Ch22: Expenses Flashcards
Why is this chapter on expenses important?
In order to set premium or contribution rates for a financial contract or to establish provisions for an existing contract, it is necessary to understand the NATURE and TIMING of the expenses.
Explain fixed vs variable expenses
Variable expenses: Varies directly according to the level of business being handled at that time.
May be linked to the number of policies or claims or to the amount of
premium or claims. Eg: Commission, legal expenses…
Fixed expenses: These expenses are fixed in the short term and does not generally vary with
the level of business currently being handled. Eg: Rental costs
Explain difference between direct and indirect expenses.
Direct expenses: Can clearly be identified to be directly belonging to a certain class of
business. Eg: Underwriting, claims settlement expenses, commission.
Indirect expenses: These expenses do not have a direct relationship to any one or more
classes of business. These need to be apportioned between the appropriate
classes. Eg: IT, marketing, distribution costs, human resources
Why do expenses need to be allocated between classes of business and function? (8)
- Determining the expense loading for premiums
- Determining the expense loading for calculating provisions
- Understanding the profitability of a particular product
- Analyzing sources of surplus (deviations from expected expenses)
- Analyzing areas of inefficiency in the business
- Financial planning (expense budgeting)
- Cashflow management (ensure liquid funds are available)
- Reporting of expenses (business as usual or once-off)
Why adjustments are made to expenses loadings for pricing purposes (3)
- To reflect cross subsidies (within product class i.e. small policy vs large policy or between
product classes e.g. funeral sold direct vs funeral sold through
financial advisors) - for past and future expense inflation
- competition considerations (marketability and competitiveness)
