ISSN 1940-204X Product Costs: Application in an Insurance Company Scott McGregor
Question # 00144351
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Updated on: 12/02/2015 12:20 PM Due on: 01/01/2016
ISSN 1940-204X
Product Costs: Application in an Insurance Company
Scott McGregor
Western Connecticut State University
INTRODUCTION
AXE Life sells individual life insurance products,
individual annuities, and group annuities. The individual
products, both life and annuity, are sold through insurance
agents. The group annuity products are sold by banks
and brokerage firms. The group business represents
approximately 40% of total sales, and the individual business
represents the remainder. The company continually
develops new products, both life and annuity, typically
bringing one or two new products to market each year.
The company currently has 17 different life and annuity
insurance products.
AXE Life has a functional organization structure with
Sales, Marketing, Finance, IT, and Service departments
representing a functional discipline. The Service department
has a joint management team but has separate functions to
service annuity products and life insurance products. All
other departments provide support to both life and annuity
products. Because of the size of the functional departments
and their annual expense budgets, there are financial
support roles in each department. The financial support
staffs provide budgeting and financial analysis support to the
departments.
Greg McAndrews has recently been hired as Vice President
for Expense Management at a large insurance company. His
responsibilities include the process for allocating expenses to
products. Through discussions with his staff, he has learned
that there is a great deal of discontent with the expense
allocation process. He decided that one of his top priorities
will be to analyze the product costing process and make
necessary corrections.
Greg is a CMA® (Certified Management Accountant) and
CPA (Certified Public Accountant) with an undergraduate
degree in accounting and a Master of Business Administration
(MBA). Although he has worked in various roles with
progressing responsibilities throughout his 12-year career, Greg
has never been directly responsible for expense allocations.
He has read numerous articles on the current applications of
cost accounting techniques in service industries, including
activity-based costing (ABC). He believes that he has a good
understanding of cost accounting techniques and is eager for his
team to improve the expense allocation process.
COMPANY OVERVIEW
LIFE INSURANCE TERMS, PRODUCTS, AND
PROCESSES
AXE Life Insurance Company is among the leading life
insurance companies in the United States. AXE Life
employs more than 5,000 people and has assets in excess
of $17 billion and annual premiums (“revenue”) in excess
of $10 billion. The company is well established with a long
successful history.
IM A ED U C ATIO NA L C A S E JOURNAL
The two primary types of products sold and serviced by
life insurance companies are life insurance and annuities.
These two products have different characteristics. In general,
life insurance is used for financial protection and annuities
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VOL. 7, N O. 3, ART. 1, SEPTEMBER 2014
for retirement savings. A life insurance policy provides a
payment to the beneficiary upon the death of the insured.
An annuity provides a stream of periodic payments to the
customer upon attaining a specified age.
A life insurance policy is usually sold to customers to
provide financial protection for their families in the event
of the insured’s death. If the policy provides coverage for
the full life of the insured, it is called whole life insurance.
If the insurance coverage is only for a specified period, it is
called term life insurance. For life insurance, customers most
often pay the cost of the policy (“premiums”) over a long
period of time. During the period of time that the policy’s
coverage is active, the policy is considered to be “inforce.”
The process involved with life insurance begins with the
sale of the policy, often through a life insurance agent. The
life insurance agent meets with the potential customer
and gathers personal information, which is collected using
an application for insurance. Potential customers also will
provide medical information and are often subjected to a
medical examination. The application containing personal
information and medical information is submitted to the
Underwriting department, which is responsible for deciding
whether a policy should be issued and the appropriate
premium for the policy.
After the company and the customer agree on the policy’s
terms and conditions, the company issues the physical policy.
Most life insurance companies have service departments
that have an “issuance” function that performs this activity.
After the policy has been issued, the company collects
the premiums, answers ongoing customer questions, and
terminates the policy if the insured decides to cancel the
policy or fails to pay the premium. These functions also
are performed in their service departments. Then, when
the insured dies, the insurance company pays the benefits
specified in the insurance policy to the beneficiary—this
process is performed by the Claims department.
Premiums under an annuity product may be paid in
a lump sum or periodically over a number of years. The
insurance company invests these funds and provides either
a set return (“fixed annuity”) or a return that varies with
investment performance (“variable annuity”). For individual
annuity sales, the issuance and premium collection processes
are very similar to the processes for life insurance policies.
For group annuity products, the sales process is completed
by a licensed representative of a bank or brokerage firm
instead of an insurance agent. But the other activities are
consistent with individual annuity sales.
