- TIA EXAM 5 - WERNER CH 07

• Expenses assumed to be the same for each risk, regardless of amount of premium
• E.g., overhead costs associated with the home office

• Expenses vary directly with premium (i.e., constant percentage of premium)
• E.g., premium taxes and commissions

• 1. All Variable Expense Method
• 2. Premium-based Projection Method
• 3. Exposure/Policy-based Projection Method

• Does not differentiate between fixed and variable
• Expenses assumed to be a constant percentage of premium

• Use written if believe expense generally incurred at onset of policy
• Use earned if believe expense generally incurred throughout the policy

• Based on latest year or multi-year average
• Also use management input, prior expense loads, and judgment
• Expense load should reflect expectations in the future

• Examine the materiality and nature of the expense to determine how/if should be incorporated
• May choose to spread out over several years or not include at all

• Assumes all expenses vary directly with premium
• However, portion may be fixed

• Understates premium need for small premium risks
• Overstates premium for large premium risks

• Premium discount to reduce expense loadings for larger premium polices
• Expense constants to handle expenses such as policy issuance and auditing

Similarity: Premium-Based assumes expense ratios during projection period will be same as historical

Enhanced: Prem-Based calculates fixed and variable expense ratios separately

1. Determine percentage of premium attributable to expenses for each of the expense categories

• 2. Divide ratio into fixed and variable ratios:
• Ideally split based on detailed company data;
• Without needed data, make reasonable assumptions

3. Sum expense ratios across categories to determine fixed and variable provisions

Note: this gives you the fixed expense ratio, which is a ratio to premium - this is used with the loss ratio approach (Ch. 8)

If using the pure premium approach, convert to fixed expense per exposure: Fixed per Exposure = Fixed Expense Ratio * Projected Average Premium

1. Rate changes can impact the historical expense ratios and lead to an excessive or inadequate overall rate indication

2. Significant premium trend between the historical experience period and the projected period can lead to an excessive or inadequate overall rate indication

3. Can create inequitable rates for regional or nationwide carriers because it uses countrywide expense ratios and applies them to state projected premiums to determine the expected fixed expenses

• 1. Divide expenses into fixed and variable amounts
• 2. Divide fixed expenses by corresponding exposures (written/earned, countrywide/state)
• 3. Divide variable expenses by corresponding premium

Note: this gives you the fixed expense per exposure - this is used with the pure premium approach

• Similar expense ratios over several years implies expenses and exposures are increasing or decreasing proportionately
• Must consider impact of economies of scale given expected growth

• 1. The actuary splits expenses into fixed and variable
• 2. Allocates countrywide fixed expenses to each state based on exposures
• 3. Some expenses considered fixed vary by other characteristics
• 4. Existence of economies of scale in a changing book

• Variable Expenses
• No trend needed
• Constant % of premium

• Premium-based Projection Method
• If average expenses and average premium changing at same rate: Need no trending
• If assume average fixed expenses changing at different rate than average premium: Trend fixed expense ratio

• Exposure-based Projection Method
• If inflation sensitive exposure base used: No trending necessary if assume expenses & exposure base changing at same rate
• If non-inflation sensitive base or policy counts: Trending necessary b/c ave FE expected to change over time

Reduce projected losses for reinsurance recoveries and premiums for cost of reinsurance

Net cost of non-proportional reinsurance may be included as an expense item: i.e., cost of reinsurance minus expected recoveries

Investment Income + UW Profit

• Investment income on capital
• Capital belongs to owners of the company
• Substantial disagreement whether this investment income should be included in ratemaking

• Investment income earned on policyholder-supplied funds
• Two types - unearned premium reserves and loss reserves
• Longer the tail of the line, the longer opportunity for investment

Sum of profits generated from insurance policies

• VPLR = 1.0 - Variable Expense % - Target Profit % = 1.0- V - Q
• Portion of each dollar of premium to be spent on Projected Loss, LAE & Fixed Expense

• PLR = 1.0 - Total Expense % - Target Profit % = 1.0 - F -V - Q
• Portion of each dollar of premium to be spent on Projected Loss & LAE
• If all expenses treated as variable, VPLR = PLR