Expense analysis

Hi Kiran

Yes, what you've said is right.

Direct costs can be the costs of selling the business (initial expenses), eg underwriting costs, initial policy documentation. But they can also be maintenance expenses (renewal expenses), eg reserving, annual statement to policyholders, premium collection. Or they could be termination expenses, eg claims processing.

There are a variety of techniques to then allocate these expenses to cells, eg timesheets for salaries, floorspace for rent.

Best wishes

Mark

 

Hi Kiran

I would say that allocating overhead expenses is much harder than allocating direct expenses. Direct expenses are quite easy to allocate to the correct product as, by definition, they directly relate to the product. It's not clear what approach to use with overheads, and so we often end up using a simple pragmatic approach (although which approach is actually used will vary between insurers).

An example may help. Let's say an underwriter is paid 1000 in a time period, and has worked on term assurances (TA), endowment assurances (EA) and whole life (WL). This is a direct expense. In this case it is clear that the underwriter's salary should be allocated to initial expenses, but we need to split it by product. We could do this with timesheets. Let's say they have spent 30% of their time on TA, 20% of their time on EA and 50% on WL. Then we allocate their salaries as 300, 200 and 500 to TA, EA and WL respectively.

Similarly we can use floorspace. Let's say the rent is 500 and 10% of the building is used by underwriters. So we have an initial expenses of 50. We could split this by products in the same proportions as the salaries. So 15, 10 and 25 to TA, EA and WL respectively.

Unfortunately timesheets are less likely to be of use to us for overheads. Consider the salaries of canteen staff, human resources and security. They do not work directly with products and so their timesheets won't help us to allocate their costs to particular products. For these we might need to use a simple pro rata approach as you suggest, splitting their costs in the ratio 100:50.

I hope these examples help.

Best wishes

Mark

 

Hi Kiran

Yes, what you've written above looks right.

Chapter 30 at the bottom of page 15 says:

"Direct expenses are typically variable (ie they depend on either the volume of new business or the level of in-force business), but may be fixed to some extent.

For example, the amount of underwriting performed will depend on the number of applications that need to be underwritten, ie it is a variable cost. However, we wouldn’t expect to hire and fire underwriters on a daily basis depending on volumes, so underwriters’ salaries are a fixed expense at least in the short term."

So we'd say that underwriters' salaries are a fixed direct cost, while doctors' reports are variable direct. In contrast, the salaries of service departments are overheads.

Best wishes

Mark