Although many of the processes are similar for life
and annuity products, insurance companies often have
IM A ED U C ATIO NA L C A S E JOURNAL
separate Service departments performing functions for
annuities products since there are activities associated with
the products that differ. For example, when an annuity
policy is canceled, or surrendered, the customer receives a
payment that represents the premiums they have paid in
addition to investment returns less a surrender fee. Most life
insurance companies have a separate unit within its Service
department that performs the surrender function. Once a
customer reaches the age specified in the annuity contract,
the company begins making a series of periodic payments,
which is performed by the annuity Service department.
CURRENT COSTING SYSTEM
The vast majority of AXE Life’s financial reporting is prepared
at a company level, although there are periodic reports on
product results. AXE Life allocates all expenses to products.
All expense allocations are prepared within the expense
management function in the Finance department with little
input from the finance staff in the functional departments.
AXE Life has a cost center structure with approximately
1,000 cost centers. In its hierarchy, multiple cost centers make
up a functional center (see Figure 1). Each of these functional
centers is part of a department. A manager may be responsible
for one or more cost centers, a higher-level manager for
a functional center, and an executive-level manager for
departments. One of the performance measurement factors
for cost center managers is how effectively they manage the
expenses of the cost center against the budget. For managers
of functions, their performance measurement includes how
effectively they manage the expenses of all of the cost centers
within their function. For the executives managing the
business departments, their cost effectiveness is measured on
all of the cost centers and functions within their department.
Responsibility and accountability for expenses is
based on responsibility center. There is no accountability
for the expenses at the product level nor is there direct
measurement or accountability for the cost effectiveness
of any activities associated with the sale or service of the
company’s products.
Figure 1. Illustration of the Hierarchy of Departments,
Functions, and Cost Centers
Department
Function 1
Cost
Center
A
2
Cost
Center
B
Function 2
Function 3
Cost
Center
C
VOL. 7, N O. 3, ART. 1, SEPTEMBER 2014
Expense
allocations set
at function
level
Expense data is captured at the cost center level, and
the basis for allocating expenses is set at a functional center
level. Because of the large number of cost centers and the
lack of attention on cost allocations, Greg finds that cost
driver information often is not used or is unavailable at the
cost center level. The current system makes use of more
generalized expense allocation bases, such as assets or sales,
and uses that basis to allocate expenses of all cost centers
within the functional center. These allocation bases may
differ from the cost driver (the activities that actually drive
expenses). For example, the expenses of the underwriting
function within the Service department are allocated to
products based on life insurance sales, even though the cost
driver is the number of life insurance applications.
Even when cost driver information is available at a cost
center level it can vary with the allocation basis for expense
since the same basis is used for all cost centers within
the functional center. Due to the limited time available
to analyze the inputs and results of the process, the basis
of expense allocations to products is only reviewed on
an annual basis. Greg finds that much of the cost center
information has not been updated in years.
During Greg’s first month, he reviews AXE Life’s process
of allocating costs and finds that the current process takes
up to three business days to complete during each monthly
close, with significant manual intervention required. The
expense allocation process is performed using a spreadsheet
that was developed eight years ago, and the process requires
a series of iterations. Under the current process, the staff
accountant receives a downloaded file of cost center
expenses on the day after the monthly expense accounting
close is complete. She also receives information on the
sales volume (in U.S. dollars) during the month, the annual
premium for the policies inforce, and the amount of assets
under management. These measures serve as the bases to
allocate expenses to products.
The staff accountant enters the volume information for
the allocation bases (sales, assets, premium) for the month
into the spreadsheet. She imports the cost center expenses
into the spreadsheet to populate the cost centers with the
expenses for the month. She runs a series of Microsoft
Excel macros to allocate the expenses to product. The staff
accountant then reconciles the allocations to ensure that all
expenses have been allocated.
The costs for the Sales department, Marketing
department, and Service department related to issuing new
policies (new customers) are allocated to product based on
sales volume. The total annual premium per product is used
to allocate the costs for the service functions including those
IM A ED U C ATIO NA L C A S E JOURNAL
related to supporting and terminating customers and the
costs for the claims function.
After the costs are allocated to products, the process is
considered complete. There are no rates per policy or per
function calculated as part of the process. Additionally,
there is no study of the time or cost required for activities.
Table 1 shows the outcome of the expense allocations for
the most recent month (July 2012) using the current cost
allocation process.
