1. 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

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

3. ``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

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

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

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

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

8. 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

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

10. 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]

11. 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

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

13. 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

14. 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

15. 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)

16. 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.

17. 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)

20. 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).

21. 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.

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

23. 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.

24. Group Expenses - Valuation
Questions?