PROCEEDINGS May 15, 16, 17, 18, 2005 - Casualty Actuarial Society

684 INCORPORATION OF FIXED EXPENSESIn the example in Exhibit 1-A, the data are fairly stableand there are no extraordinary expenses; therefore, a three-yearstraight average is selected.Once the expense ratios are selected, they are divided intofixed and variable ratios. Ideally, the company has detailed expensedata and can do this directly or has activity-based coststudies that help split the expenses appropriately. In the absenceof any such data, the actuary should consult with other insuranceprofessionals within the company to arrive at the best possibleassumptions given the company’s allocation of expenses. In thisexample, the company assumes that 75% of the general expensesand other acquisition costs and 100% of the licenses and fees arefixed. All other expenses are assumed to be variable. Some sensitivitytesting was performed on these selections. For the exampleincluded, the difference in the indications between assuming thatthe aforementioned percentage of the general expenses, other acquisitioncosts, and licenses and fees were fixed and assumingthat 100% of those expenses were fixed is not material. The exactimpact will vary and depend on the magnitude of the expenseratios.The fixed expense ratio represents the fixed expenses for thehistorical time period divided by the premium written or earnedduring that same time period. Often, companies trend this ratioto account for expected growth in fixed expenses. Some companiesuse internal expense data to select an appropriate trend.Given the volatility of internal data, many companies use governmentindices (e.g., Consumer Price Index, Employment CostIndex, etc.) and knowledge of anticipated changes in internalcompany practices to estimate an appropriate trend. Exhibit 1-Bdisplays one such methodology. Basically, the indicated trend isa weighting of the Employment Cost Index and the ConsumerPrice Index. The weights are based on the percentage that salariesrepresent of the total expenditures for the two largest fixed expensecategories, other acquisition and general expenses. Theseweights can be determined directly from data contained in theIEE. The selected fixed expense ratio will be trended from the