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Chapter 21 - Expenses Practice Questions

Terms in this set (15)

Define the following categories of expenses:

1) variable

2) fixed

3) direct

4) indirect
- varies with amount of business, may be linked to the number of policies or claims or amount of premium or claims

- fixed in real terms over a short to medium period, don't vary according to level of business being handled

- direct, direct relationship with a class of business

- indirect, don't have a relationship with a specific class of business
'No expenses are truly fixed'.

Discuss this statement.
fixed expenses are those that don't vary with the amount of business handled

biggest source of expense to financial services providers is most likely to be salaries payable to employees

while these are relatively fixed in the short term as it's not possible to hire and fire staff immediately, if volume of business increases or decreases, longer term changes can be made to number of staff

senior management is relatively fixed but changes when there's a change in structure of business provider

property expenses: long term could mean expansion while declining operations could be sub-letting a whole floor of its premises when it becomes small enough

- something that's fixed could be expenses relating to regulators, for example fees that have to be paid to a regulator
Explain what is meant by the statement: 'all variable expenses are direct, but fixed expenses can be direct or indirect'.
variable expense is an expense that increases with volume of business written or handled

so it's associated with a class of business and is a direct expense

example of direct fixed expense is a design and launch of a new product, can be linked to a line of business but also doesn't depend on the amount of business written

indirect fixed expense is HR director
Explain why it is necessary to 'sub-divide' the function of the expenses for the purpose of premium rating.
- so they can be allowed for in different ways when determining expense loadings for premium ratings

- marketing, sales and commission as % of premium or SA

- processing and policy issue costs are fixed amount p/policy

- underwriting costs can be proportional to the amount of benefit

a more detailed breakdown of new business costs helps with profitability of certain products and inefficiencies with others

knowing whether function of expense is new business, existing business of termination gives info about timing of occurrence of expense

- breaking down by function also ensures that costs that are only incurred in regular premiums are not loaded onto customers with single premium
A general insurance company writes only personal motor and health insurance.

The health insurance policies provide money for medical treatment. Varying degrees of cover are offered. The premium rates for the health insurance contract are due to be reviewed.

All aspects of new business processing are performed in a single department. It has therefore been suggested that the total loading for initial expenses, other than commission, should be derived by dividing the total expenses incurred by the department over the preceding three months by the total number of motor and health insurance policies processed over this period.

Explain why this might not be appropriate.
- expenses are likely to be different for motor insurance and health

- health insurance might have higher underwriting costs

- not all expenses are per policy, for example underwriting expenses may be more closely linked to the level of benefit

- marketing expenses might be linked to the size of the premium

- period of three months might not be long enough, NB sales vary by time of year

- historical expenses would need to be adjusted for inflation from middle of three month period up to middle of period for which premiums are expected to be in force
Describe how the following expenses would be allocated in an insurance company's expense analysis:

(i) salaries of actuarial department staff
i)

- can be attributed to initial expenses and to renewal expenses

- staff timesheets can be used to determine between the different functions and direct and indirect

- actuaries can be involved with direct in terms of a specific product line or indirect (some kind of valuation)

- allocation of indirect might be pragmatic, same proportions as already done for direct expenses
(ii) costs of running the investment department
directly related to investment maintenance expenses

cost of running the investment dept. depends on the level of funds
(iii) costs associated with a computer model purchased from a third party
- amortised over the model's estimated useful lifetime and added to ongoing computer costs

- allocated by computer usage, product or initial, maintenance or termination expenses

- split across product and by function can be done through the computer logs
(iv) costs of property owned by the policyholders' fund.
asset, but no rental income so expense has to be covered by policy expense loading

notional rent or property needs to be determined

done by dividing into departments according to usage

allocated to products and then allocated to new business, renewal or terminations
Explain why it is important to reflect the results of an expense analysis in the premiums charged for life insurance contracts.
- charge premiums that cover expected level of initial and ongoing expenses assoc. with writing and servicing contracts

- understand the levels of cross-subsidy between small and large contracts

- understand the actual costs of writing and servicing costs and how they might vary through

distr. channel,
Outline which method would be appropriate for loading each of the following types of expense into an insurance company's premium basis:
(i) commission paid to a sales intermediary

(ii) underwriting costs

(iii) administration costs of setting up customer records

(iv) investment management costs

(v) long-term care claims handling expenses

(vi) overheads.
i) commission paid to sales intermediary - % per premium

ii) fixed cost per contract or % per benefit

iii) fixed cost per policy

iv) % of funds under management

v) fixed per claim or benefit payment

vi) in proportion to rest of expenses
List the different ways in which expenses could be categorised (ie split) for a general insurance company when undertaking an expense analysis for product pricing purposes.
- fixed and variable

- direct and indirect

- class of business

- by function

- further sub division (admin, marketing)

- by what the expense is most closely linked to
Outline how the results of such an expense analysis would be included in premium rates.
- by product or type of cover

- expenses separated in line with previous categories

- expenses related to number of claims or policies will be divided by an average first and then loaded into premium rates
Explain why it is important to reflect the latest expense analysis in premium rates.
to allow company to charge premiums that will allow for expenses etc.

to allow the company to understand cross subsidising better, for example renewals subsidising NB

To understand the cost of writing business
The expense loadings in a life insurance company's annuity pricing basis consist of:

- a percentage of single premium
- a one-off initial monetary deduction from the single premium
- regular deductions from the annuity payments.

The company has recently carried out an expense analysis. The results of the analysis have been published in a format that breaks down the expenses of the whole company into the following:

- staff costs, split by sales and marketing, underwriting, new business processing and existing business servicing and support function departments (eg human resources, finance, compliance, senior management)
- buildings' rental costs
- computer costs.

The pricing actuary wants to be able to use the results of the expense analysis to check whether the existing expense loadings in the annuity pricing basis are adequate.

Describe how the actuary could derive the expenses loadings for the annuity pricing basis from these results, in order to perform the required check
Staff costs:

- various depts. are likely to deal with several classes of businesses, so we need a way to allocate expenses to classes of business to allocate to the annuity business

- this could be done by timesheets, staff timesheets spent on working on different products

- support function tasks can be allocated in the same proportion as the direct expenses

In terms of loading these expenses;

- sales and marketing would be % of single premium

- underwriting: one of initial monetary deduction based on the SA or % of premium

- NB: one off initial expenses p/policy

- renewal: regular deductions from the annuity payments

* support function expenses will be allocated between categories in proportion to overall allocation of other dept.

Determining the size of loading

for the % of premium:

divide the total annuity '% of a single premium' by total annuity new business single premium written in that business period

for the one-off monetary deductions:

divide the total 'one-off initial per policy' by total number of NB policies written over that period

for regular deductions from the annuity payments

divide the total 'regular deductions from the annuity payments' by total existing policies handled in that business period

Buildings' and computer cost:

- for buildings we allocate the expenses by dividing the floor by depts. that use it, if the company owns the property then it's an asset and should be earning rent

notional rent is charged

- for computer costs, then this could be done by 'charging out' the costs, this is done by charging based on the time the dept uses

- one off computing costs could be amortised over regular payments

- buildings and computer costs can then be split out by class of business according to the salaries of the employees in that dept.

- allocated for expense loading by using the split for staff costs
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