Ceding Commission

edited September 2019 in BK.Reins

How does ceding commission work?

Assume 50% quota share with 15% ceding commission, GWP =1500, GLR = 850. How is the ceding commission calculated?

1500 x50%x15%= GWPx % ceded% x commission ratio?

Thank you.

Comments

  • There are many different ways to set up ceding commissions, but your example accurately captures the basic idea: the ceding commission is a percentage of ceded premium. (The purpose of ceding commissions of course is to help the ceding company cover admin, U/W, and acquisition costs.)

  • How is ceding commission lead to increase in surplus/ result surplus relief? Also, why you say "surplus relief"is only created temporary only exit when there is UEPR?

  • I'm sorry - I don't think I understand your question. Which example from the BK.Reins reading are you asking about?

  • For Spring 18. 27. The solution shows "provide surplus relief most likely due to ceding commission. Shown by decrease in loss reserve/ surplus ratio." You also mentioned in "BK.Reins" ceding commission lead to increase in surplus/ result surplus relief. Could you give me an example on how ceding commission decrease reserve/ surplus ratio?

    I forgot where I read it, "Surplus relief is temporary, it only exists where there is UEPR". Is this true?

    Thank you.

  • Thanks, I understand your questions better now. To determine if there has been surplus relief, we can calculate these "loss leverage" ratios:

    • (gross reserves / surplus) before reinsurance = 1100 / 2000 = 55.0%
    • (net reserves / surplus) after reinsurance = 1170 / 2710 = 43.1%

    You can conclude that there has been surplus relief because loss reserves are now a smaller percentage of surplus. (This is good because there is more surplus relative to losses so the insurer is better able to absorb future losses.)

    That is the reasoning you were supposed to give. If you had shown the above calculations (which the examiner's report did NOT do) you should get full credit. The examiner's report also mentioned a possible reason for the surplus relief but I don't think it was necessary to provide that. They said the increased surplus could be due to ceding commissions the reinsurer paid to the insurer (for acquisition of this reinsurance business.) This ceding commission would flow into the income statement and possibly end up in surplus if it wasn't used for something else. The question does not provide ceding commissions, so you cannot verify this.

    As a side point I don't think this was a very good exam question because the "premium leverage" ratios do NOT show surplus relief:

    • (GWP / surplus) before reinsurance = 500 / 2000 = 25.0%
    • (NWP / surplus) after reinsurance = 1500 / 2710 = 55.4%

    But the examiner's report used the increase in NWP as a benefit because it shows that the insurer may have increased their market share.

    About your last question:

    • "Surplus relief is temporary, it only exists where there is UEPR". Is this true?

    This could be true if the ceding commissions are paid as the UEPR is earned. Once the UEPR is earned, the insurer no longer receives that income but would still be liable for their share of the retained losses. If this retained business has a high loss ratio (which often happens during periods of premium growth) the initial surplus relief could eventually be eliminated. (But note that this was not part of this particular exam question.)

  • Thank you for the thoroughly explanation. It makes much more sense to me now.

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