Per policy expense

Discussion in 'SP1' started by Himanshu Sikri, Nov 1, 2020.

  1. Himanshu Sikri

    Himanshu Sikri Keen member

    As per my understanding, per policy expense are not really fixed for each policy and it does vary by the size of the policy. Secondly, usually fixed expenses are allocated using as per policy method, is this correct?

    Problem with this is, large policies are subsidizing for the small policy which will make the large policy poor value for money and probably will make them uncompetitive.
    We have 3 different method to deal with this problem:
    1. Individual calculation of premium rates
    2. Policy fee addition to the premium
    3. Sum insured differential
    Under first two method we still have the problem that small policy will become uncompetitive, so company would reduce the expense charge for the small policies to make them more marketable.
    Then how does it solves the problem of cross subsidy?

    Sum insured differential, I am not sure if I understand this method completely.
    Broadly it is a per policy expense allocation as per the average policy size, where we are calculating average policy size as per the different bands instead of using single average benefit size in a normal scenario. Is his correct?
     
    Himanshu Sikri, Nov 1, 2020
    #1
  2. Mark Willder

    Mark Willder ActEd Tutor Staff Member

    Hi Himanshu

    Just so others can follow this discussion, your references above are taken from Chapter 15 pages 10 to 12.

    Some expenses really are fixed per policy, eg postage costs. But you're right that a lot of expenses that we take as being fixed per policy for reasons of simplicity, probably do vary by contract size in reality.

    Yes, we often take fixed expenses and charge them to policies as a per policy cost.

    On page 10 we begin by considering a premium rate that is £x per £1,000 benefit. The text suggests that we derive this using the average sum assured. So the expense loading will be correct for the average policy. But large policies will effectively be paying more towards per policy expenses, and hence large policies cross-subsidise small ones.

    Then on page 11, the Core Reading suggests calculating the premium using methods 1. and 2. Here, you're right that small policies become uncompetitive because they carry the full cost of the per policy expenses. So the company may reduce the expense charge for competitive reasons - you're right this introduces a cross-subsidy from large to small. I'm afraid there is no solution that leads to both a competitive premium, but the absence of cross subsidy. So it is up to the company to make a commercial decision as to what is more important.

    Yes, you're right about method 3. It is the same as the method we begin with on page 10, except we use the average benefit in each band to calculate the premium rate.

    Best wishes

    Mark
     
    Mark Willder, Nov 9, 2020
    #2

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