Synopsis Gibson Company is an insurance company that mainly sells annuities and life insurance. Gibson possesses two subsidiary companies, Midwest and Compton, which also sell the same products but with different prices and features. Both subsidiaries rely on Gibson provides administrative supports for maintaining. Gibson used to use an objective measure to calculate each policy as the support costs allocation basis. The original method did not reflect the real cost by support activities.
Moreover, when the sales volume had increased, the profitability declined. The managers are considered the prices are set improper or costs are out of control. Management is looking for a better solution for solving pricing and support costs allocation. Therefore, the controller of Gibson, Rebecca Hampton, is asked to investigate these issues and has to figure out a better strategy for improving cost allocations. However, Hampton is an experienced controller and contributes her professional to set a new costs allocation method more precisely.
She classifies numerous cost accounts as 4 categories and listed costs details for new allocation bases. Required 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. Step 1. Calculate Total Activities and Cost by Activity. A. From Exhibit 3 Data Summary for New Allocation Bases, Hampton provides each support activity details.
As referring to the provided policy units for the company from Exhibit 1 Number of Policies by Type and Business Unit for this Year, we can get the total activities by support activities time policy units. B. Based on above results, we divide total activities by support costs to get the cost by per support activity. (Support costs from the table on page-3) Step 2. Calculate Cost Amount. As the new allocation bases, we use total activities time cost by activity and times each new basis, thus we get the total cost for each policy.
Step 3. Calculate Support Cost by Policy Using the above result of cost by activity time each support activity steps or contacts, then get the total support cost by policy. |Table 1. Support Costs by Policy | | |Annuities |Life Insurance | |Support Costs |New Basis |New |In-force |New |In-force | |Policy acquisition |Steps |$84 |$0 |$211 |$0 | |Customer service |Calls |$22 |$9 |$26 |$18 | |Sales and marketing |Contacts |$100 |$0 |$200 |$0 | |Corporate overhead |AUM |$15 |$15 |$0 |$19 | |Total Cost |? |$221. 52 |$23. 73 |$438.
22 |$37. 02 | Step 4. Calculate Total Support Costs by Product for each Legal Business Unit Entity. Since the support activities are from three companies, we have to weight the proportion of each company engaged. Using number of policies by a company divides by the total number of policies and then time the total cost for each policy. Therefore, we get the total costs by company and also by products. |Table 2. Total Support Costs by Product for each Legal Business Unit Entity | |? |Midwest |Gibson |Compton |Total | |Annuities: |?
|? |? |? | |New policies |$2,215,223 |$1,910,630 |$269,150 |$4,395,003 | |In-force policies |$1,068,015 |$859,159 |$111,548 |$2,038,723 | |Subtotal |$3,283,239 |$2,769,789 |$380,698 |$6,433,726 | |? |? |? |? |? | |Life insurance: |? |? |? |? | |New policies |$547,778 |$1,511,866 |$3,549,599 |$5,609,243 | |In-force policies |$207,325 |$499,801 |$1,169,905 |$1,877,032 | |Subtotal |$755,103 |$2,011,668 |$4,719,504 |$7,486,274 | |? |? |? |? |? | |Total |$4,038,341 |$4,781,457 |$5,100,202 |$13,920,000 | 2.
Why would Hampton want to track that information by product even if that level of detail was not required by regulators? In the case, it mentions that Hampton admitted to herself as she perused the allocations and as she learned more about the nature of selling and supporting various products that she sensed those allocations did not reflect the relative claim that those products had on the shared corporate resources. The current simple allocation approach is insurance premiums and sales commissions are tracked at the legal business unit entity and product line level to properly compensate sales agents.
Certain support functions are only accounted for at the corporate level and are subsequently allocated to product lines and business units according to the number of policies outstanding. Along with the recent development trend, Hampton thinks that this approach cannot reflect the claim on resources that is made by various business units and product lines. She also realizes that although sales volume has increased, profitability declines. So a new approach is necessary and extremely urgent.
Better and appropriate allocation approach can help management obtain more accurate insight into product profitability, make correct product pricing decisions and so on. From the aspect of cost center[1], tracking information of cost expenses would facilitate management to figure out the productivity by an unbiased measurement. In operations, company units such as the human resources department or marketing department, except sales department, are not engaging in market share or generating revenues.
In contrast, these departments contribute their capabilities for internal supports and help sales department turn profits to the company. Those efforts are a part of product costs and also are a norm for performance evaluation. Thus, managers need to know how many services are provided by each division and further to know how much are costing. Therefore, through tracking the resources usage across projects, managers can control product costs by an elaborate calculation and use unbiased view to evaluate personnel performance. 3.
Will the new support cost allocation information help Gibson Insurance establish better pricing guidelines for the various annuities and life insurance products sold by each legal business unit entity? Why or Why not? We think through the thorough analysis by Hampton, the new support cost allocation information helps Gibson Insurance establish better pricing guidelines for the various annuities and life insurance products sold by each legal business unit entity. There are several reasons contribute to this conclusion: First, the new support cost allocation information offers more accurate information of costs.
The management can allocate the costs more rational by using cost allocation by support activities. Second, as above Table 1, the support cost for each policy is different with the original allocation method. For instance, the new allocation bases of annuities new policy cost is $221. 52 and the original method is $82. 25 per policy that does not matter which product line. The result of support cost by policy reveals a phenomenon that different policy involves different level of working procedures. As the result of Table 1, the support cost for new policies is greater than in-force policies in general.
Thus, managers should have different pricing strategy as a better assessment. Third, as below Table 3 the total support cost comparison, for company Midwest and Gibson, the new total support costs is lower than original method; in contrast, Compton’s support costs of new method is greater than original method. That is because Compton sold the highest cases of life insurance new policies than other companies. The support costs of life insurance new policies increase significantly as $82. 25 to $438. 22.
Thus, Compton managers need to adopt a new pricing method for each product line, especially to life insurance new policies. They also can adjust their sales strategy more focusing on in-force policies selling, which consume lower support costs. |Table 3. Total Support Costs Comparison | |? |Midwest |Gibson |Compton | |Original method |$5,087,166? |$5,080,997? |$3,751,837?? | |New method |$4,038,341 |$4,781,457 |$5,100,202 | 4. Is there room for improvement in the means by which the corporate support costs are allocated under Hampton’s new approach? If yes, in what way(s)? If no, why not?
The point of view of cost center, the new approach that Hampton conducted will help Gibson management to track cost expenses and to evaluate each department performance easily. In general, a corporation’s final goal is to capture the maximum profit for a company. One way for gaining profits is to raise sales revenues from external; another way is saving costs from internal and performing the best teamwork effect. Using cost center approach, managers can simply estimate how many workforces would be needed by project and how much revenues they generate. Moreover, managers can measure the breakeven point as an important leverage for management.
Overall, this approach is a fundamental concept that facilitates the company to employ profit center[2] approach for further managerial scenarios. [1] Cost center: is part of an organization that does not produce direct profit and adds to the cost of running a company. Examples of cost centers include research and development departments, marketing departments, help desks and customer service/contact centers. (SearchCRM, 2008) [2] Profit Center: The profit center’s revenues and expenses are held separate from the main company’s in order to determine their profitability. (Investopedia, 2008)