Disadvantage of the Exposure based expense method
Hi Graham,
Can you please give examples of the 2 bullet points below stating the disadvantage of the exposure based expense method?
- some expenses treated as fixed are actually variable by certain characteristics (Ex: by new versus renewal business)
- economies of scale may reduce fixed expenses but this is not captured in the method
Thank you in advance!
Comments
An example for the first bullet point could be the item in parentheses above: Both new and renewal policies count as 1 exposure. That means an exposure-based method could produce the same expense dollars for both new and renewal policies but new policies are generally more expensive than renewals. A premium-based method may perform better because premiums for new business tend to be higher and so would capture (at least partially) the higher expenses.
For economies of scale: A fixed expense could be rent on the building and if average premium were increasing, the fixed expense ratio would go down in a premium-based method but would not change in an exposure-based method.