C21 Expenses Flashcards
Define ‘fixed expenses’ and ‘variables expenses’
Fixed – remain relatively fixed in real terms (e.g. building maintenance)
Variable – vary directly according to the level of business (policies/claims/premiums) being handled at that time (e.g. Commission)
Expenses that are fixed in the short term, variable in the long term
1. Staff-related costs and accommodation costs can vary in the long term to meet:
- Changes in the structure of an organisation
- Changes in new and existing business levels
- Changes in the services provided
- Automation
Differences between benefit scheme expenses and insurance company expenses
Differences between benefit scheme expenses and insurance company expenses
1. No commission
2. No fixed overheads such as building maintenance or rent
3. Administration, legal advice, actuarial advice or investment management may be charged for on a fee basis or, if done ‘in-house’ will form part of the sponsor’s total overheads
Define ‘Direct expenses’ and ‘Indirect expenses’
Direct – belonging to a particular class of business
Indirect – Do not have a direct relationship with a class of business and need to be apportioned between the appropriate classes in performing an analysis
Outline the other purposes for which expenses need to be allocated, ie other than determining the expense loading for premiums.
Other reasons for carrying out expense analyses include: DUA CAF
1. Determining the expense loading for calculating provisions
2. understanding the profitability of a particular product
3. analysing sources of surplus (deviations of actual from expected expenses)
4. Cashflow management (to ensure that liquid funds are available to pay the expenses).
5. Analysing areas of inefficiency within the organisation
6. Financial planning (expense budgeting)
Explain how expenses can be allocated by class of business
Expenses need to be allocated between:
- classes of business, and
- functions (relates to timing of expenses e.g. underwriting, admin, HR, mgmt)
Direct:
1. One class of business: All costs
2. More than one class of business : split by time sheet
Indirect:
1. Salaries of staff who deal with lots of different products – use timesheets. Salaries of staff who don’t deal with any products e.g. human resources – treat as overheads or split in proportion to the salary-related expenses that have already been allocated
2. Property costs – charge a notional rent, allocated to department using floor space occupied and then to product in accordance with salaries
3. Computer costs – treat as overheads or charge out to departments bases on departmental usage and then to product in accordance with salaries .The cost of purchasing a new computer should first be amortised over its useful life
4. Investment costs - offset against investment income, allowed for by reduced investment return assumption
It would be necessary to know what investments backed a particular product
- Stockbroker commission and stamp duty would be added to the purchase price of an asset or deducted from sale proceeds. They are therefore reflected in the capital gain assumption for a product.
- Salary costs and custody fees are offset against investment income. They are therefore reflected in the investment return assumption used for a product.
- One-off costs – could be spread over the expected future lifetime of the item, then just treated as an overhead
5. Exceptional expense items – which are not likely to recur, may be ignored completely from the analysis
Explain how expenses can be allocated by function
Function – determines whether the cost is a:
1. NB expense,
2. Renewal expense,
3. Termination expense,
4. Claim expense
5. Investment expense.
Division may be further subdivided by department, e.g. NB by:
1. Marketing
2. Sales and Commission
3. Underwriting
4. Administration
The functional analysis of expenses is important in determining which expenses are charged to which contracts. For example, in a life insurance company the costs of regular premium collection would not be charged to single premium or paid-up policies.
Outline the purpose of expense loading in pricing or provisioning basis
Expense loading in pricing or provisioning basis is required to ensure:
- Sufficient premiums are charges or adequate provisions are established to cover…
- cost of expenses related to administration, and claim handling, including the contribution to the general fixed costs of the insurer-
How commission cost would normally be loaded and allowed for in pricing or provisioning
- Commission will usually be proportional to the size of the contract
- Expressed as a % of premium
Five ways in which expense loading could be expressed
The expense loading could be expressed as a:
1. percentage of premium or sum assured
2. percentage of funds under management
3. fixed amount per contract
4. fixed amount per claim or percentage of claim amount
5. combination of the above.
How investment expenses would normally be loaded and allowed for
- Expressed as a % of fund under management
- Allowed for by a direct reduction from investment return assumption
How office administration loading would normally be expressed
- Office administration expenses relates to the activities that are independent of the size of the contract (e.g. cost of collecting a premium)
- Expressed as a monetary amount per contract
Different possible approaches to treating claim expenses
Life insurance:
- Expense independent of claim size
- An amount per claim
General insurance:
- Expense proportional to claim size
-
Adjustments to expense loading for pricing purposes
Having determined appropriate expense loadings for each policy based on past data, it may be necessary to make some adjustments for pricing purposes. For example:
to reflect cross-subsidies
for past and future expense inflation
due to competition considerations.
Explain the importance of functional analysis of expenses
Functional analysis of expenses
- Important in determining which expenses are charged to which contracts
- e.g. cost of regular premium collection should not be charged to single premium or paid up policies.
