First Year Expenses and Renewal Expenses

The expense equation for an insurance company consists of:
First Year Expense + Renewal Expenses

The First Year Expenses has the following constituents:

• Initial Costs: These normally include a Commission Payment and is usually related to Premium. Other categories include advertisement and miscellaneous marketing expenses.
• An x% of premium of the first year which is the premium related expenses like expenses involved in assessing the health and/or financial status of the policyholder
• A constant expense per policy of unit sum insured. These normally include stamp duty which is the cost of stamps to be affixed on the policy which is levied by the Government.
• A constant cost which is independent of premium and sum insured but can be calculated per policy. These include administrative expenses to handle all administrative costs for preparing the insurance contract document and rendering service to the policy holder to pay premium.

Renewal Expenses have the following constituents:

• A y% of premium receivable after the first year: These include commission payments if any, advertisement, reinsurance taxes and so on.
• A constant expense per policy of unit sum insured: These normally include expected litigation costs.
• A constant cost which is independent of premium and sum insured but can be calculated per policy.These normally include settlement of claims and expenses incurred for doubts posed by the policyholders,payment of salaries to the staff and employees of the insured.

To reiterate,

The value of expenses = First Year Expenses + Renewal Expenses

The value of expenses is discounted to the date of commencement of policy. It should be noted that expenses would not occur once the contract has ended. For this purpose, the probability that the expense would be incurred would be taken into account.

Value of expenses in mathematical terms is the discounted value calculated as follows:

(The amount of expenses/benefit * The probability that the expense/benefit is payable at that point of time)