2007 General Meeting Assemblée générale 2007 Montréal, Québec Canadian Institute of Actuaries L’Institut canadien des actuaires 2007 General Meeting Assemblée générale 2007 Montréal, Québec IP-18 Group Expenses Ken Fraser

Expense Analysis (As Extreme Activity) Ken Fraser Nov 29, 2007

``Before I draw nearer to that stone to which you point,'' said Scrooge, ``answer me one question. Are these the shadows of the things that Will be, or are they shadows of things that May be, only?'' Charles Dickens, A Christmas Carol

Expense Analysis by Charles Dickens Ghost of Expenses Past Ghost of Expenses Present Ghost of Expenses Future

The Three Ghosts of Expense Analysis Past = Financial Reporting Legal and Statutory Management information Present = Pricing Future = Valuation

The Three Ghosts of Expense Analysis Past = Financial Reporting Legal and Statutory Management information Present = Pricing Future = Valuation

Challenges in Expense Analysis Data density 30 to150 cost centres 50 to 200 accounts

Challenges in Expense Analysis Data Organization (lack thereof) Too much or too little aggregation Inappropriate classification Accounts follow org chart not business model External fees

Challenges in Expense Analysis Root canal syndrome Operating managers and front line staff are often reluctant and unenthusiastic participants

Expense 101 Define Expense Buckets Get Expenses by Cost Centre Get Time splits for each cost centre Questionnaires Interview supervisors, staff Cross multiply time splits by cost centres [for unit costs, divide by activity counts]

Extreme Demands → New approach The Objective Real time tracking of expense gaps by client segment Requirements Available within days of quarter end Consistent with expense accounting for major clients Reconcilable to external benchmarking studies

Extreme Demands → New approach Background 9 client segments creditors Employers of various sizes Some segments with one client 150 cost centres

Extreme Demands → New approach Objective = segment the Group business unit income statement by Client Segment Premiums/ASO fees Investment Income Claims Commissions Taxes Operating Expenses

Expense Allocation Model Excel based (no Visual Basic) Download accounting data Restructure raw data (e.g. reinsurance allowances) Pseudo cost centres created to clean accounting data Substitute String Library for time studies

Pseudo Cost Centres Cost centres with low proportion of salary expense were flagged. Pseudo cost centres created to house unrelated expense items (e.g. external provider fees)

String Library Concept Rather than define custom allocation factors for each cost centre (typically through time studies) Create a limited set of standard allocation strings (the Library). Select the most appropriate string (or set of strings) for each cost centre.

String Library Most based on objective activity data such as claims, certs, phone calls, bills, etc. A few based on management mandates such as sales salaries, advertising, etc. Library consisted of 60 strings (20 fundamental metrics plus variants)

Updating the Library Strings are updated on various frequencies. Quantitative based metrics are updated quarterly. Management mandates are reviewed annually. A few elements based on special studies are updated less frequently (grading factors used to allocate underwriting activity by case size).

Advantages Highly responsive to changes in business activity. Allocations within a period are linked to activity within the period. Legitimacy within the organization is high since allocation strings are logically related to each department. Model can be run and updated with modest staff resources.

Disadvantages Initial construction somewhat more complex than traditional approach. Needs conscientious maintenance. More activity data is required. Reconciliation demands are higher.

Lessons Learned A highly quantitative, mechanistic system can achieve similar levels of sophistication as traditional interview based methods. In addition, such a system can dynamically adapt to changes in business volumes and activity mix.

Group Expenses - Valuation Questions?