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Gibson Insurance Company Case Solution
Rebecca Hampton, the capable controller of Gibson Insurance Company, finds herself facing a crucial task at the end of the year: to evaluate the company's financial resources and expenses and bring changes. The ultimate goal is to enhance pricing strategies and allocate resources more effectively such that profitability increases and expenses are minimized. Gibson Insurance is determined to gain clearer insights into profitability, pricing decisions, and compensation for their diligent sales agents. Recent troubling observations by the management team reveal a concerning trend: sales volume has been on the rise while the company's profitability has been declining. This situation raises suspicions that incorrect pricing and uncontrolled costs might be the reasons for this mishap. Therefore, Gibson Insurance must devise a fresh cost allocation method and approach that will enable them to make more informed financial choices and eliminate these problems for good. Rebecca Hampton, with her extensive experience, must find a solution to steer the company towards better financial decision-making and secure a bright future for the Gibson Insurance Company.
Following questions are answered in this case study solution:
-
Calculate the unit support cost per policy for new and in-force annuity and life insurance policies using the new allocation bases. In addition, calculate the total support costs to be reported by product for each legal business unit entity. Compare to the total support costs reported using the old allocation bases in Exhibit 2 and provide comments on the major differences.
-
Why would Hampton want to track that information by product (computed above in question 1) even if that level of detail was not required by regulators?
-
Is there room for improvement in the means by which the corporate support costs are allocated under Hampton’s new approach? Why, or why not?
-
Estimate the amount of “Customer Service” support costs allocated to the product called “Annuities-New Policies-Midwest” under the old system. Also, estimate the amount of “Customer Service” support costs allocated to same product under the new system. Comment on what is driving the difference.
Case Study Questions Answers
1. Calculate the unit support cost per policy for new and in-force annuity and life insurance policies using the new allocation bases. In addition, calculate the total support costs to be reported by product for each legal business unit entity. Compare the total support costs reported using the old allocation bases in Exhibit 2 and provide comments on the major differences.
New basis |
Aggregate support cost |
Total Units |
Cost per unit |
|
Policy Acquisition |
Steps |
$ 4,375,000 |
103,680 |
$ 42.20 |
Customer Service |
Calls |
$ 2,426,000 |
55,060 |
$ 44.06 |
Sales and Marketing |
No. of sales |
$ 4,552,000 |
454,400 |
$10.02 |
Corporate Overhead |
AUM |
$ 2,567,000 |
8,601,700,000 |
$ 0.0003 |
|
|
Annuities |
|
|
Life Insurance |
|
|
Support cost |
New basis |
New |
|
In-Force |
New |
|
In-Force |
Policy Acquisition |
Steps |
2 |
|
0 |
5 |
|
0 |
Customer Service |
Calls |
0.5 |
|
0.2 |
0.6 |
|
0.4 |
Sales and Marketing |
Contacts |
10 |
|
0 |
20 |
|
0 |
Corporate Overhead |
AUM |
$ 50,000 |
|
$ 50,000 |
$1,500 |
|
$ 65,000 |
|
Unit support cost per policy using new allocation bases |
|
|
|
|
||
|
|
|
Annuities |
|
Life Insurance |
||
Support cost |
New basis |
New |
|
In-Force |
New |
|
In-Force |
Policy Acquisition |
Steps |
$ 84.39 |
|
0 |
$ 210.99 |
|
$- |
Customer Service |
Calls |
$ 22.03 |
|
$ 8.81 |
$ 26.44 |
|
$ 17.62 |
Sales and Marketing |
Contacts |
$100.18 |
|
0 |
$ 200.35 |
|
$- |
Corporate Overhead |
AUM |
$14.92 |
|
$14.92 |
$ 0.45 |
|
$ 19.40 |
Unit support cost per policy |
|
$ 221.52 |
|
$ 23.73 |
$ 438.22 |
|
$ 37.02 |
Total Basis |
||||
Annuities |
|
Life Insurance |
||
New |
In-force |
New |
|
In-Force |
39,680 |
|
|
|
|
9,920 |
17,180 |
7,680 |
|
20,280 |
198,400 |
|
256,000 |
|
|
992,000,000 |
4,295,000,000 |
19,200,000 |
|
3,295,500,000 |
Midwest |
Gibson |
Compton |
Total |
|
Annuities: |
|
|
|
|
New Policies |
$ 2,216,300 |
$ 1,911,558.75 |
$ 269,280.45 |
$ 4,397,139.20 |
In-Force Policies |
$ 1,071,450 |
$ 861,922 |
$111,907 |
$ 2,045,279.00 |
Sub total |
$ 3,287,751 |
$ 2,773,480.75 |
$ 381,187.45 |
$ 6,442,419.20 |
Life Insurance: |
|
|
|
|
New Policies |
$ 547,862.50 |
$ 1,512,100.50 |
$ 3,550,149.00 |
$ 5,610,112.00 |
In-Force Policies |
$ 207,872 |
$ 501,120 |
$ 1,172,992.00 |
$ 1,881,984.00 |
Subtotal |
$ 755,734.50 |
$ 2,013,220.50 |
$ 4,723,141.00 |
$ 7,492,096.00 |
Total |
$ 4,043,485.50 |
$ 4,786,701.25 |
$5,104,328.45 |
$ 13,934,515.20 |
When the new policies for subsidiaries are analyzed for cost allocation, it is clear that the total costs have increased compared to the prior method, which allocated costs based on the number of policies. The adoption of a new total base system is responsible for this development. A significant amount of the overall basis is assigned to new policies in both annuities and life insurance under the new cost allocation scheme. This allocation plan attempts to guarantee that the expenses related to purchasing additional policies are sufficiently covered. As a result, new policies now account for a bigger share of overall expenditures, while existing policies bear a disproportionately smaller burden.
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