Chapter 22: Expenses

Question 1

What are examples of expenses for most financial services providers?

Answer 1

1. Staff salaries
2. Pensions contributions
3. National Insurance contributions
4. Commission payments
5. Office rent and related expenses
6. Office equipments
7. Investment costs
8. Office consumables

Question 2

How can the expenses incurred by an organisation be divided into?

Answer 2

1. Fixed and variable expenses
2. Direct and indirect expenses

Question 3

Give examples of expenses that are essentially fixed but can vary in large amounts from time to time

Answer 3

Staff related costs and accommodation costs can vary in the long term to meet changes in:
1. The structure of the organisation
2. New and existing business levels
3. The services provided
4. The degree of automation used

Question 4

How do the expenses relating to a benefit scheme differ from insurance company expenses?

Answer 4

1. No commission
2. No fixed overheads such as buildings maintenance
3. Administration, legal advice, actuarial advice or investment management may be charged for on a fee basis or, if done “in-house”, will form part of the sponsor’s total overheads

Question 5

Explain briefly the process of allocating expenses to individual contracts

Answer 5

All expenses of the organisation must be identified and categorised as direct / indirect

Direct expenses can be immediately allocated to a particular class of business.

Indirect expenses must be pragmatically apportioned between classes of business

Not only must expenses be allocated to class but also to function, i.e. securing new business, maintaining existing business and terminating business.

Finally, an appropriate loading type must be determined, e.g. a fixed amount per contract / claim, a percentage of premium / sum assured / funds under management or a combination of these approaches.

Question 6

List 3 allocation methods that could be used for indirect expenses and give an example of a cost that could be allocated by each method

Answer 6

1. 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.
2. By floor space taken up by a department, e.g. premises costs
3. 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

Question 7

What is meant by the term “function” in relation to expense allocation?

Answer 7

The function determines whether the cost is a new business expense, a maintenance (renewal administration or investment) expense, or a termination (or claim) expense.

This division may then be fruther subdivided.

For example, new business costs may be split into:
* marketing
* sales and commission
* administration
* underwriting

Question 8

Different ways of loading premiums for expenses

Answer 8

1. Fixed amount per contract - administration expenses
2. % of premium - commission
3. % of SA - underwriting expenses
4. % of funds under management - investment expenses
5. Fixed amount per claim - death benefit processing expenses
6. % of claim amount - general insurance claims administration expense
7. A combination of the above

Question 9

Fixed expenses

Answer 9

Remain broadly fixed in real terms.

These expenses vary in the long term, so it is usually more beneficial to look at these expenses in the short term.

Question 10

Variable expenses

Answer 10

Vary directly according to the level of business being handled at that time and are linked to the number of policies or claims or the amounts of premiums or claims

Question 11

Direct expenses

Answer 11

Can be identified as belonging to a particular class of business

Question 12

Indirect expenses

Answer 12

Do not have a direct relationship to any one class and needs to be apportioned between the appropriate classes in performing an analysis.

Question 13

Expenses need to be allocated by…

Answer 13

1. Class of business
2. Function

Question 14

Non-commission expenses can be split into…

Answer 14

1. Initial expenses
2. Maintenance expenses, including renewal & investment expenses
3. Termination expenses

Question 15

Reasons for which expenses might be allocated by “function”

Answer 15

In order for them to be loaded onto premiums.

This will mean that each policy contributes an appropriate amount to the total level of expenses

Question 16

3 functions of costs (by which they’re divided)

Answer 16

1. Securing new business
2. Maintaining existing business (renewal and investment)
3. Terminating business (including claims)