Table 1. Panel A: Monthly Expense Results
Expenses July 2012
Expenses by Department
Sales
$ 30,700,125
Marketing
5,524,850
Finance
8,624,567
Customer Service
15,750,225
Information Technology
11,424,525
Human Resources
3,942,563
Executive
2,512,235
Corporate & Other
4,046,032
Total
$82,525,122
Table 1. Panel B:
Expenses July 2012 under Current Cost Allocations
Product
Product Expense
Whole Life Series 1
$ 2,212,742
Whole Life Series 2
2,598,048
Variable Life Series 1
3,718,892
Variable Life Series 2
3,983,063
Term Life 2000
1,315,393
Term Life New Horizon
1,627,201
Flexible Life
1,719,782
Secure Life
Brokerage Annuity
Fixed Annuity, Brokerage
Happy Life Annuity
7,018,232
10,457,380
3,298,115
12,849,825
Bankers Choice
1,958,313
Fixed Annuity, Bank
4,161,012
Individual Fixed Annuity 1
6,646,289
Individual Fixed Annuity 2
6,775,007
Individual Fixed Annuity 3
1,431,363
Life Style Annuity
Total Allocated
3
10,754,464
$ 82,525,122
VOL. 7, N O. 3, ART. 1, SEPTEMBER 2014
Table 1. Panel C:
Product Allocations by Department, Current System
Product
Sales
Service
Whole Life Series 1
$568,673
$972,669
Marketing
$104,376
$211,240
IT
Finance
$160,037
All Other
$195,746
$2,212,742
Total
Whole Life Series 2
614,643
1,306,637
81,388
234,203
168,655
192,523
2,598,048
Variable Life Series 1
1,024,239
1,416,358
232,353
372,157
294,340
379,445
3,718,892
Variable Life Series 2
1,373,039
761,773
397,999
482,686
406,466
561,101
3,983,063
Term Life 2000
391,680
446,071
81,663
143,664
111,570
140,745
1,315,393
Term Life New Horizon
586,255
338,417
114,267
216,523
165,901
205,837
1,627,201
Flexible Life
279,446
962,249
146,498
85,970
91,727
153,893
1,719,782
Secure Life
1,520,900
3,049,065
698,525
486,402
485,649
777,691
7,018,232
Brokerage Annuity
4,731,929
959,177
341,303
1,856,485
1,259,212
1,309,274
10,457,380
Fixed Annuity, Broker
1,161,666
573,359
336,322
408,455
343,836
474,476
3,298,115
Happy Life Annuity
4,897,700
1,790,417
1,142,659
1,773,658
1,411,813
1,833,579
12,849,825
494,749
563,186
294,031
145,714
167,162
293,470
1,958,313
Fixed Annuity, Bank
1,912,221
283,261
163,261
745,479
512,342
544,447
4,161,012
Ind. Fixed Annuity 1
3,230,604
310,625
137,274
1,285,402
846,537
835,846
6,646,289
Ind. Fixed Annuity 2
3,268,866
402,744
114,201
1,305,252
853,169
830,776
6,775,007
Ind. Fixed Annuity 3
740,165
27,522
783
300,243
189,736
172,914
1,431,363
Bankers Choice
Life Style Annuity
3,903,351
1,586,694
1,137,947
1,370,992
1,156,416
1,599,065
10,754,464
Total Allocated
$30,700,125
$15,750,225
$5,524,850
$11,424,525
$8,624,567
$10,500,830
$82,525,122
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VOL. 7, N O. 3, ART. 1, SEPTEMBER 2014
Table 1. Panel D: Cost Driver Information, Current Allocations
Department/Function
Description of Activities
Cost Driver
Products Supported
Allocation
Manage marketing dept.
