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HMRC internal manual

Business Income Manual

Specific receipts: insurance and other commission: indemnity terms: commercial background

Many financial consultants, insurance agents and brokers rely heavily on commission for their trading income. Selling life and other long-term insurance policies they would suffer serious cash flow problems, particularly during the early years, if they had to wait for their commission until the policyholder had paid a number of premiums. On the other hand, some time may elapse before the insurance company can recoup its commission costs out of premiums received. Therefore, it is common practice for agents to receive their commission on ’indemnity terms’.

Under those terms, when the policy is sold the agent receives ’initial commission’ (as against very much smaller amounts of ’renewal commission’) based on the assumption that the policy holder will continue to pay premiums for a given period, usually two to four years. If, however, the policy lapses within that period, part of the commission becomes repayable.

Agents typically do not receive the full amount of their initial commission up-front on indemnity terms. It is a feature of the insurance industry that policyholders sometimes have second thoughts, or find they have over-stretched themselves, so that a proportion of policies will inevitably lapse. Rather than pay the agent all the commission and then have to seek repayment of some, many insurers will only pay a certain percentage up-front, typically 50% or 75%. In these situations it is unlikely that the agent will ever have to repay any of the commission received on indemnity terms: any policy lapses will be covered by the proportion of commission not received up-front.

The amount received up-front is usually discounted recognising the time value of money (i.e. that £1 in hand now is worth more than £1 receivable in say three years time). So, for example, an agent may be permitted to receive a half of his or her commission up-front on indemnity terms with the balance bit by bit as the policyholder pays the first few years’ premiums. In those circumstances, if, say, the total commission on a policy is £100, the amount actually received up-front will not be the full £50 but a discounted amount, say £47. So, overall, the agent receives £47 now and £50 later, making a total of £97, instead of receiving £100 later.