Contingent Profit Commission in an Excess of Loss Reinsurance Agreement

Today’s blog focus is on the contingent commission in a reinsurance treaty.  Accounting for the contingent commission need not be as daunting as it would seem in the actual agreement.  Generally, these calculations are simple enough to be kept in a spreadsheet without too much trouble. This blog shares an example of a practical way to account the contingent commission.

Note: Actual terms vary by reinsurance contact so it is important to read and understand the terms of your particular reinsurance agreement, and of course, if you need help, feel free to give us a call.

Example Details

In the example with this blog, we have an Excess of Loss reinsurance agreement that contains a Contingent Profit Commission (also referred to as a Contingent Commission) on the net profit from the reinsurance contract. The example assumes that there is risk transfer to the reinsurer. Additional assumptions as follows:

Treaty Year 20X0 – Ceded Premium of $5,740,000 and a Loss Ratio of 24.32% with negative development into 20X1 of 27.60%

Treaty Year 20X1 – Ceded Premium of $5,304,000 and a Loss Ratio of 25.90%

For this example of the excess of loss contract, “the reinsurers will allow the Company a Contingent profit commission of 45% of the net profit of the agreement”. The net profit per the agreement is as follows:

– A: Reinsurance Premium, less

– B: Reinsurance losses and LAE (reinsurer’s portion) made on claims made during the term of the agreement plus the Company’s estimate of the reinsurers’ portion of the reserve for outstanding losses/LAEs on policies in force during the term of this agreement, less

– C: 25% of “A” for reinsurers’ home office expenses.

Per this example agreement, the commission will be computed 12 months after the expiration or cancellation of the agreement (April of each year).

Guidance

Below is an excerpt from Statement on Statutory Accounting Procedures No. 62R Property and Casualty Reinsurance (SSAP No. 62R), paragraphs 48-51:

48. Reinsurance treaties may provide for adjustment of commission, premium, or amount of coverage, based on loss experience. The accounting for common examples is outlined in the following paragraphs:

Commission Adjustments

49. An accrual shall be maintained for the following adjustable features based upon the experience recorded for the accounting period:
50. Contingent or Straight Profit—The reinsurer returns to the ceding entity a stipulated percentage of the profit produced by the business assumed from the ceding entity. Profit may be calculated for any specified period of time, but the calculation is often based on an average over a period of years; and
51. Sliding Scale—A provisional rate of commission is paid over the course of the agreement, with a final adjustment based on the experience of the business ceded under the agreement.

Recording Issues

The issues is the proper recording of the liability/asset and expense/revenue from the contingent commission clause in the reinsurance treaty.

Following SSAP 62R guidance above and the calculations below, for the 20X0 treaty year, the Company would record a Contingent Commission receivable of $1,309,000 with a related Contingent Commission revenue of the same.  In 20X1 treaty year, the Contingent Commission receivable would be $2,396,000 after posting the change in Contingent Commission revenue of $1,087,000.   The change is the result of $1,172,000 activity in the 20X1 treaty year and the loss ratio for 20X0 year deteriorating from 24.32% to 27.60% resulting in a 20X1 treaty year downward adjustment of $85,000 (=$1,309,000 – $1,224,000).