Marketing Campaigns
All
Sales
Marketing
Marketing Management
Marketing Department Staff
Marketing campaigns
Secure Life Insurance Campaign
Total Company Ad Campaign
Marketing Campaigns
All
Sales
Costs for media campaign
Media campaign
Happy Retirement Annuity
Sales
Media campaign for secure life product
Media campaign
Secure Life
Sales
Media campaign for company
Happy Retirement Annuity Campaign
Media campaign
All
Sales
Customer Service – Life
New Business Management
Manage new business
New policy volume
Life (all)
Sales
Applications
Review applications
Number of applications
Life (all)
Sales
Underwriting
Underwriting applications
Number of applications
Life (all)
Sales
Issuing new policies
Number of policies issued
Life (all)
Sales
Tech support for e-applications
Number of e-applications
Life (all)
Sales
Manage customer service
Number of policies
All
Premium
Policy Issuance
e-Issuance
Customer Service Management
Call Center
Life Insurance Inforce Maintenance
Claims Management
Staff in call center
Number of phone calls
All
Premium
Servicing life policies
Number of policies
Life (all)
Premium, life
Manage staff for claims
Number of claims
Life (all)
Premium, life
Life Insurance Claims Adjusters
Adjudicate claims
Number of claims
Life (all)
Premium, life
Life Insurance Claims
Issue claim checks
Number of claims
Life (all)
Premium, life
Manage new business issuance
New policies sold
Annuities (all)
Sales
Customer Service – Annuity
New Business Management
Applications
Reviewing applications
Number of applications
Annuities (all)
Sales
Staff issuing new policies
Number of policies issued
Annuities (all)
Sales
Tech support for e-applications
Number of e-applications
Annuities (all)
Sales
Service all annuity products
Number of policies
Annuities (all)
Premium, annuity
Issue surrenders
Number of surrenders
Annuities (all)
Premium, annuity
Manage staff for IT
Number of systems/projects
All
Assets
Managing financial systems
Number of systems/projects
All
Assets
Manage HR systems
Number of systems/projects
All
Assets
Managing life claim system
Number of systems/projects
Life
Assets
Managing life systems
Number of systems/projects
Life
Assets
Annuity Systems
Managing annuity systems
Number of systems/projects
Annuity
Assets
Annuity Projects
Projects for annuity products
Project hours
Annuity
Assets
Policy Issuance
e-Issuance
Annuity Inforce Maintenance
Annuity Surrenders
Information Technology
IT Management
Financial Management Systems
Human Resource Systems
Life Insurance Claims Systems
Life Policy Systems
Life Insurance Projects
Projects for life products
Project hours
Life
Assets
Project for upgrading financial system
Project hours
All
Assets
Controller
Accounting staff
Number of reports
All
Assets
Actuarial
Actuarial staff
Number of reports
All
Assets
Financial analysts and budget analysts
Number of analysis and reports
All
Assets
Cost accounting staff
Number of reports
All
Assets
Financial Systems Update
Financial Planning and Analysis
Expense Management
IM A ED U C ATIO NA L C A S E JOURNAL
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VOL. 7, N O. 3, ART. 1, SEPTEMBER 2014
Table 1. Panel D: Cost Driver Information, Current Allocations (continued)
Department/Function
Description of Activities
Cost Driver
Products Supported
Allocation
Manage staff
Employees
All
Assets
Executive and employee compensation
Employees
All
Assets
Recruit for all company positions
Open positions
All
Assets
Human Resources
HR Management
Compensation and Payroll
Staffing and Recruiting
Sales
Sales Management
Manage sales function for company
Sales
Life and annuity (all)
Sales
East coast sales staff and management
Sales for region
Life and annuity (all)
Sales
Midwest Region
Midwest sales staff and management
Sales for region
Life and annuity (all)
Sales
South Region
Sales staff and management for south
Sales staff and management
for west coast
Sales for region
Life and annuity (all)
Sales
Sales for region
Life and annuity (all)
Sales
East Region
West Region
Facilities
Facilities Management
Facilities Staff
Corporate Unallocated Rent
Manage staff for Facilities
Number of employees/sq. ft.
All
Assets
Maintenance and other Facility staff
Number of employees/sq. ft.
All
Assets
Rent for entire corporate office
Number of employees/sq. ft.
All
Assets
Manage staff for Treasurer’s dept.
Assets
All
Assets
Manage cash & banking relationships
Number of bank accounts
All
Assets
Manage investments
Invested assets
All
Assets
All
Assets
All
Assets
Treasurers
Treasurer
Cash Management and Banking
Investments
Executive & Corporate
Office of the CEO
Corporate
CEO and support staff
Expenses not chargeable to
any business area
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VOL. 7, N O. 3, ART. 1, SEPTEMBER 2014
In discussions with his team, Greg finds that the team
does not fully understand how the information is used and
its importance. Also, he learns that they are frustrated with
the time required to complete the expense allocation process
and complain that they do not have adequate time to review
results or maintain the inputs for the expense allocation
process. Greg believes that the expense allocation process
could be accomplished in one business day instead of three.
If processing time can be reduced, Greg anticipates the
staff would be afforded more time to analyze the results and
maintain the cost allocation information used in the process.
