Lesson 6: Calculation D – Commission & Expense
Insurance products are acquired via various distribution channels appointed by an insurance / takaful company, such as tied agents, brokers and banks. As parts of compensations to the distribution channels, the insurance / takaful company pays commissions in accordance to the volume of new business acquired.
Apart from commissions, management expenses are one of the key components of gross premiums. These expenses can be split into (1) general acquisition expense (“GAE”) and (2) agency related expense (“ARE”):
- GAE refers to the expenses occurred from company operations, such rental, overhead, IT, etc.
- ARE refer to expenses incurred for the provision of benefits in cash or kind to insurance / takaful agents, which include medical expenses, insurance / takaful schemes, contributions to retirement / gratuity schemes and sponsorship of agents’ participation in seminars / conferences, but excludes commissions.
We normally further split GAE & ARE into acquisition expense (i.e. expense arising from new business acquisitions; applicable on t = 1 only) and maintenance expense (applicable to all policy months during policy term).
Understand calculations required for commission & expenses and identify inputs required for the calculations. Update your cash flow models.
Commissions are payable during premium term only. For the purpose of cash flow modeling, we can split commission payable into three categories:
- Basic & Overriding commission – Payable during premium term. For the purpose of modeling, you do not need to define commission rates for every policy year until end of policy term. Instead, you can set the commission rate for particular policy year (e.g. policy year 7, as many insurance products pay commissions up to policy year 6 only) as the “ultimate” rate if all future policy years use the same commission rate (either level rate or zero).
Basic & overriding commission rates vary by premium term and policy year:
- Production bonus – Payable during policy year 1, to tied agents who achieve particular target of new business volume. We assume all policies pay production bonus for actuarial modeling.
- Persistency bonus – Payable during policy year 2 & 3, to tied agents who manage to maintain the persistency above a particular target % (separately for policy year 2 & 3). Similarly, we assume all policies pay persistency bonus.
Commissions are calculated a % of premium income: