Chapter 22: Expenses

Question 1

List the expenses that would apply to most financial service providers

Answer 1

• Staff salaries, pensions contributions, national insurance contributions etc.
• Commission payments
• Office rent and related expenses
• Office equipment
• Investment costs
• Office consumables

Question 2

Give examples of expenses that are essentially fixed but can vary in large amounts over time.

Answer 2

In practice, all expenses can vary in the long term, so the concept of fixed expenses make most sense if we confine it to the short term.

Staff related costs and accommodation costs can vary in the long term to meet changes in:
1. The structure of the organisation
2. New and existing business levels
3. The services provided
4. The degree of automation used

Question 3

How do the expenses relating to a benefit scheme differ from insurance company expenses?

Answer 3

1. No commission
2. No fixed overheads such as buildings maintenance
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.

Question 4

Fixed expenses

Answer 4

Remain broadly fixed in real terms

Question 5

Variable expenses

Answer 5

Vary directly according to the level of business being handled at that time and are linked to the number of policies or claims or the amoutns of premiums or claims.

Question 6

Direct expenses

Answer 6

Can be identified as belonging to a particular class of business

Question 7

Indirect expenses

Answer 7

Do not have a direct relationship to any one class and need to be apportioned between the appropriate classes in performing an analysis.

Question 8

Expenses need to be allocated between …

Answer 8

1. Classes of business, and
2. Functions

Question 9

What is meant by the term ‘function’ in relation to expenses

Answer 9

The function determines whether the cost is a new business expense, a maintenance (renewal administration or investment) expense, or a termination (or claim) expense.

This division may then be further subdivided.

For example, new business costs may be split into:
* marketing
* sales and commission
* administration
* underwriting

Question 10

What is the reason for which expenses might be allocated by ‘function’

Answer 10

In order for them to be loaded onto premiums.
This will mean that each policy contributes and appropriate amount to the total level of expenses.

Question 11

List 3 ‘functions’ of cost (by which they’re divided)

Answer 11

• Securing new business
• Maintaining existing business (renewal and investment)
• Terminating business (including claims)

Question 12

Explain briefly the process of allocating expenses to individual contracts

Answer 12

All expenses of the organisation must be identified and categorised as direct / indirect.

Direct expenses can be immediately allocated to a particular class of business.

Indirect expenses must be pragmatically apportioned between classes of business.

Not only must expenses be allocated to class but also to function, i.e. securing new business, maintaining existing business and terminating business.

Finally, an appropriate loading type must be determined, e.g. a fixed amount per contract / claim, a percentage of premium / sum assured / funds under management or a combination of these approaches.

Question 13

List 3 allocation methods that could be used for indirect expenses and give an example of a cost that could be allocated by each method.

Answer 13

1. Using a ‘charging out’ basis, e.g. computer rime and related staff costs could be charged to the direct function departments based on actual use.
2. By floor space taken up by a department, e.g. premises costs
3. Using an arbitrary basis, e.g. statutory fees or senior management costs could be added at the end of the analysis as a percentage loading to all the other attributed costs.

Question 14

Different ways of loading premiums for expenses

Answer 14

1. Fixed amount per contract - administration expenses
2. % of premium - commission
3. % of sum assured - underwriting expenses
4. % of funds under management - investment expenses
5. Fixed amount per claim - death benefit processing expenses
6. % of claim amount - general insurance claims administration expense
7. A combination of the above.

Question 15

Non-commission expenses can be split into …

Answer 15

• initial expenses
• maintenance expenses, including renewal and investment expenses
• termination expenses