Incorporation of Fixed Expenses

When setting rates, actuaries must include all of the costs of doing business, including underwriting expenses. Actuaries generally divide the underwriting expenses into two groups: fixed and variable. This paper addresses the incorporation of fixed expenses in the calculation of the actuarial indication. More specifically, the paper describes how the generally accepted method for including fixed expenses overstates or understates the actuarial indication. The materiality of the distortion depends on the magnitude of past rate changes, premium trend, and variations in average premiums for multi-state companies. For the example included, the generally accepted procedure overstated the indication by +1.8 percentage points. Finally, the paper suggests an alternative procedure that addresses the distortions.