Commutation
An agreement by which reinsurer and cedant finally settle their mutual obligations against a single payment.
Textbook case: 31 million euros of ceded reserves remain on a 1998 liability treaty; the reinsurer offers 23.5, and the deal closes at 26.2. Commutation is the agreement by which parties terminate a treaty in run-off ahead of time: the reinsurer pays a lump sum, and the cedant takes back all future claims, reported or not. Each has a distinct interest. The reinsurer closes a year, releases reserves and the capital behind them, and removes a long dated uncertainty. The cedant receives immediate cash, eliminates credit exposure to a signature it considers fragile, and simplifies its balance sheet. The problem it solves is the cost of the tail: on a long tail line, keeping a relationship open for twenty years costs more in administration, capital and attention than the residual uncertainty is worth. Everything turns on price, which rests on a discounted estimate of future claims: the reinsurer's, which wants out, and the cedant's, which wants to be paid for what it takes back. A badly valued commutation silently transfers a liability, and regulators examine its assumptions.
A cedant commutes a 1998 liability treaty in 2026 whose remaining ceded reserves stand at 31 million euros. The reinsurer, discounting at 3.4 percent over a nine-year duration, offers 23.5 million. The deal closes at 26.2 million. Four years later, claims actually incurred total 29.8 million, and the cedant carries a 3.6 million gap that no recourse can reopen.
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