expense assumptions

To set a fair price an insurer has to guess, before a single policy is sold, how much it will cost to run that policy over decades — the commission to the agent, the cost of underwriting and issuing it, the yearly cost of sending statements and collecting premiums, the cost of paying a claim, and a share of overhead like rent and IT. Expense assumptions are that careful set of guesses: the company's best estimate of every running cost attached to a policy, used to turn the net premium into a gross premium.

Precisely, actuaries classify expenses by how they behave so the loading attaches to the right driver. Per-policy expenses are a fixed dollar amount per contract (e.g., $35 a year to administer it) regardless of size. Per-premium (or percent-of-premium) expenses scale with the premium, like a 50%-of-first-year-premium commission. Per-unit (per-$1,000 of benefit) expenses scale with the size of cover. And expenses split by timing into one-time acquisition costs at issue versus recurring renewal/maintenance costs. The actuary derives these from the company's own expense studies — total costs divided across the relevant exposure — and often loads on a margin for adverse experience.

Expense assumptions matter enormously because they are large, uncertain, and partly within management's control. Set them too low and the product is underpriced and loses money; too high and it is uncompetitive. They also feed reserving, profit testing, and the recovery of deferred acquisition costs. A subtle trap: a small policy carries the same fixed per-policy costs as a large one, so flat-dollar expenses hit small policies proportionally much harder — which is why minimum premiums and policy-fee charges exist.