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Old 04-29-2016, 11:01 AM
Fi_L Fi_L is offline
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Default Why are fixed expenses in the numerator of the indicated rates formula?

I understand that it has been proven mathematically from the fundamental insurance equation.... But why are fixed expenses in the numerator? Because it is set in stone? But isn't the formula also "loading" fixed expenses with profit and variable expenses? But yet the indicated rate change would be lower if F is in the numerator instead of the denominator.

What am I missing here?
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Old 04-29-2016, 11:09 AM
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the derivation of the formula
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Old 04-29-2016, 11:17 AM
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Vorian Atreides Vorian Atreides is offline
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Better question to ask is why are the provisions that are in the denominator in there to begin with?

Don't be confused with the ability to express fixed expenses as a "percent of premium" . . . the question you should ask is: "How does this cost (in dollars) relate to the premium charged? If the premiums charged change, should this value (in dollars) also change?"
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Old 04-29-2016, 01:56 PM
Howard Mahler Howard Mahler is offline
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We can just add fixed expenses to loss and LAE; mathematically fixed expenses act the same.
Assume we need $300 for loss and LAE and $50 for fixed expenses.
Then ignoring variable expense and profit we need $350 in premium.

Assume variable expenses and profit were 20% of premium.
Then 350/0.8 = 437.5.

If we charge $437.5 in premium, then we have (0.2)(437.5)= 87.5 to cover variable expense and profit.
There is $350 left to pay for loss, lae, and fixed expenses.

Quote:
Originally Posted by Fi_L View Post
I understand that it has been proven mathematically from the fundamental insurance equation.... But why are fixed expenses in the numerator? Because it is set in stone? But isn't the formula also "loading" fixed expenses with profit and variable expenses? But yet the indicated rate change would be lower if F is in the numerator instead of the denominator.

What am I missing here?
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Old 04-30-2016, 01:23 AM
Fi_L Fi_L is offline
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Ah... right. Thanks guys, esp to Mr. Mahler. Your numerical example is short, precise and illustrative. I can now see how the set in stone concept come into play. A fixed expense acts differently from a component varying with premium. So if it is recognised in the denominator component like the All-Variable approach, you are then essentially loading up losses (i.e $300) for fixed expenses as well, which shouldn't vary with the size of the policy. As mentioned by Vorian, fixed expenses in %-form in the numerator caused a bit of confusion.

THANKS AGAIN GUYS!

Last edited by Fi_L; 04-30-2016 at 01:26 AM..
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Old 04-30-2016, 02:08 PM
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Old 04-06-2020, 03:31 PM
ykpyoung ykpyoung is offline
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Quote:
Originally Posted by Vorian Atreides View Post
Better question to ask is why are the provisions that are in the denominator in there to begin with?

Don't be confused with the ability to express fixed expenses as a "percent of premium" . . . the question you should ask is: "How does this cost (in dollars) relate to the premium charged? If the premiums charged change, should this value (in dollars) also change?"
Could you elaborate more on "the ability to express fixed expenses as a "percent of premium"" and the logic behind expressing fixed expenses as a percent of premium? Thank you.
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