Sal further explains that the product expenses are a critical
component in determining the appropriate pricing for each
of AXE Life’s existing products. Additionally, when new
products are developed, the actuaries rely on the historical
unit costs for similar products. Thus, if the product expenses
are inaccurate, they could over-price or under-price a product,
which would hurt AXE Life’s long-term profitability.
Sal believes that the cost information is inadequate in
meeting the needs of his department and AXE Life. Sal
expresses concern that the cost system is inaccurate, and
the information is not available in a timely fashion. As a
result, Sal’s staff spends hours analyzing the data and making
adjustments, all within a compressed time frame. He outlines
the format the actuaries would prefer the cost information to
be organized, with the following broad categories of expenses
organized along the major activities associated with a product:
OBJECTIVES OF THE PRODUCT COST
ALLOCATIONS
In his discussion with the staff, Greg learned that they receive
limited information after recording the monthly product expenses.
Their understanding is that the product expense allocation
is coupled with claims information and premium revenue
information to determine the profitability of each product. This
process of reporting on product profitability is completed within
the Actuarial department. To better learn what the objectives of
the expense allocation process should be, Greg meets with the
actuaries to find how the product expense information is used
and gathers their concerns with the current process.
Sal Enrich, the company’s chief actuary, discusses how
his department uses the expense allocation information.
Sal explains that the product-based expenses are critical for
determining product profitability and for setting the pricing
for products, both of which are vital to the company’s success.
The Actuarial department is the sole provider of product
profitability information for the company. Sal explains that
no individual manager is directly responsible for individual
product profitability and that his department is in charge of
monitoring product profitability, and the results are shared
with executive management. Sal emphasizes that executive
management looks to his department to ensure that products’
profitability information is correct. Executive management uses
the information to determine which products to emphasize
in the sales process and the insurance agents receive larger
commissions on the sale of more profitable products.
Sal details how the actuaries take the product expense
information, revenue, mortality results (death benefits), sales
commissions, and other nonoperating expenses to determine
the profitability of each product. Since the product expense
information is a significant component in determining the
profitability of each product, misstating it could lead the
company to cease selling a profitable product or to oversell an
unprofitable product.
IM A ED U C ATIO NA L C A S E JOURNAL
•
Cost to develop the product
• Cost to market the product
• Cost to sell the product
• Cost to issue the product
• Cost to service the product
• Overhead expenses (other administrative expenses)
•
One-time expenses (such as special projects) and
nonrecurring expenses
After the meeting, Greg decides that the expense
allocation system needs immediate attention. He assembles
a small project team and, during the first meeting, outlines
the features of a useful cost system:
•
Timely, accurate information
to use the information for product pricing, product
profitability, and management decision making
•
Ability
Greg also lists the shortfalls of the current system:
•
Requires
significant manual intervention using
spreadsheets
•
Long processing time
•
Expense allocations based on general factors
(e.g., sales at the functional level)
•
Outdated or nonexistent cost driver information
for cost centers
•
Lack of reporting (limited monthly information, no
comparison of budget to actual results)
•
Lack of cost information based on activity
•
Lack of information on the time to complete each activity
•
No identification of direct costs vs. indirect costs
•
No identification of expenses as variable or fixed
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VOL. 7, N O. 3, ART. 1, SEPTEMBER 2014
PROJECT OVERVIEW
Greg explains the importance of the information to the
company and the value of the involvement of the financial
support staff. He also seeks management’s input as how
to best implement a process to ensure the information is
consistently updated on an ongoing basis.
The group is receptive and agrees to the following actions:
Greg and two staff members make up the primary project
team. The team decides that the first tw...
Product Costs: Application in an Insurance Company
Scott McGregor
Western Connecticut State University
INTRODUCTION
AXE Life sells individual life insurance products,
individual annuities, and group annuities. The individual
products, both life and annuity, are sold through insurance
agents. The group annuity products are sold by banks
and brokerage firms. The group business represents
approximately 40% of total sales, and the individual business
represents the remainder. The company continually
develops new products, both life and annuity, typically
bringing one or two new products to market each year.
The company currently has 17 different life and annuity
insurance products.
AXE Life has a functional organization structure with
Sales, Marketing, Finance, IT, and Service departments
representing a functional discipline. The Service department
has a joint management team but has separate functions to
service annuity products and life insurance products. All
other departments provide support to both life and annuity
products. Because of the size of the functional departments
and their annual expense budgets, there are financial
support roles in each department. The financial support
staffs provide budgeting and financial analysis support to the
departments.
