In the solution it says Profit commissions tend to act in a non-linear fashion and significantly reduce diversification benefits as majority of excess profits are ceded so increase is likely. Isn't profit commission what insurers get from reinsurers for ceding good business? I don't see the relationship between profit commissions and diversification.
Profit commission does not only apply to reinsurance business, it can apply to direct business as well. It acts in a non-linear fashion, because typically it is only paid once the loss ratio falls below a certain value. In addition, once the loss ratio has fallen below this value, most of the additional profit is passed back to the cedant. This means that any further diversification benefits obtained from writing this profitable business are no longer available to the insurer/reinsurer.
