Chapter 22

Question 1

Some examples of expenses (descending order of amount): -6

Answer 1

• Staff salaries, pension contributions, national insurance contributions
• Commission payments
• Office rent and related expenses
• Office equipment
• Investment costs
• Office consumable (e.g. stationery)

Question 2

Types of expenses:

Answer 2

1. Fixed expenses
   – remain relatively constant in the short term.
   - e.g. building maintenance
2. Variable expenses
   – vary by the amount of business being handled at the time
   - could be linked to (number of policies, number of claims, claim amounts, premium amount)
   * Some expenses fall into a third category where they are essentially fixed but can vary in large amounts from time to time e.g. senior management costs
3. Direct expenses
   – can be identified as belonging to a particular class of business
   - e.g. salaries of underwriters, claims handlers and administrators, product development costs
4. Indirect expenses/overheads
   – cannot be identified as belonging to a particular class or classes of business (IT, marketing, HR)
   -need an expense analysis to determine appropriate class of business

Question 3

• Expenses allocations take place for many different purposes including

Answer 3

• Pricing
• Provisioning
• analysis of surplus
• analysing inefficiencies within the organisation
• profitability investigations
• financial planning

Question 4

• Expenses need to be allocated by:

Answer 4

• Allocation to class of business
• Direct expenses are often allocated to class of business using staff timesheets (if direct expenses arise from areas dealing with more than one class of business )
• Indirect expenses (or overheads) can be allocated to class of business in several different ways and are hard to allocate.
• Other indirect expenses may be excluded until the end of the allocation and then allocated in proportion to all other expenses
• Allocation to function
• This function allocation helps to determine which expenses are charged to which contracts, e.g. regular premium vs single premiums or paid-up policies

Question 5

• The (non-commission) expenses can be split into:

Answer 5

• Initial expenses maintenance expenses, including:
  = renewal expenses
  = investment expenses
• Termination expenses

Question 6

• The expense loading could be expressed as a:

Answer 6

• Percentage of premium (e.g. commission) or sum assured (e.g. underwriting)
• Percentage of funds under management (e.g. investment expenses – deducted directly from investment return assumed)
• Fixed amount per contract (e.g. administration expenses – activities that are independent of the size of the contract)
• Fixed amount per claim (for claims that depend on death and survival of lives) or percentage of claim amount (e.g. termination or claim expenses – like general insurance as costs will be proportionate to the size of claim)
• Combination of these methods

Question 7

Adjustments to pricing expense loadings:

Answer 7

• Cross-subsidies
  General insurance – renewals subsidise new business - The assumption regarding the proportion of policies expected to renew will be crucial
  Life insurance – larger policies subsidise smaller policies where expense loadings are a percentage of premiums/sum-assured
• Past and future expense
  Initial allocation is based on past data, whereas the expense loading in the premium rates will need to reflect the levels of future expenses.
• Competition
  expense loadings in premiums may be adjusted to ensure marketability and competitiveness

Question 8

What is meant by the term ‘function’ in relation to expense allocation?

Answer 8

-function is the activity or operation
-function determines if the expense is a new business, maintenance or termination expense

Question 9

Expenses relating to benefit schemes differ from insurance companies expenses: (3)

Answer 9

-no commissions
-no fixed overheads, such as building maintenance
-admin, legal advice, actuarial advice may be charges on a fee basis or if done in-house, it will form part of the total overheads of the sponsor

Question 10

Reasons for carrying out an expense analysis/expense allocation: (7)

Answer 10

1. determine the expense loading for premium calculations
2. determine the expense loading for calculating provisions
3. understanding the profitability of a particular product
4. analysing sources of surplus i.e., deviations of actual from expected expenses.
5. Analysing areas of inefficiency within the organisation.
6. Financial planning (expense budgeting)
7. Cashflow management i.e., to ensure that liquid funds are available to pay the
   expenses.

Question 11

The process of allocating expenses to individual contracts:

Answer 11

1. All expenses of the organization must be identified and categorised as direct or indirect.
2. Direct expenses can be immediately allocated to a particular class of business.
3. Indirect expenses must be pragmatically apportioned between classes of business.

▪ Direct Expenses Allocation methods below

4. Not only must expenses be allocated to class but also to function within a particular business class:
   a) Securing new business.
   * Underwriting expense.
   * Commission expense.
   * Initial admin expense.
   b) Maintaining existing business.
   * Policy renewal administration.
   * Investment management expense.
   * Renewal admin expenses.
   c) terminating business.
   * Claims admin expenses.
5. The expenses also need to be categorised as variable or fixed expenses to determine the appropriate expense loading method.
6. Finally, an appropriate expense loading type must be determined,
   ▪ % of premium - commission.
   ▪ % of sum assured - underwriting expenses.
   ▪ % of funds under management - investment expenses.
   ▪ Fixed amount per contract - administration expenses.
   ▪ Fixed amount per claim - death benefit processing expenses.
   ▪ % of claim amount - general insurance claim administration expenses.
   ▪ A combination of the above.

▪ Indirect Expenses Allocation methods below

7. Using a ‘charging out’ basis.
   ▪ E.g., computer time and related staff costs could be charged to the direct function departments based on actual use.
8. By floor space taken up by a department.
   ▪ E.g., office premises costs.
9. 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.