Greg McAndrews has recently been hired as Vice President
for Expense Management at a large insurance company. His
responsibilities include the process for allocating expenses to
products. Through discussions with his staff, he has learned
that there is a great deal of discontent with the expense
allocation process. He decided that one of his top priorities
will be to analyze the product costing process and make
necessary corrections.
Greg is a CMA® (Certified Management Accountant) and
CPA (Certified Public Accountant) with an undergraduate
degree in accounting and a Master of Business Administration
(MBA). Although he has worked in various roles with
progressing responsibilities throughout his 12-year career, Greg
has never been directly responsible for expense allocations.
He has read numerous articles on the current applications of
cost accounting techniques in service industries, including
activity-based costing (ABC). He believes that he has a good
understanding of cost accounting techniques and is eager for his
team to improve the expense allocation process.
COMPANY OVERVIEW
LIFE INSURANCE TERMS, PRODUCTS, AND
PROCESSES
AXE Life Insurance Company is among the leading life
insurance companies in the United States. AXE Life
employs more than 5,000 people and has assets in excess
of $17 billion and annual premiums (“revenue”) in excess
of $10 billion. The company is well established with a long
successful history.
IM A ED U C ATIO NA L C A S E JOURNAL
The two primary types of products sold and serviced by
life insurance companies are life insurance and annuities.
These two products have different characteristics. In general,
life insurance is used for financial protection and annuities
1
VOL. 7, N O. 3, ART. 1, SEPTEMBER 2014
for retirement savings. A life insurance policy provides a
payment to the beneficiary upon the death of the insured.
An annuity provides a stream of periodic payments to the
customer upon attaining a specified age.
A life insurance policy is usually sold to customers to
provide financial protection for their families in the event
of the insured’s death. If the policy provides coverage for
the full life of the insured, it is called whole life insurance.
If the insurance coverage is only for a specified period, it is
called term life insurance. For life insurance, customers most
often pay the cost of the policy (“premiums”) over a long
period of time. During the period of time that the policy’s
coverage is active, the policy is considered to be “inforce.”
The process involved with life insurance begins with the
sale of the policy, often through a life insurance agent. The
life insurance agent meets with the potential customer
and gathers personal information, which is collected using
an application for insurance. Potential customers also will
provide medical information and are often subjected to a
medical examination. The application containing personal
information and medical information is submitted to the
Underwriting department, which is responsible for deciding
whether a policy should be issued and the appropriate
premium for the policy.
After the company and the customer agree on the policy’s
terms and conditions, the company issues the physical policy.
Most life insurance companies have service departments
that have an “issuance” function that performs this activity.
After the policy has been issued, the company collects
the premiums, answers ongoing customer questions, and
terminates the policy if the insured decides to cancel the
policy or fails to pay the premium. These functions also
are performed in their service departments. Then, when
the insured dies, the insurance company pays the benefits
specified in the insurance policy to the beneficiary—this
process is performed by the Claims department.
Premiums under an annuity product may be paid in
a lump sum or periodically over a number of years. The
insurance company invests these funds and provides either
a set return (“fixed annuity”) or a return that varies with
investment performance (“variable annuity”). For individual
annuity sales, the issuance and premium collection processes
are very similar to the processes for life insurance policies.
For group annuity products, the sales process is completed
by a licensed representative of a bank or brokerage firm
instead of an insurance agent. But the other activities are
consistent with individual annuity sales.
Although many of the processes are similar for life
and annuity products, insurance companies often have
IM A ED U C ATIO NA L C A S E JOURNAL
separate Service departments performing functions for
annuities products since there are activities associated with
the products that differ. For example, when an annuity
policy is canceled, or surrendered, the customer receives a
payment that represents the premiums they have paid in
addition to investment returns less a surrender fee. Most life
insurance companies have a separate unit within its Service
department that performs the surrender function. Once a
customer reaches the age specified in the annuity contract,
the company begins making a series of periodic payments,
which is performed by the annuity Service department.
CURRENT COSTING SYSTEM
The vast majority of AXE Life’s financial reporting is prepared
at a company level, although there are periodic reports on
product results. AXE Life allocates all expenses to products.
All expense allocations are prepared within the expense
management function in the Finance department with little
input from the finance staff in the functional departments.
