Apply appropriate techniques to manage and maintain an organisation's profitability

Welcome to Managing Profitability!

You’ve done the hard work of designing a product and setting it live. But the work doesn't stop once the "Buy Now" button is active. In this chapter, we look at how to keep the business healthy and profitable over the long term. Think of this as the "maintenance" phase of a car—if you don't check the oil and tires regularly, things will eventually break down. In actuarial terms, we call this "Living with the Solution."

We will explore how to monitor what’s happening, identify where money is being lost, and take action to steer the ship back on course. Don't worry if this seems like a lot of moving parts; we’ll break it down into simple, manageable steps.

1. The Core Objective: Why Manage Profitability?

The goal is simple: to ensure the organization remains solvent (can pay its debts) and meets its profit targets. Even the best-designed products can fail if the environment changes or if our initial assumptions were slightly off.

Quick Review: The Profit Equation
At its simplest level, profit is:
\( \text{Profit} = \text{Income} - \text{Outgo} \pm \Delta\text{Reserves} \)
Where:
- Income = Premiums and Investment Income.
- Outgo = Claims, Expenses, and Taxes.
- \(\Delta\)Reserves = The change in the money we set aside for future payouts.

2. Monitoring Experience: The "Actual vs. Expected"

To manage profit, you first need to know what is actually happening. This is called Experience Monitoring. We compare what we thought would happen (our assumptions) with what actually happened.

Key Areas to Monitor:

• Mortality/Morbidity: Are people dying or getting sick faster than we expected?
• Lapses/Surrenders: Are customers leaving too early (meaning we can't recover our initial costs)?
• Expenses: Is our office rent or staff cost higher than we budgeted?
• Investment Return: Is the market performing as well as we hoped?

Analogy: Imagine you're training for a marathon. You expected to run 10km in 50 minutes. If you actually ran it in 60 minutes, you need to change your training plan. Monitoring experience is the "stopwatch" for an insurance company.

Key Takeaway:

Profitability management starts with data. If you don't measure the Actual vs. Expected (A/E), you are flying blind.

3. Levers for Managing Profitability

Once we identify a problem, we need to pull certain "levers" to fix it. We can group these into four main categories using the mnemonic P.I.C.E.

P - Pricing and Product Design

If the experience is worse than expected, we might need to:
- Increase premiums for new customers.
- Adjust renewal rates for existing customers (if the contract allows).
- Change benefits: Reduce the "bells and whistles" of the product to lower the cost.

I - Investment Strategy

The money we hold in reserves isn't just sitting in a vault; it's invested. To improve profit, we might:
- Review the Asset-Liability Matching (ALM): Ensure assets move in line with liabilities to reduce risk.
- Seek higher returns: Moving into slightly riskier assets if the capital position allows it.

C - Claims Management and Underwriting

This is about making sure we only pay the claims we are supposed to pay.
- Tighten Underwriting: Be more selective about who we sell to (e.g., asking more medical questions).
- Claims Controls: Investigate suspicious claims more thoroughly to prevent fraud.

E - Expense Control

Small savings in administration can lead to big increases in profit.
- Automation: Using technology to process claims or renewals more cheaply.
- Outsourcing: Moving certain functions to cheaper locations or specialist providers.

Common Mistake: Students often forget that changing one lever affects others. For example, if you increase premiums to boost profit, you might cause more lapses, which could actually hurt profit in the long run!

4. The Feedback Loop

This is a fundamental part of the Actuarial Control Cycle. Managing profitability is a continuous loop:

1. Monitor the results.
2. Analyze the deviations (why was the result different?).
3. Act by implementing a management action (like raising prices).
4. Repeat.

Did you know? In many long-term contracts, the company can't change the price for existing customers. In these cases, management must focus heavily on Expense Control and Investment Income because the "Premium" lever is locked!

5. Capital Management and Reinsurance

Sometimes, managing profitability isn't just about the "Profit & Loss" account; it's about how we use Capital.

• Reinsurance: By passing some risk to a reinsurer, we reduce the amount of capital we need to hold. This can improve the Return on Capital, even if we give away a slice of the profit.
• Dividend Policy: Deciding how much profit to give to shareholders vs. how much to keep in the business to fund future growth.

Key Takeaway:

Profitability isn't just about the dollar amount; it's about the Return on Capital (RoC). Management must ensure the capital is working as hard as possible.

6. Summary Checklist for Students

When you get an exam question about "how to manage profitability," walk through these points:

• Check the data: Perform an Actual vs. Expected analysis.
• Identify the "leak": Is it high claims, high expenses, or poor investment returns?
• Select an action: Use P.I.C.E. (Price, Investment, Claims, Expenses).
• Consider the impact: How will customers react? (e.g., will they leave?)
• Review Reinsurance: Can we share the risk to stabilize profits?

Don't worry if this seems tricky at first! The key is to remember that an actuary is like a pilot. You set the course (pricing), you watch the dials (monitoring), and you make small adjustments to the controls (management actions) to make sure you land safely at your profit destination.

Quick Review Box:
- Objective: Maintain solvency and meet profit targets.
- Tools: Monitoring, Pricing, Underwriting, Expense Control, Investment Management.
- Risk: Beware of "secondary effects" (e.g., raising prices leading to higher lapses).
- Cycle: It’s an ongoing process, not a one-time event!