Classification of Expenses on the Basis or Variation

There is three classification of expenses on the basis:

Classification of expenses

  1. Those expenses that vary with the size of the premium, for example, the first year or renewal commissions.
  2. Those expenses that vary with the amount of policy, for example, stamp fee, and medical examiner’s fee.
  3. Those expenses that tar independent of both, being either the same per policy or the expenses are incurred for the business as a whole, for example, salaries, and establishment charges.

These expenses would be equitably distributed only the relationship between the premium.

Loading    = A fixed percentage of net premium

+ A fixed amount per 1,000 of sum assured

+ A fixed amount per policy

The insurer will have to establish what expenses are varying at what degree with premium, policy or policy amount. Therefore, he has to analyses the expenses and to determine the percentage.

(i) Analysis of Expenses

All the expenses incurred during a particular period are classified into

  1. Tose expenses which are related to the premium,
  2. This expenses which are related to the policy, and
  3. Those expenses which are independent of these two.

(ii) Determination of percentage

After classifying the expenses it is essential to determine the percentage according to the premium or policy or with another factor. The percentage is determined on the basis of past, experience. If it has been known that Rs. 10,000 will be expended in connection with a premium of Rs. 10, 00,000, it can be established that the expenses varying with the premium will be 1 percent of the premium collected.

The similar percentage in relation to policy amount and to policy number can be easily established. Thus the net premium can be easily loaded with these percentage or fixed amount per policy.

The expenses should be allocated according to policies amount, premium amount and per policy although various methods have been derived for allocation of expenses.

Methods of loading

The expenses can be allocated by any of the following methods:

  1. Constant addition loadingUnder this method, a fixed amount per thousand of sum assured is loaded to the net premium. This method is not scientific because it assumes that all expenses vary according to the amount of the policy which is not correct. Some expenses vary according to variation in the rate of premium.
  1. Percentage addition loadingAccording to this method, a fixed percentage of net premiums are added to the net premium. It assumes that all expenses vary according to the premium amount. But there are certain expenses which vary according to the policy amount or per policy.
  1. Modified percentage methodUnder the method, the loading is divided into two parts: (i) expenses varying according to a net level premium of the given, policies and (ii) expenses varying according to net level premium, of the whole life policy issued at the given age. This method is the modification of the above two methods, but it does not relate the expenses according to their variations.
  1. Constant and percentage addition methodUnder this method, the loading is done under two parts (a) a constant amount per thousand of the sum assured and 9b) a fixed percentage related to the net premium of the policy. The percentages are determined on the basis of past experience. This method assumes that the expenses vary either with the net premium or the sum assured, but the expenses also vary with the amount per policy which not taken into account. However, this method is more scientific than the methods discussed above.

Distribution of expenses over the period of policy

There are certain expenses which are incurred in the inception of the policy, certain expenses incur every year of the policy and certain expenses incur only in the end of the policy. The allocation of expenses requires that equal amount should be distributed every year.

Therefore, firstly, the nature of expenses according to the occurrence and secondly, equal distribution of the expenses every year are to be done for equitable distribution of loading.

  1. Classification of expenses

The expenses of the above purpose are distributed into four categories:

  • The initial Expenses. The initial expenses are those expenses which incurred at first before or at the time of issuing the policy. The expenses, for example, may be medical examiner’s fees, inspection of a risk of agents’ commission, expenses involved for the preparation of the policy and correspondence expenses and so on.
  • The Recurring Expenses. The recurring expenses are those expenses which are incurred every year for the policy. Some of them may be limited only up to the period of premium collection. The expenses may be expenses for issued of premium notices, premium receipts, keeping accounts and cost of correspondence, etc.
  • The final Expenses. The final expense is incurred at the time of payment of claims or of surrender values. They are expenses are accounting expenses actuarial and legal expenses, maintenance and establishment charges. They are not related to particular policy or point of time.

The recurring and final expenses, normally, vary with the policy amounts, premium amount or per policy. But the general expenses Amy does not vary in the above manner.

Equal Distribution of the Expenses

All the above expenses should be equally distributed over the policy year. The main problem of distributions of initial expense is that a heavy expense is involved in the beginning of the policy but it has to be distributed over the life of the policy, i.e., over the period o f premium payment.

Dr. Sprague’s Formula for loading

Dr. Sprague’s formula can be discussed as below:

  • A single percentage of sums discussed to cover the initial expenses.
  • A percentage of net premiums to cover recurring renewal expenses.
  • A fixed amount to cover general office expenses.

The initial expenses are equally spread over the period of premium payment by dividing it by the present value of Annuity due, of RE. 1.0 Over the given period.

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2 comments for “Classification of Expenses on the Basis or Variation

  1. Hunter
    February 2, 2017 at 11:39 AM

    This kind of article is rare on the internet whatever finally I got it and you explain classification of expenses on the basis nicely

    • rasel
      February 7, 2017 at 7:12 AM

      Thanks Hunter for your evaluation

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