Expense Allocation

Question 1

Expense allocation

Answer 1

▪ The process of identifying , accumulating and assessing costs to cost objects
▪ Expenses need to be allocated between :
▪ Classes of business : May look at term assurance, endowment
▪ Functions : this looks at the activity ( timing of expense)
▪ Such type of allocation allows for premiums to be loaded

Question 2

Purposes of expense allocation and analyses

Answer 2

▪ Determine the expense loading to be used in premium calculations
▪ Determine the expense loading for provisions calculations
▪ Understanding and determining the profitability of a particular product
▪ Used in the inefficiency analysis
▪ Used on expense budgeting
▪ Cashflow management and
▪ determining the level of liquid assets available to pay the expenses

Question 3

Allocation by class of business: Direct expenses

Answer 3

• Direct expenses
  ▪ Related to the particular class of business
  ▪ Direct expenses from departments dealing purely with one class of business and
  these can be immediately allocated to the relevant class
  ▪ If direct expenses arise from dealing with more than one class of business, then
  timesheets may be kept to help split costs between the classes
  Staff timesheets contain information based on time recorded as being spent
  underwriting each of them
  ▪ Example : staff in underwriting department may deal with several classes of
  business , costs may be allocated by looking at time spent underwriting each class
  of business

Question 4

Indirect expenses

Answer 4

• These are difficult to allocate ( not allocated to a particular class of business )
• The departments concerned are not related directly to any particular class
• But form part of the support structure of the provider
• We need to allocate these expenses by class of business
  (i) (ii) Allocate the expenses per department ( business activities) – as first time
  The allocate expenses based on when they were incurred ( by function)
  Example : computer usage
• Some computer usage may be readily identifiable as belonging to one product line
  and one function
• Example : valuations runs ( renewal expense ) while quotation calculations is an
  initial expense
• Can be allocated to the relevant class of business
• However, company’s mail system expense is not identifiable as belonging to a
  department / product
• There could be department allocation ( proportion to other known computer costs )
  or proportion to staff number
• They could then be allocated to the to class of business in the same proportion as
  the salary allocations of employees in each department – timesheet analysis

Question 5

Allocation by function

Answer 5

• Expenses need to be allocated by function so that these can be allowed for in
  determining product pricing or reserves calculation
• Functional analysis determine which expenses are allocated to which contracts (
  costs of regular premium collection cannot be charged to single or paid up policies )
• Timing is divided into:
  ▪ Securing new business (initial) : sales and marketing, commission ,
  underwriting and policy issuing
  ▪ Maintaining existing business ( renewal or regular)
  ▪ Termination of business

Question 6

Appropriate expense loading:

Answer 6

• Expense loading are required to ensure that adequate premiums and reserves are
  set up to not only cover the claims, but also cover the expenses related to the
  products
• Expense loading can be expressed as :
  o Percentage of premium ( commission costs)
  o Percentage of sum assured ( underwriting costs – high sums need a
  lot of detail)
  o Percentage of funds under management ( investment expense –
  management charges )
  o Fixed amount per contract ( administration- premium collection)
  o Fixed amount per claim (claims expenses treatment differs- life
  insurer)
  o Percentage of claim amount (case of general insurance , large claim
  amounts require a lot of assessments and law costs)
  o Combination of these methods

Question 7

Reasons for adjustments of expense loading

Answer 7

• To reflect cross subsidies
  o Example of when the renewal and new business are charged the same
  premium and therefore same expense loading even though renewal
  business is cheaper to administer ( less underwriting and etc )
  o Large policies may also subsidise small policies
• For past and future expenses ( especially inflation )
  o Inflationary adjustments : historic ( to bring the expenses to up-to-date )
  and prospective (to the time when expenses are expected to be incurred )
• Competition and marketability considerations

Question 8

Ways in which indirect expenses may be allocated to class of business

Answer 8

• Premises costs can be allocated by floor space occupied by staff
• Computing costs can be allocated by using ‘ charge out’ basis
• Others may be excluded until end of the allocation and then allocated in proportion
  to all other costs

Question 9

Ways in which indirect expenses may be allocated to function

Answer 9

• Can be split into :
  o Initial expenses
  o Maintenance expense
  o Termination expenses
• Helps determine which expenses are charged to which contracts ( regular premium
  vs single premium vs paid up policy )