Ch 22: Expenses

Question 1

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

Answer 1

Staff related costs and accommodation costs can vary in the long term to meet changes in:

1. The structure of the organization
2. New and existing business levels
3. The services provided
4. The degree of automation used

Question 2

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

Answer 2

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 3

Explain briefly the process of allocating expenses to individual contracts

Answer 3

All expenses of the organization must be identified and categorized 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 4

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 4

1. Using a ‘charging out’ basis, e.g. computer rime 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 5

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

Answer 5

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 further subdivided.

For example, new business costs may be split into:

• marketing
• sales and commission
• administration
• underwriting

Question 6

Different ways of loading premiums for expenses

Answer 6

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 7

Fixed expenses

Answer 7

Remain broadly fixed in real terms

Question 8

Variable expenses

Answer 8

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 9

Direct expenses

Answer 9

Can be identified as belonging to a particular class of business

Question 10

Indirect expeses

Answer 10

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

Question 11

Expenses need to be allocated by (2)

Answer 11

• class of business

- function

Question 12

Non-commission expenses can be split into (3)

Answer 12

• initial expenses
• maintenance expenses, including renewal & investment expenses
• termination expenses

Question 13

Reason for which expenses might be allocated by “function”

Answer 13

In order for them to be loaded onto premiums.

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

Question 14

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

Answer 14

• securing new business
• maintaining existing business (renewal and investment)
• terminating business (including claims)

Question 15

In the longer term, staff costs will vary due to (3)

Answer 15

• changing levels of new business
• changes in services provided
• the degree of automation used to provide those services

Question 16

For what purposes do expenses need to be allocated?

Answer 16

• Determining the expense loading for premiums
• determining the expense loading for calculating provisions
• understanding the profitability of a particular product
• analysing sources of surplus
• analysing areas of inefficiency within the organisation
• financial planning
• cashflow management