Reinsurance Commissions

Under a proportional reinsurance treaty, the reinsurer pays to the ceding company

a reinsurance commission to cover the acquisition and administrative costs

incurred through acquiring the business. In some very competitive markets, it has

become common practice for primary insurers to finance an aggressive market

approach, with the important margin gained from the reinsurer. By being

subsidized on the reinsurance commission, the primary insurer has the possibility

to price classes of risks at a reduced rate to obtain the business. The victim in this

process is of course the reinsurer.

A profit commission is a percentage of the profit made by the reinsurer out

of a treaty which is refunded to the ceding company at the end of the year (or at

the close of the treaty). The rate is usually indicated in the treaty as a percent of

the average profit of the preceding 3 years. In a number of treaties, there is no

profit commission but a sliding scale of commission. The rate is inversely related

to the loss ratio. This ensures a reasonable sharing in the experience of the treaty,

leaving a fair rate of return to both parties.

Facultative Obligatory Treaty

It is an agreement whereby the ceding company has the option to cede the risks

(facultative), and the reinsurer is bound to accept it under a treaty arrangement. It

is normally associated with a surplus treaty and gives reinsurance facilities for

risks of specific nature when the capacity of the surplus has been exhausted.

Excess Loss Contracts

Excess loss contracts (or XL) differ from pro-rata contracts in that the ceding

company and the reinsurance company do not share the amount of insurance

coverage, premium and losses in the same proportion. In fact, no insurance

amount is ceded under an excess loss contract. The reinsurer is not directly
concerned about the original rates charged by the ceding company. It only pays

the ceding company when the original loss has exceeded some agreed limit of

retention.

Generally, the ceding company pays a premium to the reinsurer which is

function of the nature and extent of the coverage assumed by the reinsurer, and

no commission is paid to the ceding company. This system is called the "burningcost" system.

The burning-cost is a percentage calculated by dividing the total losses

exceeding the excess point during the period by the premiums for the same period.

A maximum and a minimum rate are applied and a deposit premium is paid. As

in the retrospective premium, the final premium is adjusted at the end of the year.

Per Risk Excess

The retention under a per-risk contract is stated as a monetary amount of loss (not

an amount of loss exposure or coverage). The reinsurer is liable for any amount

of loss in excess of the retention determined in the contract. This amount is often

subject to a limit, for example $200,000 in excess of $50,000. The reinsurer under

this form of treaty pays all losses over a deductible. There may be more than

one excess of loss treaty covering the same book of business as long as they do

not overlap.

For example:

$200,000 in excess of $50,000

$500,000 in excess of $2