Chapter 3

Question 1

what is the portion of a management accounting system that provides cost information needed for use in expense management?

Answer 1

a cost accounting system.
- accounting subsystem that accumulates expense data for the dual purposes of effective cost control and accurate product design activityes.

Question 2

what is cost accumulation?

Answer 2

process of capturing all of a company’s costs and categorizing them in meaningful ways.

Question 3

insurance company expenses are divided into two main categories for cost accumulation purposes.

Answer 3

1) investment expenses

2) General and administrative expenses.

Question 4

What is investment expenses?

Answer 4

costs associated with investing the company’s assets.

Question 5

What are general and administrative expenses?

Answer 5

costs incurred as a result of undertaking normal bsuiness activities to generate sales and to support products:

1) expenses for benefits. (cost of paying contractual obligations to customers)
2) Operating expenses. (costs of operations other than expenses for contractual benefits)

Question 6

how are insurance company’s non-investment expenses classified?

Answer 6

general and administrative expenses- the expenses that result from undertaking nromal business activites to generates sales of products and to support products.

Question 7

For insurance company’s general and administrative expenses can be subdivided into what 2 categories?

Answer 7

1) expenses for contractual benefits

2) operating expenses.

Question 8

What are operating expenses?

Answer 8

the costs of operations other than expenses for contractual benefits.

Question 9

Insurers typically track what 4 important types of operating expenses?

Answer 9

1) development expenses,
2) Acquisition expenses,
3) maintenance expenses
4) overhead expenses.

Question 10

What are development expenses for insurance and annuity products?

Answer 10

expenses an insurer incurs in starting a new product or product line.

• product design and pricing
• purchase or design of new adminsitrative software
• product approval
• creation of product brochures and sales information
• development of customer and trade promotions

Question 11

What are acquisition expenses for insurance and annuity products?

Answer 11

expenses an insurer incurs to obtain and issue new business.
- eg: pre-ossuie and first year axpenses.

Question 12

What are maintenance expenses?

Answer 12

product related expenses an insuere incurs while a contract is in force. ie: renewal/trail commissions, premium taxes, changes to customer records, trsnaction processing.

Question 13

What are overhead expenses?

Answer 13

cost an insurer incurs during nromal business operations that are not directly connected to a specific product or service
- agency support, system support, furnities, utilities, legal services, accounting, taxes, licensing.

Question 14

Overhead expenses can be divided further into controllable and non-controllable expenses, direct and indirect expenses, and variable and fixed expenses.
What are Controllable expenses ?

Answer 14

cost over which a specified manager or organizational unit has power to influence. ie:
advertising, technology purchases, overtime compensation, accounting

Question 15

Overhead expenses can be divided further into controllable and non-controllable expenses, direct and indirect expenses, and variable and fixed expenses.
What are non-controllable expenses.

Answer 15

a cost over which no specified manager or organizational unit has power or influence.

Question 16

Overhead expenses can be divided further into controllable and non-controllable expenses, direct and indirect expenses, and variable and fixed expenses.
What are direct expenses?

Answer 16

product expenses incurred for or physically traceable to a specified life insurance or annuity product.

Question 17

Overhead expenses can be divided further into controllable and non-controllable expenses, direct and indirect expenses, and variable and fixed expenses.
What are indirect expenses.?

Answer 17

expenses that cannot be traced to or that are not incurred for one specific product.
= result from activities that relate to several or all of an insurer’s products.

Question 18

Overhead expenses can be divided further into controllable and non-controllable expenses, direct and indirect expenses, and variable and fixed expenses.
What is a variable expense?

Answer 18

an expense amount that varies in direct proportion to some variation in a specified level or operating activity
-ex: some variable expenses may vary based on number of policies sold

Question 19

Overhead expenses can be divided further into controllable and non-controllable expenses, direct and indirect expenses, and variable and fixed expenses.
What are fixed expenses?

Answer 19

an expense that remains relatively constant regardless of the number of policies sold or some other measure of the level of operating activity.

Question 20

How can insurers, insurance regulators, and rating agencies measure operating efficiency by means of financial ratios.
What is the Return of equity ratio? (ROE)

Answer 20

tatio of the insurers net income to its owner’s equity.

ROE= (net income)/owners’ equity

ROE= (revenues-expenses)/ owner’s equity

Question 21

if an insurer is able to increase its revenues, ROE will what?

If an insurer is able to decrease it expenses, ROE will what?

Answer 21

increase.

Increase.

Question 22

Insurers can take one of what 3 approaches to controlling operating expenses?

Answer 22

1) making major expense reductions. (eliminating or drastically reducing expenses in certain areas, staff, closing offices. etc. *should be used selectively)
2) Making minor expense reductions (involve findings more cost-effective ways to perform certain functions: maintenance, outsources,)
3) reallocating corporate expenses (separating expenses that are related to the total company from expenses related to particular products or line of business)

Question 23

What is rightsizing?

downsizing

Answer 23

the elimination of non-essential employees or jobs within an organization.

• careful redesign.
• can be achieved through attrition.

Question 24

Define outsourcing:

Answer 24

the practice of hiring an external vendor to perform specified operation or functions.

Question 25

What are common functions that life insurance companies commonly outsource?

Answer 25

1) informaiton management functions
2) investment management functions
3) life insurance claim administration functions
4) customer service functions
5) human resources functions

Question 26

What factors are generally considered before one would outsources a function?

