Chapter 7 - Other Expenses and Profit

Question 1

For all Uw Expenses, tell which type of expenses (variable/fixed), the data (state/countrywise) used and the premium basis (Written/Earned)?

Answer 1

• Commission and Brokerage
  
  • Variable
  • Countrywide and Statewide
  • Written Premium
• Other Acquisition
  
  • Mix of Variable & Fixed
  • Countrywide
  • Written Premium
• Taxes, Licenses, Fees
  
  • Taxe=Variable and Licences&Fees=Fixed
  • Statewide
  • Written Premium
• General
  
  • Mix of Variable & Fixed
  • Countrywise
  • EarnedPremium

Question 2

Briefly discuss the trade of between the two source of profit (assuming the same overall target) for long tailed versus short tailed lines of business.

Answer 2

Long tailed lines of business often target a lower UW income (sometime event negative) since they will earn a higher Investment income (greater than target profit).

Question 3

What are the two Permissible Loss Ratio?

Answer 3

Variable Permissible Loss Ratio (VPLR):

Percentage of each dollar premium intended to pay for Projected Loss, LAE and Fixed expenses.

(Total) Permissible Loss Ratio (PLR):

Percentage of each dollar premium intended to pay for Projected Loss and LAE

Question 4

Describe the All Variable Expenses method and list the advantages and disadvantages.

Answer 4

Treat all expenses as variable exepnses (a constant percentage of premium). For each type of expenses, the ratio is simply the CY expenses / CY Premium.

Advantages:

• Simple calculation

Desadvantages:

• Underestimate expenses on small risk (with small premium) and overestimate expenses on large risks (with large premium).

Question 5

Describe each Uw Expenses.

Answer 5

Commission and Brokerage are the amountpaid to agents or broker in compensation for generating business,

Other Acquisition are the other cost of acquiring business

General expenses are the remaining cost associated with insurance operation including salaries and building rent.

Taxes, Licences, Fees are the taxes and miscellaneous fees paid by the insurer (excluding federal income tax)

Question 6

Describe the Premium-Bases Expenses method and list the advantages and disadvantages.

Answer 6

This method allocate the expenses between fixed and variable expenses. Each one is than divised by the CY premium.

Advantages:

• Advantage over all variable method it that variable and fixed expenses are split.

Desadvantages:

• Fixed Premium vary by premium which can create inaccuracies if prospective premium is different from historical.
  
  • Rate change (can on-level premium)
  • Change mix of business (can trend premium)
• When using countryweide data, will allocate expenses by state based on premium, which can create inequities in rates.

Question 7

Describe the Exposure/Policy-Bases Expenses method and list the advantages and disadvantages.

Answer 7

This method calculate the variable expenses in the same way as the Premium-Bases method, but devise Fixed expenses by exposure or policy count.

Advantages:

• Measure fixed expenses relative to exposure rather than premium

Desadvantages:

• Still needs to split judgmentally Fixed and Variable expenses.
• When using countryweide data, will allocate expenses by state based on premium, which can create inequities in rates.
• Some Expenses considered fixed may change by other characteristics.
• In a changing book, economics of scale is not captured.

Question 8

Explain when it is needed and when it not needed to trend Expenses?

Answer 8

No Expenses Trend is needed when

• Change with premium
• Change with inflation-sensitive exposures

Expenses Trend is needed when

• Change with non-inflation ensitive exposure
• Change with policy count

Question 9

Discuss how reinsurance cost are included in Ratemaking?

Answer 9

Proportional reinsurance does not need to be included it in Ratemaking

Non-Proportional reinsurance needs to be included

• Reduce the premium with the cost of reinsurance and loss with the ceded part.
• Calculate the net cost of reinsurance (Cost - expected ceded loss) and add it as item in expenses.

Question 10

Name and explain the two source of insurer profit?

Answer 10

Investment income - two source

• Capital Funds
• Policyholder Supplied Funds - are the incrome from investing:
  
  • Unearned premium untils it is earned
  • Loss Reserve holded to pay claims. This income is bigger in long-tailed lob.

Underwriting Profit - are the sum of profit generated from insurance operation in exchange of assuming the risks.