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Profit Commission

Q: A profit commission calculation produces a negative figure. What happens?

No commission is paid and the deficit is carried forward — Profit commission is never negative. The shortfall simply carries into the next calculation period, where it must be earned back before any commission is due.

Q: The management expense allowance in the formula represents:

The reinsurer's retained margin before profit sharing — It is the reinsurer's own cost-and-margin deduction, taken before any profit is shared with the cedent.

Share of the treaty profit

An extra commission paid out of whatever profit the treaty actually makes, calculated after the fact.

Open the interactive version → definition, quiz, structure diagram and progress tracking

Definition

Profit commission pays the cedent an agreed percentage of the reinsurer's profit on the treaty, calculated on a defined formula: ceded premium less ceded losses, less ceding commission, less the reinsurer's management expense allowance, and usually less any deficit carried forward from earlier years.

Rewards the cedent for underwriting quality rather than volume — the cedent only earns it if the business performs.
The management expense allowance (typically 3–7.5% of ceded premium) is the reinsurer's retained margin before any profit is shared.
Deficit carry-forward is the sting: a losing year is carried into the next profit calculation, often for three years or until extinguished.

PC = Rate × (Premium − Losses − Ceding commission − Expense allowance − Deficit b/f)

If the bracket is negative, no commission is paid and the deficit carries forward.

Worked example

On $30M of ceded premium with $16M of losses, $9M of ceding commission and a 5% expense allowance, the profit is $3.5M. At a 25% profit commission the cedent receives $875,000.

Scenario · figures in USD

A profitable year dragged down by last year

A quota share carries 20% profit commission with a 5% management expense allowance and a three-year deficit carry-forward. Last year closed $1.0M in deficit. This year: ceded premium $25M, ceded losses $13M, ceding commission 30%.

Ceded premium	$25.00M
Less ceded losses	−$13.00M
Less ceding commission (30%)	−$7.50M
Less management expense allowance (5%)	−$1.25M
Profit before carry-forward	$3.25M
Less deficit brought forward	−$1.00M
Profit available for commission	$2.25M
Profit commission at 20%	$450,000

So whatThe prior-year deficit costs the cedent $200,000 of commission this year. Over a soft market, carry-forwards are how reinsurers make a multi-year deal out of an annual contract.

Check your understanding

A profit commission calculation produces a negative figure. What happens?

No commission is paid and the deficit is carried forward. Profit commission is never negative. The shortfall simply carries into the next calculation period, where it must be earned back before any commission is due.

The management expense allowance in the formula represents:

The reinsurer's retained margin before profit sharing. It is the reinsurer's own cost-and-margin deduction, taken before any profit is shared with the cedent.

Word problem

A treaty pays 25% profit commission with a 7.5% expense allowance and a two-year deficit carry-forward. Year 1: ceded premium $40M, losses $34M, ceding commission 30%. Year 2: ceded premium $44M, losses $22M, ceding commission 30%. Calculate the profit commission in each year.

Show a hint

Run the formula for year 1 first. Whatever deficit it produces has to be recovered in year 2 before any commission is payable.

Reveal the worked answer

Year 1 — commission 30% × $40M = $12.0M; expense allowance 7.5% × $40M = $3.0M
Result = $40M − $34M − $12.0M − $3.0M = −$9.0M → no profit commission; $9.0M deficit carried forward
Year 2 — commission 30% × $44M = $13.2M; expense allowance 7.5% × $44M = $3.3M
Profit before carry-forward = $44M − $22M − $13.2M − $3.3M = $5.5M
Less deficit brought forward $9.0M = −$3.5M → still negative
Profit commission in year 2 = nil; $3.5M carries forward into year 3

No profit commission in either year. A strong second year ($22M of losses on $44M of premium — a 50% loss ratio) still earns the cedent nothing, because the carry-forward has to be extinguished first. This is why the length of the carry-forward is negotiated as hard as the commission rate itself.