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

INCORPORATION OF FIXED EXPENSES 689average expense amounts are trended from the average date theywere incurred in the historical period to the average date expenseswill be incurred in the period the rates will be in effect. 10Once the projected expenses per exposures are determined, theactuary then must select an appropriate figure.As with the current procedure, the selection will generallybe based on either the latest year or a multiyear average. Consistentvalues for the projected average expense per exposureimply that expenses are increasing or decreasing proportionatelyto exposures. This makes intuitive sense for many expense categories(e.g., full-time employee costs), but may not be accuratefor all fixed expenses because of economies of scale. If the companyis growing and the projected average expense per exposureis declining steadily each year, the selected expense trend maybe too high or expenses may not be increasing as quickly asexposures because of economies of scale. If the decline is significantand the actuary believes it is because of economies ofscale, then the selection should be adjusted to include the impactof economies of scale corresponding to expected growth inthe book. 11 As mentioned earlier, nonrecurring expense items,one-time changes in expense levels, or anticipated changes inexpenses should be considered in making the selection. In theexample shown the figures are stable and the three-year averageis selected to facilitate comparisons with the results of the currentprocedure.Exhibit 2-A, Sheets 1—4 show the calculations for each of themajor expense categories. The following chart summarizes the10 In the example, the same trend period is used for all expense categories to maintainconsistency with the current procedure. See Appendix A for more discussion on thisissue.11 If the selected expense trend is based on historical internal expense data (e.g., historicalchanges in average expense per exposure) rather than external indices, then the trendwould implicitly include the impact of economies of scale in the past. Assuming theimpact of economies of scale will be the same as in the past, the projected averageexpense per exposure should be consistent and no further adjustment would be necessary.