Get complete information on the 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 expense according to 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 for the above purpose are distributed into four categories:

(a) 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 risk of agents’ commission, expenses involved for preparation of the policy and correspondence expenses and so on.

(b) 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 issue of premium notices, premium receipts, keeping accounts and payment of renewal commissions to agents.

(c) The Final Expenses:

The final expenses are incurred at the time of payment of claims or of surrender values. They are expenses for approving the claims, cost of paying surrender values and cost of correspondence, etc.

(d) The General Expenses:

These expenses are fixed and incurred for the business as a whole. The important general expenses are accounting expenses actuarial and legal expenses, maintenance and establishment charges. They are not related to a 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 may 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 expenses 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 of premium payment.

Dr. Sprague’s Formula for Loading :

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

(a) A single percentage of sums discussed to cover the initial expenses.

(b) A percentage of net premiums to cover recurring renewal expenses.

(c) 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.