Expense Allocation and Policyholder Persistency

Many insurers and rating bureaus use "expense flattening" procedures to allocate insurance expenses to policyholder classifications. High risk insureds with large expected pure premiums, do not necessarily cause higher "general and other acquisition" expenses. Flattening the expense loading reduces total premium for high loss cost policyholders, thereby enhancing equity and alleviating affordability problems. Such is the theory. In truth, many high risk policyholders have poor persistency. Insurance expenses are incurred primarily in issuing the policy, not in renewing it, particularly for direct writing carriers. Expenses incurred are a higher than average percentage of premium for many high-risk low-persistency insureds. Expense flattening has been used to reduce automobile insurance premiums for young male drivers - a high loss cost classification. The paper examines persistency rates for young male drivers versus other drivers, and calculates the actual expenses paid by the carrier in insuring these risks. The average expense incurred for insuring young male drivers is a larger percentage of premium than that incurred for insuring the average driver. Thus, both equity and competitive pressures lead to the same conclusion: many high risk insureds require a higher than average expense load. The true incidence of expenses exacerbates affordability problems for policyholders of the discerning insurer, and it erodes profitability for the "expense flattening" insurer.