Question

Millennium insurance inflates its loss reserves because doing so reduces its reported income (and therefore taxes) and allows it to request state approval for rate increases. Which statement about Millennium's action is correct?

a) Millennium's action is ethical and contributes to the company's long-term success.
b) Inflating loss reserves is a common practice in the insurance industry to maintain financial stability.
c) Millennium's action is illegal and constitutes financial fraud.
d) Adjusting loss reserves has no impact on tax liabilities or rate approval processes.

Answer 1

Millennium's action of inflating loss reserves is unethical and likely illegal, constituting financial fraud, as it misrepresents the financial health of the company for gain through reduced taxes and higher rates.

Step-by-step explanation:

The correct answer to the question regarding Millennium's action of inflating its loss reserves is that the action is unethical and potentially illegal. Inflating loss reserves can misrepresent the financial health of the company, leading to incorrect financial reporting. This practice does not align with proper accounting standards and is likely to be considered as financial fraud, hence option c) Millennium's action is illegal and constitutes financial fraud, is correct.

In practicing this kind of behavior, Millennium Insurance violates legal and ethical standards. Loss reserves should accurately reflect the expected costs of claims that the company will have to cover. By inflating these reserves, Millennium reduces its reported income, which in turn lowers their tax liability. It also can petition for rate increases under the guise of needing more funds to cover potential losses. This can deceive stakeholders, regulators, and the public, and could lead to severe legal consequences if discovered.