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Chapter 4 Features and operation of proportional reinsurance treaties 4/21

• How much will the market stand and what phase of the underwriting cycle is the market presently at?
• Is the treaty part of a reciprocal exchange?
• Is it a new treaty for the insurer?
• Is the treaty being offered to a new reinsurer?
• What part of the world does it come from?
• What will be allowed for reinsurers’ expenses?
• What will be the effect of any deficits in previous accounts?
• Will the profit be averaged over a number of years of account?
• What is the past profitability of the treaty?

There are many variations in the formulae used for calculating a profit commission, but in each treaty the
terms and conditions should show clearly the basis that is to apply.
Two principal methods that are used to deal with the problem of fluctuations from year to year are as
follows:

Average system Each year, the profit commission is based on the average of the aggregate treaty results Chapter
for the current and preceding years, typically between three and five years in total. 4
Deficit carried forward A deficit in any one treaty year is carried forward and set against profits in an ensuing
year or years. It may be agreed that any deficit should be carried forward for no more
than a specified number of years; for example, three years. Sometimes it is carried
forward to extinction. Whichever feature is used, it will be clearly identified in the
‘outgoings’ section of the profit commission statement.

Question 4.5
What is the principal advantage of the ‘deficit to extinction’ method from the reinsurer’s point of view?

The collection of profit commission can be effected either by the reinsured rendering a specific account
after the close of the accounting year or by including it in the last periodic account for the year in Reference copy for CII Face to Face Training
question.

Example 4.11
To ascertain whether an account has made a profit or not, all the component parts relating to the profitability of the
treaty need to be identified. All the relevant income from whatever source needs to be compared with all the relevant
expenditure from whatever source. In the event of income exceeding expenditure, a ‘profit’ has been made and a
profit commission could be calculated.
The relevant details that may form part of the profit commission calculation can be summarised as follows:

• Income:
– premiums credited for the underwriting year;
– premium reserves from the previous year, if applicable;
– incoming premium portfolio and/or loss reserves from the previous year, if applicable;
– incoming loss portfolio, if applicable.
• Expenditure:
– losses and loss expenses paid during the underwriting year and outstanding loss reserves at the year end, if
applicable;
– outgoing loss portfolio, if applicable;
– premium reserve at the year end, if applicable;
– outgoing premium portfolio;
– ceding commissions on premiums for the current year, taxes, fire brigade charges or similar levies paid by
insurers;
– an allowance for reinsurer’s expenses (usually a percentage of the ceded premiums),
– deficit, if any, carried forward from previous years.
Net profit is the amount by which the credit items exceed the total of the debit items. The precise manner in which a
profit commission is calculated varies from contract to contract and is agreed in the profit commission clause of the
treaty wording.