AXE Life has a cost center structure with approximately
1,000 cost centers. In its hierarchy, multiple cost centers make
up a functional center (see Figure 1). Each of these functional
centers is part of a department. A manager may be responsible
for one or more cost centers, a higher-level manager for
a functional center, and an executive-level manager for
departments. One of the performance measurement factors
for cost center managers is how effectively they manage the
expenses of the cost center against the budget. For managers
of functions, their performance measurement includes how
effectively they manage the expenses of all of the cost centers
within their function. For the executives managing the
business departments, their cost effectiveness is measured on
all of the cost centers and functions within their department.
Responsibility and accountability for expenses is
based on responsibility center. There is no accountability
for the expenses at the product level nor is there direct
measurement or accountability for the cost effectiveness
of any activities associated with the sale or service of the
company’s products.
Figure 1. Illustration of the Hierarchy of Departments,
Functions, and Cost Centers
Department
Function 1
Cost
Center
A
2
Cost
Center
B
Function 2
Function 3
Cost
Center
C
VOL. 7, N O. 3, ART. 1, SEPTEMBER 2014
Expense
allocations set
at function
level
Expense data is captured at the cost center level, and
the basis for allocating expenses is set at a functional center
level. Because of the large number of cost centers and the
lack of attention on cost allocations, Greg finds that cost
driver information often is not used or is unavailable at the
cost center level. The current system makes use of more
generalized expense allocation bases, such as assets or sales,
and uses that basis to allocate expenses of all cost centers
within the functional center. These allocation bases may
differ from the cost driver (the activities that actually drive
expenses). For example, the expenses of the underwriting
function within the Service department are allocated to
products based on life insurance sales, even though the cost
driver is the number of life insurance applications.
Even when cost driver information is available at a cost
center level it can vary with the allocation basis for expense
since the same basis is used for all cost centers within
the functional center. Due to the limited time available
to analyze the inputs and results of the process, the basis
of expense allocations to products is only reviewed on
an annual basis. Greg finds that much of the cost center
information has not been updated in years.
During Greg’s first month, he reviews AXE Life’s process
of allocating costs and finds that the current process takes
up to three business days to complete during each monthly
close, with significant manual intervention required. The
expense allocation process is performed using a spreadsheet
that was developed eight years ago, and the process requires
a series of iterations. Under the current process, the staff
accountant receives a downloaded file of cost center
expenses on the day after the monthly expense accounting
close is complete. She also receives information on the
sales volume (in U.S. dollars) during the month, the annual
premium for the policies inforce, and the amount of assets
under management. These measures serve as the bases to
allocate expenses to products.
The staff accountant enters the volume information for
the allocation bases (sales, assets, premium) for the month
into the spreadsheet. She imports the cost center expenses
into the spreadsheet to populate the cost centers with the
expenses for the month. She runs a series of Microsoft
Excel macros to allocate the expenses to product. The staff
accountant then reconciles the allocations to ensure that all
expenses have been allocated.
The costs for the Sales department, Marketing
department, and Service department related to issuing new
policies (new customers) are allocated to product based on
sales volume. The total annual premium per product is used
to allocate the costs for the service functions including those
IM A ED U C ATIO NA L C A S E JOURNAL
related to supporting and terminating customers and the
costs for the claims function.
After the costs are allocated to products, the process is
considered complete. There are no rates per policy or per
function calculated as part of the process. Additionally,
there is no study of the time or cost required for activities.
Table 1 shows the outcome of the expense allocations for
the most recent month (July 2012) using the current cost
allocation process.
