Reinsurance tutorials #36
What is profit commission?
A profit commission is another kind that could be part of the reinsurance agreement.
The Profit Commission could be seen as an incentive from the reinsurer to the Ceding Company that consists in paying back a part of the Treaty profitability. This is to encourage the Ceding Company to a quality underwriting and good management of the Agreement to optimize its profits.
The profit Commission formula can integrate a fixed percentage of the net premium to refund or a sliding scale. In this last case, the higher the refund premium, the lower the loss ratio. It is worth mentioning that, generally, the formula includes a loss carry forward.
Let’s focus on a usual Profit Commission formula example:
XX % [ P – (C+E+DC) ]
It shows the:
P = Net premium
C = Claims paid, outstanding plus IBNR
E = Reinsurer’ Expense equal to XX % of the Net Premium
DC = Deficit carried forward to the number of the year forward.
If the “Income” exceeds the “Outgo”, the Reinsurer shall pay the Ceding Company a profit commission equal to a XX% that have been decided at the initial stage of the contract.
Reinsurer’s expenses profit commission
As previously explained in the Commission tutorial, a Profit Commission could be part of the terms and conditions agreed in the reinsurance Agreement.
When we agree or suggest a Profit Commission on an Agreement we are dealing with, in the formula applicable there is always an item called “General Management expenses” or “Reinsurance expenses”.
The reinsurance expenses take into consideration the Reinsurer’s general and administrative expenses such as costs of underwriting medical, accounting, claims incurred by the Treaty managed.
The percentage could vary significantly, notably regarding the business size and segment of Bus concerned.
Note the Profit Commission formula shouldn’t include the brokerage costs as the Profit Commission reflects the Ceding Company visions’ and not the Reinsurer ones’.
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