per policy expenses

Hi,

Why does the per policy expenses assumptions always relate to the average benefit size assumed for a particular policy?

Why if the average size turn out to be smaller than assumed, it will not cover the per policy expenses? Do you have any specific numerical examples to illustrate this?

Also, is "per policy expenses" same as "fixed expenses"?

and "% SA expenses" & " % Premium expenses" are categorised as "variable expenses" ?

thanks lot for help....





i know it is a stupid question

 

Hi,

Generally, the fixed expenses are charged as 'per policy'.I will put forward my thoughts by the following simple example. Comments from other people are welcome–

Let us say you own a company and planning to launch a product X. If the total fixed expenses say the cost of the product launch is £10,000.
An Actuary will have made some assumptions about future policies to be sold. Suppose The total number of policies expected to be sold is 100 and all are of 10 years long. So the contribution of each policy to the fixed expenses is £10 per policy per year (=10,000/10/100).This £10 per year may not be chargeable as £ 10 per policy because some policies may be very small and £10 is even higher than their annual premium (just an assumption). It will be difficult to charge a very high expense relative to the premium size.

So what the company will do is that it will arrive at an expected Average premium size(which is related to the policy size or benefit size) based on these 100 policies. Let us say the average premium comes out to be £200 pa per policy. The company will load £10/£200 = 5% on premium for every policy as each policy’s contribution to fixed expenses..

Now
- if a policy sold is of bigger size and the premium is £500 pa (more than average), the contribution to expenses is 5%*500 = 25 which is higher than the £10, so the company benefits.
- If a policy is of small size and the premium is £150 (less than average), the contribution to fixed expenses is 5%*150 = 7.5 which is less than £10, so the company loses.

This is how the large policies subsidises the small policies. As a result of this cross subsidies the company is exposed to some significant risks-

- Low volume = e.g. less than 100 policies sold so less contribution to expenses (assuming all sold are of average size)
- Selling more of small policies than larger policies out of 100
- Selling the policies of term shorter than 10 yrs (assuming policies of average size) so the policies contributes for less number of years.

Note that it is just a simple illusrtration and a lot of complexities can be built in. Also note that it is not a stupid question at all ..

 

Great example!!

 

Thanks lot to Curious_actuary!! Your efforts in explaining the questions ... appreciate it!

Guess what, you are the brilliant Actuary!!

Who says Actuary not good in communicating?! At least you're not one of them

 

Thanks for those kind words....All the best for your studies.