Two policies cost the insurer $50 each to issue, but one carries a $1,000 premium and the other $4,000. The company still pays 15% commission on each. That split, flat dollars versus a slice of premium, is the whole game when you load an indication.
Every dollar of premium must cover losses, the cost of running the company, and a margin for profit. The running costs are the underwriting expenses, and they split into two behaviors.
Variable expenses move with premium. Write a bigger policy and they grow proportionally. The big ones are commissions paid to agents, premium taxes paid to the state, and licenses and fees. Because they are a percentage of premium, they belong in the denominator of the rate formula.
Fixed expenses do not move with premium size. Issuing a policy, underwriting it, and general overhead cost roughly the same on a $1,000 policy as on a $4,000 one. You express them as flat dollars per exposure (or per policy), and they belong in the numerator.
Common mistakes
- Putting fixed expenses in the denominator. Fixed costs are flat dollars, not a percentage. Loading $45 as a variable percentage instead of an above-the-line dollar amount distorts the grossing up.
- Adding the profit provision to losses. Profit belongs in the denominator as part of . Adding a 6% profit dollar amount to the numerator understates the required rate.
- Loading gross ceded premium as the reinsurance cost. The load is the net cost, ceded premium minus expected recoveries, not the full ceded premium.
Bottom line
- Variable expenses scale with premium (commissions, premium taxes, licenses and fees); fixed expenses are flat dollars per exposure or policy (general expenses, some acquisition costs).
- Derive the provisions three ways: an all-variable ratio, a premium-based split by percent assumed fixed, and an exposure-based fixed dollar per exposure.
- Pure premium method: Rate = (Pure Premium + Fixed Expense per exposure + Reinsurance load) ÷ (1 − Variable% − Profit and Contingency%).
- Fixed expenses and the reinsurance net cost go ABOVE the line as per-exposure dollars; variable expenses and the profit provision go BELOW the line as percentages of premium.
Exam shortcut
Sort every load before you compute. Percentages of premium go in the denominator (variable expense, profit and contingency); flat dollars go in the numerator (fixed expense, reinsurance net cost). Misplacing one is the most common trap. For any reinsurance number, net it first: ceded premium minus expected recoveries.
The full lesson (about 2,990 words, 20 min read) adds 5 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- A9
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