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10/8 M97/February 2018 Reinsurance

With proportional business, the reinsurer follows the original premium rates set by the reinsured.
Provided that those original premium rates are adequate, the reinsurer should, in the long run, make a
profit. The only way that a reinsurer is able to affect the rating of proportional treaties is to exercise a
careful control over the level of commission that the reinsurer returns to the reinsured. This is how the
term ‘exchange commission’ originates.
Most reinsurers plan loss ratios, so the addition of the planned or projected loss ratio plus commission,
Most reinsurers plan
loss ratios other deductions such as taxes and/or brokerage, plus any planned profit or return on capital provision,
including the cost of any in-built or specific excess of loss protections on that treaty, will give the
reinsurer a clear indication of whether that treaty will ultimately be profitable or not.
The way in which the reinsurer influences the pricing of a proportional reinsurance is by negotiating the
level of ceding and profit commissions to be allowed by the reinsured. This is a key feature of
proportional reinsurance underwriting. If the reinsurer permits the reinsured to deduct higher
commissions than those involved in acquiring the business or administering the reinsurance, the
reinsurer is effectively charging a lower reinsurance rate. If the results of the treaty are currently
profitable and are envisaged to remain so then it will be easier for a reinsured to negotiate and the
reinsurer to agree to preferential commission terms than it would be if the account continued to produce
poor results.
Alternatively, if the commissions allowed by the reinsurer are less than those applicable to the
reinsured’s business, the reinsurer is effectively charging a higher reinsurance rate and, in theory, that
should allow the reinsurer to increase its profits relative to the risk ceded. As mentioned previously, the
commission structure may be arranged to reflect a sharing of the profits or the losses of the treaty
through profit and loss ‘corridors’. This is a further illustration of the flexible approach that reinsurers
sometimes use to make the placement of a treaty more attractive.
Many reinsurers now prefer to use a sliding scale of commission rather than a combination of flat
commission and additional profit commission, as this gives an immediate result at the end of a treaty
period. It is generally agreed that sliding scales of commission are easier to use for treaties accounted
on an annual ‘clean-cut’ basis.

Question 10.5 Reference copy for CII Face to Face Training

Why are sliding scales of commission more complicated to administer for treaties accounted for on an underwriting
year basis?

C Underwriting features of non-proportional reinsurance

The reinsured may envisage ceding large volumes of premium for individual risks, many of which will
never suffer a loss. In these circumstances the reinsured may prefer to effect a non-proportional excess
of loss contract. This will allow it to bear all losses in their entirety up to a specified fixed monetary
amount, known as the deductible or retention, and to recover any amounts above this sum up to a figure
that the reinsurer specifies as its limit. This form of cover can be applied both to individual risks and on
a treaty basis.
Many of the underwriting considerations that were relevant under proportional reinsurance would also
apply here. However, there are additional factors to bear in mind.
With property reinsurances, the amount of reinsurance at any one level or on any one reinsurance policy
is usually limited. In order to negotiate the correct amount of cover required by the reinsured,
information regarding the number of reinstatement provisions to be included in the cover must be
available. If reinsurers are prepared to grant this extension of cover, the terms that will apply to the
calculation of any additional premium must be set out clearly in the final negotiated contract.
Consider this…
10 As the excess of loss reinsurer is not proportionately sharing the premium and claims on the reinsured’s original
portfolio of risks, it may be more greatly exposed to loss, particularly in the early years of any such arrangement.
Chapter Any fund built up by the receipt of reinsurance premiums will inevitably be low in relation to the possible major loss.

Therefore, the relevance of historical loss detail is even more significant in influencing any predictions of
Relevance of
historical loss detail future losses and the consequent price of the reinsurance.
is even more
significant The nature of the reinsured’s business should be clearly defined. It is important to know whether it is
specialising in one specific class of business or writing a general book of risks.