Gibson Insurance Company (GIC) faces a challenge during the current year. GIC’s current cost allocation system must be revised to accommodate the implementation of a new management planning and performance management system. The goal is to better allocate GIC’s corporate support-service costs to the business lines and business units in a result of more precise pricing strategies, sales compensation and improved cost control.
We have analyzed GIC’s situation based on the given information, and concluded with a solution to improve the old cost allocation system. The new cost allocation uses adjusted cost bases which better reflects to the actual usage for new and existing policies. More support-service costs are assigned to new policies than existing ones as it requires more resources for implementation.
We have also provided recommendations to improve the new allocation approach. We suggested that GIC use step method and revised allocation bases to effectively control costs, measure performance and reflect actual costs.
GIC is an insurance company that offers two different kinds of financial products: annuities and life insurance. It has full ownership of two subsidiary companies: Compton Insurance Services and Midwest Mutual Insurance Company. Compton and Midwest both sell annuities and life insurance; however, the pricing strategies and the features of these products differ between the companies. Although its subsidiary companies are presented as three separate legal entities, GIC, as the parent company, provides support services for all three companies.
The objectives of this report are:
1.To analyze the current support-service costs allocation method with the given information 2.To indentify drawbacks of the new cost system
3.To recommend improvement for the new support-service cost allocation method
ANALYSIS OF SUPPORT-SERVICE COST ALLOCATION
The New Support-Service Cost Allocation Method
GIC originally used a simple approach to allocate the corporate level support-service costs to product lines and business units with number of policies as the allocation basis. However, according to GIC’s controller, this approach did not reflect the relative claim on resources that was made by various units and product lines. In this approach, it has classified fifty cost accounts into four categories and assigned a unique allocation base for each, and used direct method to allocate the support-service costs to each business unit.
Table 1. Unit Support Cost Per Policy
Based on the new allocation bases, we calculate the unit support cost per policy (Table 1) . Originally, GIC used the number of policies as the only allocation base. The cost per policy was $82.25, no matter which product line it was. However, from the Table 1, we have found out that total cost per policy has different unit cost under the new allocation bases. For example, the unit cost per new life insurance is $438.22, which is $355.97 more when it was under the old cost allocation base. While the new cost per in-force life insurance is $45.26 less when it was under the old base. This demonstrates the fact that different policy actually requires different level of services from each support service department. In general, all new policies will be assigned more cost than the in-force ones. It matches the reality that actually more support services are consumed by the new policies.
Table 2. Total Support Costs by Product for Each Legal Business Unit &
Comparison with the Old Allocated Costs
In Table 2, we have used the total unit support cost per policy in Table 1 to calculate the new support service costs allocated by the revised allocation bases and compared the results with the old allocated costs for each business unit . The total support costs allocated to Midwest and Gibson were lower than that under the original method, while Compton’s cost was much greater under the new method. Even though the...