A contingent commission is a commission paid by an insurer or reinsurer to an insurance intermediary that depends on the profitability of the business that the intermediary has placed with the insurer or reinsurer. In other words, these programs reward intermediaries for hosting (and maintaining) a large volume of business that is likely to incur below-average losses with the insurer. The purpose of contingent commissions is to induce the insurer or reinsurer to post a substantial business book and to provide the insurer or reinsurer with “forefront” assistance in underwriting, administration and risk control for that business book. Because they may be contrary to the best interests of policyholders, the practice of accepting contingent commissions by insurance brokers was criticized by the New York Attorney General in 2003–2005 and is no longer a common practice, at least for larger firms. On the other hand, since they are the legal representatives of the insurers, the acceptance of contingent commissions by independent agents is not considered unfavorable and is still widely practiced. Conditional fees are not considered illegal or, subject to proper disclosure, unethical.
Insurance is a contractual relationship that arises when one party (the insurer), for a fee (premium), agrees to compensate the other party (the insured) for losses caused to a certain subject (risk) caused by certain unforeseen circumstances (hazards or dangers). The term ‘guarantee’, commonly used in England, is considered synonymous with ‘insurance’.
The 10/10 Rule is a matter of analyzing and demonstrating the transfer of risk as a precondition for the use of reinsurance accounting, which was codified in the early 1990s with the adoption of Financial Accounting Standard (FAS) 113 (and its statutory counterpart, SSAP 62). FAS 113 itself was a response to alleged abuses and set the standard for testing whether something should be called an insurance contract. FAS 113 required that the transfer of risk be demonstrated by comparing the present value of the cash flows associated with the contract and, in particular, by exceeding certain thresholds of “significance” of risk. The thresholds, often referred to as the 9a and 9b tests, are: 9a. The reinsurer assumes significant insurance risk under the reinsured parts of the underlying insurance contracts. 9b. It is possible that the reinsurer could suffer a significant loss from the transaction. While neither “significant” nor “reasonably possible” was defined in this context, standard rules of thumb quickly emerged in the implementation of FAS 113. The most commonly cited is the “10/10 Rule”. This rule states that a contract reaches a threshold if there is at least a 10 percent chance that it will suffer a loss of 10 percent or more in present value (expressed as a percentage of the contract premium ceded).