Ratemaking (expense provision)

[DrNO811]

In the McClenahan paper, there is a point where they add together several expense percentages to get the expense provision. However, some of the percentages have a written basis while general expenses have an earned basis. Is there any logical reason why we are able to add these together when they don't have the same basis?

[jk]

Because of that old standby, "ratemaking is prospective". Suppose you're setting rates that will be in effect during calendar year 2006. The associated premium will be written during '06 and earned during '06 and '07. One way or another, you're going to incur all of the variable expenses on every policy you write; only the timing will vary. You need a rate that will cover them all. The distinction between whether the variable expense is a percent of written or earned premium is important only when you're using results from earlier periods to estimate the percentages. (It also has a very minor impact on investment income.)