W&M Ch 7 Flashcards
Fixed Expenses
- Expenses assumed to be the same for each risk, regardless of amount of premium
- e.g. overhead costs associated with the home office
Variable Expenses
- Expenses that vary directly with premium (i.e. constant percentage of premium)
- e.g. premium taxes and commissions
All Variable Expense Method
- Does not differentiate between fixed and variable
- Expenses assumed to be a constant percentage of premium
Relate historical expenses to either historical written or earned
- Use written if believe expense generally incurred at onset of policy
- Use earned if believe expense generally incurred throughout the policy
Selection of expense provision
- Based on latest year or multi-year average
- Also use management input, prior expense loads, and judgment
- Expense load should reflect expectations in the future
If non-recurring expense items during the historical period, the actuary should:
- Examine the materiality and nature of the expense to determine how/if should be incorporated
- May choose to spread out over several years or not include at all
Potential Distortions of all variable method:
- Assumes all expenses vary directly with premium
- However, portion may be fixed
- Understates premium need for small premium risks
- Overstates premium for large premium risks
Options for companies using the All Variable Expense method to deal with distortion
- Premium discount to reduce expense loadings for larger premium policies
- Expense constants to handle expenses such as policy issuance and auditing
What are the steps in the Premium-Based Projection Method?
- Determine percentage of premium attributable to expenses for each of the expense categories
- Divide ratio into fixed and variable ratios
- Ideally split based on detailed company data
- Without needed data, make reasonable assumptions - Sum expense ratios across categories to determine fixed and variable provisions
- Note: this gives you the fixed expense ratio, which is a ratio to premium - this is used with the loss ratio approach
- If using the pure premium approach, convert to fixed expense per exposure
- - Fixed per Exposure = Fixed Expense Ratio x Projected Average Premium
Potential Distortions of Premium Based Projection
- Rate changes can impact the historical expense ratios and lead to an excessive or inadequate overall rate indication
- Significant premium trend between the historical experience period and the projected period can lead to an excessive or inadequate overall rate indication
- Can create inequitable rates for regional or nationwide carriers because it uses countrywide expense ratios and applies them to state projected premiums to determine the expected fixed expenses
What are the steps in the Exposure/Policy-Based Projection Method?
- Divide expenses into fixed and variable amounts
- Divide fixed expenses by corresponding exposures (written/earned, countrywide/state)
- Divide variable expenses by corresponding premium
- Note: this gives you the fixed expense per exposure - this is used with the pure premium approach
Selecting projected average expense per exposure in the Exposure/Policy-Based Projection Method
- Similar expense ratios over several years implies expenses and exposures are increasing or decreasing proportionately
- Must consider impact of economies of scale given expected growth
Other Considerations/Future Enhancements in the Exposure/Policy-Based Projection Method
- The actuary splits expenses into fixed and variable
- Allocates countrywide fixed expenses to each state based on exposures
- Some expenses considered fixed vary by other characteristics
- Existence of economies of scale in a changing book
Trending Expenses
Premium-Based Projection Method
-If average expenses and average premium changing at same rate
-If assume average fixed expenses changing at different rate than average premium
Exposure-Based Projection Method
-If inflation sensitive exposure base used
-If non-inflation sensitive base or policy counts
What are two ways to consider Reinsurance Costs in ratemaking analysis?
- Reduce projected losses for reinsurance recoveries and premiums for cost of reinsurance
- Net cost of non-proportional reinsurance may be included as an expense item
- -i.e. cost of reinsurance minus expected recoveries
