainty. So a commutation can show up as a negative amount in the paid losses (income statement) and as an increased loss reserve (balance sheet), hence both described effects.

Commutations can affect both the income statement and the balance sheet in a way that distorts reported results. When the reinsurer pays a settlement, that cash inflow is recorded as a reduction in losses paid in the period, which looks like a negative paid loss and acts like a one-time gain in earnings. At the same time, the way the loss obligations are carried on the books can change: the remaining gross loss reserves may be kept or adjusted in a way that appears larger on the balance sheet, because the transfer of risk to the reinsurer changes the net position but often leaves or increases the gross reserve to reflect future uncertainty. So a commutation can show up as a negative amount in the paid losses (income statement) and as an increased loss reserve (balance sheet), hence both described effects.

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