Monte Carlo simulation for insurance agency contingent commission

Many insurers pay independent agencies a contingent commission based on the agency´s performance. The insurer must accrue funds during the year to recognize the expected contingent commission payout in the financial statements. Westfield Insurance wanted to reduce their accrual forecasting error from 20 percent to less than five percent. We built a Monte Carlo simulation to simulate each Westfield agency´s performance. We clustered agencies into representative groups as a proxy for generating correlated random variables and then designed an experiment to shift statistical distributions of agency key performance indicators. The results of the simulation were then used to derive a formula for forecasting expected contingent commissions based on overall company results. The approach, results, and areas for further research are discussed.