Answer 26

1) insurers own ability to perform the function efficiently, effectively and cost-effectively.
2) important of immediate implementation.
3) availability of start-up capital.
4) important of control over the operation.

Question 27

Benchmarketing company operations is a popular way to manage operating expenses and improve operating efficiency. what does it consist of?

Answer 27

1) identifying the best outcomes that other companies have achieved for a specific activity or process and the practices that produced those outcomes.
2) implementing the best practices to equal or surpass the best outcomes.

Question 28

insurers frequently use benchmarking to improve the efficiency in what sections?

Answer 28

1) employee training and development programs
2) document management processes
3) accounting processes
4) compensation and incentive programs
5) distribution systems.

Question 29

sales commissions for individual life insurance are generally divided into what two categories?

Answer 29

1) first-year commissions: payable when a policy is sold.
2) renewal commissions: are payable while a policy is in force. deisgned to encourage persistency by providing producers with a continuing stream of income from existing policies. (usually 2-5% of premiums recieved)

Question 30

Renewable commissions can be vested, nonvested, or conditionally vested.

Answer 30

1) vested commissions: commission that is guaranteed payable to a producer whether or not the producer represents the company when the commissions becomes due.
2) nonvested commission (a commission that is payable to a producer only if the producer still represents the company when commission become due).
3) conditionally vested commission (commission that becomes vested only after a producer reaches a certain age or number of years of service with the company)

Question 31

what is a heaped commission schedule?

Answer 31

> features relatively high first-year commissions and lower renewal commissions.
encouraging for generating new bsuiness and minimal losses for low persistency.
Expensive for company’s perspective, but good for maintaining top-notch producers.

Question 32

How can an insurer do have several options for improving persistency rates?

Answer 32

1) an insurer can link production bonuses to persistency.
- as an alternative to production bonuses, insurers may offer producers a separate persistency bonus (which provides extra earnings for favourable persistency results)
2) an insurer can impose penalties for excessive policy lapses.

Question 33

What do you call a commission schedule that pays commissions only on new premium payments made by annuity owners?

Answer 33

deposit-based commission schedule.
- some schedules stupilate that a producer must return part or all of the commissions recieved on an annuity that is surrendered in the first year.

Question 34

In addition to deposit-based commissions, some insurers use asset-based commission schedules for deferred annuities. what is that?

Answer 34

An asset-based commission schedule, is a commission schedule in which commissions are calculated as a percentage of the accumulation value of a deferred annuity contract’s funds.

• commisions earned after premium payments stop are freferred to trail commissions.
• designed to improve persistency, conserve annuity assets, and persuade producers to provide better service to annuity contact owners.

Question 35

Knowledgeable employees have the expertise to spot oppertunities for cost reductions, which improve profitability. What are some examples that employees can do?

Answer 35

1) analyze work processes and suggest improvement to increase productivity
2) detect irregularities in records related to dealing swith customers and report suggestions of fraud or unecessary expenditures
3) use lowest-cost most effective way of working
4) apply a team-oriented, cooperative attitude to improve work processes and procedures.

Question 36

What are two common combination commission schedules used for the sale of individual deferred annuities?

Answer 36

1) 4% deposit-based commision on new premium plus 0.% asset-bnased commisison on accumulated contract calue, starting 1 yr following end of the surrender penalty.
2) 2% deposit-based commission during the first contract year, + 1% asset-based commission on accumulated contract value, starting in second contract year.

Question 37

define: operational risk

Answer 37

is generally defined as the risk of financial loss resulting from 1) inadequate or failed internal processes and control, people, or system or 2) external events.

Question 38

Why is it difficult to manage operational risks?

Answer 38

they are difficult to categorize. They may involve more than one risk category.

Their effects can also be devastating.

Question 39

Operational risk is often subdivided into which risk categories ?

Answer 39

distribution risk 
human resources risk 
technology risk 
business process risk 
event risk

Question 40

Define internal control

Answer 40

consists of the steps a company takes to encourage adherence to the company’s management policies promote operating efficiency, and safeguard the organization’s asset.
- helps ward off potential misconduct and establishes accountability for compliance throughout the company.

Question 41

What are the components of a company’s internal control system?

Answer 41

1) cross-functional risk committee
2) company’s compliance department
3) company’s ethical culture

Question 42

Teh role of the risk commitee

Answer 42

responsible for identifying, measuring, and managing all the significant risks to which an insuere is exposed,

Question 43

What is the role of the compliance department?

Answer 43

1) establish a company’s policies and procedure that comply with the regulatory requiremetns of the jurisdictions in which the insurer operates.
2) monitor the activites to insure policies are being followed.
3) internal audits

Question 44

What is an internal audit?

Answer 44

examination of the company’s records, policies, and procedures conducted by a person associated with the organization.

Question 45

What is the role of ethics in risk control?

Answer 45

ethis is defined as the standards of moral conduct.
ethic behavior is defined as behavior that meets acceptaed standards of moral conduct.
> company can reduce chances of employees defrauding by offering ethics training and emphasizing ethics.

Question 46

Define Fraud:

Answer 46

an act by which someone intentionally deceives another party in order to get that party to part with something of value.
* difficult to measure but essential to manage.

Question 47

What is a loss-incident database?

Answer 47

data base that records every loss that an insurer has experiences.

Question 48

what is a control self-assessment?

Answer 48

detailed report typically compiled by each line manager, capturing each areas key risks, controls and management complications.