REINSURANCE COMMISSION
Primary insurers are the ones who market the business and incur acquisition cost and management expenses towards procuring business like agency commission, brokerage, and management expenses. The reinsurers do not directly contribute to any of those expenses. So, the general practice is that the reinsurers participate in the insurers’ acquisition cost by paying some commission on the premium ceded to them. The purpose of reinsurance commission is to reimburse the ceding insurer with some amount of what is incurred by the ceding reinsurer for acquiring the business. Generally, reinsurance commission and profit commission are payable only in respect of proportional treaties and not in excess of loss treaties.
There are different types of Reinsurance Commission.
1.Flat Commission
This is a flat rate of commission agreed between the insurer and the reinsurers agreed under the treaty agreement. This method is very easy to calculate as the commission payable is arrived at by applying the agreed percentage of commission to the premium ceded less returns and cancellation. A surplus treaty may contain different rates of flat commission for different types of businesses within the treaty.
For example, an Engineering Surplus Treaty may contain annual policies like MBD, CPM, EEI etc. and project policies like EAR, CAR, Marine cum Erection etc. and ALOP policies. The annual policies may carry a commission of 30% and project policies may carry a commission of 20% and ALOP 10%.
The reinsurance commission will be the premium ceded under respective heads multiplied by that respective percentage.
A typical flat Commission Clause may appear as below in a Surplus Treaty
“COMMISSION:
a)35 % in respect of all cessions other than those relating to Industrial Package Policies with a total PML value exceeding 2500 Crore INR.
b) 25 % in respect of cessions relating to Industrial Package Policies with a total PML value exceeding 2500 Crore INR.”
2.Sliding Scale Commission
Under this method the commission percentage is linked to the loss ratio. In other words, the commission payable by the reinsurer is based on the ratio of earned premiums to the incurred losses.
The earned premium and incurred losses are calculated as follows:
The purpose of sliding commissions is to align the interests of the reinsurer and the ceding company by incentivizing better underwriting and risk management practices. If the reinsured business performs well and generates profits, the reinsurer's commission rate may increase, rewarding the insurer for producing profitable business. Conversely, if the reinsured business performs poorly and experiences higher-than-expected losses, the commission rate may decrease, reflecting the higher risk and potential impact on the reinsurer's profitability.
Sliding commissions can be negotiated and agreed upon between the ceding company and the reinsurer as part of the reinsurance contract. The specific criteria for adjusting the commission rate are typically outlined in the contract, providing transparency and clarity to both parties. It's important to note that the specific details of sliding commission structures can vary depending on the terms agreed upon by the parties involved.
Since the incurred loss ratio will be known only after the close of the accounting year, generally a provisional commission is allowed to be charged during the 4 quarters, which will be finally adjusted based on the actual % of the commission calculated as per the incurred loss. Generally, the provisional commission would be a midpoint between minimum and maximum commission.
A simple, typical example of Sliding Scale Commission structure is given below:
In the above example, 17.50% would probably be the provisional commission. The sliding scale commission aims to stabilize the results under a treaty, reducing the profit to the reinsurers in good years and the loss in bad years.
3.Profit Commission
Profit Commission is a form of additional compensation that a reinsurer pays based on the profitability of the reinsured business. It is contingent on the profitability of the ceding company’s treaty. Profit Commission is calculated and paid to the insurer when the ceding company achieves a certain level of profitability to the treaty. The specific criteria for determining profit commission are outlined in the treaty contract.
There are two types of Profit Commission:
a.Accounting Year Basis
Fire and Accident Proportional treaties are usually on accounting year basis.
b.Underwriting Year Basis
Treaties covering long tail business, like marine and aviation are usually on underwriting year basis.
