What is Adjustable Feature
An adjustable feature is contract language that allows adjustments to be made to the premium and commission features of a reinsurance treaty. An adjustable feature may include such features as sliding scale commissions and adjustable ratings. The formulas used by contract parties to adjust premiums and commissions are agreed to in the original contract. Adjustable features are found in most pro rate reinsurance treaties.
BREAKING DOWN Adjustable Feature
Adjustable features are considered a risk that reinsurance companies have to account for, and which reinsurers wish to limit as much as possible. It alters the timing and amount of cash flows between the reinsured, which cedes premiums, and the reinsurer, which assumes risk. While reinsurance companies may prefer contracts without adjustable features, the number of contracts that are considered straightforward reinsurance contracts tend to be small.
Accounting for contracts with adjustable features is different from accounting for contracts that don’t have adjustable features. Reinsurers need to take into account future rights and obligations for claims that have occurred in the past. This is because the adjustable feature takes into account loss experience. Reinsurance companies examine the likelihood of different outcomes and determine how reasonable each outcome is, and use the likelihood of the outcomes when making estimates. These estimates may be created through the use of financial modeling, with the models taking into account the cash flows between the reinsured and the reinsurer.
Insurance companies that use reinsurers often have many different contracts, and some of the contracts are interrelated. This means that the performance of one contract, including the adjustable features of that contract, could be tied to the results of another contract. This in turn means that both the reinsurer and the reinsured need to have a thorough understanding of all contracts and agreements that they have between each other. For example, an insurer may have separate reinsurance contracts for different levels of loss.
The Prevalence of Adjustable Features
Quite frequently in the broker market, and less frequently in the direct market, working excess-of-loss treaties contain adjustable premium or commission features. These adjustable features include retrospective rating plans, profit commission or profit sharing plans, and sliding scale commission plans. A relatively small number of excess-of-loss treaties contain both adjustable premium or commission features and non-proportional coinsurance clauses. Pro rata treaties also frequently contain adjustable commission features. In order to price the impact of adjustable features, it is necessary to estimate the aggregate loss distribution.