Table 1. Panel A: Monthly Expense Results
Expenses July 2012
Expenses by Department
Sales
$ 30,700,125
Marketing
5,524,850
Finance
8,624,567
Customer Service
15,750,225
Information Technology
11,424,525
Human Resources
3,942,563
Executive
2,512,235
Corporate & Other
4,046,032
Total
$82,525,122
Table 1. Panel B:
Expenses July 2012 under Current Cost Allocations
Product
Product Expense
Whole Life Series 1
$ 2,212,742
Whole Life Series 2
2,598,048
Variable Life Series 1
3,718,892
Variable Life Series 2
3,983,063
Term Life 2000
1,315,393
Term Life New Horizon
1,627,201
Flexible Life
1,719,782
Secure Life
Brokerage Annuity
Fixed Annuity, Brokerage
Happy Life Annuity
7,018,232
10,457,380
3,298,115
12,849,825
Bankers Choice
1,958,313
Fixed Annuity, Bank
4,161,012
Individual Fixed Annuity 1
6,646,289
Individual Fixed Annuity 2
6,775,007
Individual Fixed Annuity 3
1,431,363
Life Style Annuity
Total Allocated
3
10,754,464
$ 82,525,122
VOL. 7, N O. 3, ART. 1, SEPTEMBER 2014
Table 1. Panel C:
Product Allocations by Department, Current System
Product
Sales
Service
Whole Life Series 1
$568,673
$972,669
Marketing
$104,376
$211,240
IT
Finance
$160,037
All Other
$195,746
$2,212,742
Total
Whole Life Series 2
614,643
1,306,637
81,388
234,203
168,655
192,523
2,598,048
Variable Life Series 1
1,024,239
1,416,358
232,353
372,157
294,340
379,445
3,718,892
Variable Life Series 2
1,373,039
761,773
397,999
482,686
406,466
561,101
3,983,063
Term Life 2000
391,680
446,071
81,663
143,664
111,570
140,745
1,315,393
Term Life New Horizon
586,255
338,417
114,267
216,523
165,901
205,837
1,627,201
Flexible Life
279,446
962,249
146,498
85,970
91,727
153,893
1,719,782
Secure Life
1,520,900
3,049,065
698,525
486,402
485,649
777,691
7,018,232
Brokerage Annuity
4,731,929
959,177
341,303
1,856,485
1,259,212
1,309,274
10,457,380
Fixed Annuity, Broker
1,161,666
573,359
336,322
408,455
343,836
474,476
3,298,115
Happy Life Annuity
4,897,700
1,790,417
1,142,659
1,773,658
1,411,813
1,833,579
12,849,825
494,749
563,186
294,031
145,714
167,162
293,470
1,958,313
Fixed Annuity, Bank
1,912,221
283,261
163,261
745,479
512,342
544,447
4,161,012
Ind. Fixed Annuity 1
3,230,604
310,625
137,274
1,285,402
846,537
835,846
6,646,289
Ind. Fixed Annuity 2
3,268,866
402,744
114,201
1,305,252
853,169
830,776
6,775,007
Ind. Fixed Annuity 3
740,165
27,522
783
300,243
189,736
172,914
1,431,363
Bankers Choice
Life Style Annuity
3,903,351
1,586,694
1,137,947
1,370,992
1,156,416
1,599,065
10,754,464
Total Allocated
$30,700,125
$15,750,225
$5,524,850
$11,424,525
$8,624,567
$10,500,830
$82,525,122
IM A ED U C ATIO NA L C A S E JOURNAL
4
VOL. 7, N O. 3, ART. 1, SEPTEMBER 2014
Table 1. Panel D: Cost Driver Information, Current Allocations
Department/Function
Description of Activities
Cost Driver
Products Supported
Allocation
Manage marketing dept.
Marketing Campaigns
All
Sales
Marketing
Marketing Management
Marketing Department Staff
Marketing campaigns
Secure Life Insurance Campaign
Total Company Ad Campaign
Marketing Campaigns
All
Sales
Costs for media campaign
Media campaign
Happy Retirement Annuity
Sales
Media campaign for secure life product
Media campaign
Secure Life
Sales
Media campaign for company
Happy Retirement Annuity Campaign
Media campaign
All
Sales
Customer Service – Life
New Business Management
Manage new business
New policy volume
Life (all)
Sales
Applications
Review applications
Number of applications
Life (all)
Sales
Underwriting
Underwriting applications
Number of applications
Life (all)
Sales
Issuing new policies
Number of policies issued
Life (all)
Sales
Tech support for e-applications
Number of e-applications
Life (all)
Sales
Manage customer service
Number of policies
All
Premium
Policy Issuance
e-Issuance
Customer Service Management
Call Center
Life Insurance Inforce Maintenance
Claims Management
Staff in call center
Number of phone calls
All
Premium
Servicing life policies
Number of policies
Life (all)
Premium, life
Manage staff for claims
Number of claims
Life (all)
Premium, life
Life Insurance Claims Adjusters
Adjudicate claims
Number of claims
Life (all)
Premium, life
Life Insurance Claims
Issue claim checks
Number of claims
Life (all)
Premium, life
Manage new business issuance
New policies sold
Annuities (all)
Sales
Customer Service – Annuity
New Business Management
Applications
Reviewing applications
Number of applications
Annuities (all)
Sales
Staff issuing new policies
Number of policies issued
Annuities (all)
Sales
Tech support for e-applications
Number of e-applications
Annuities (all)
Sales
Service all annuity products
Number of policies
Annuities (all)
Premium, annuity
Issue surrenders
Number of surrenders
Annuities (all)
Premium, annuity
Manage staff for IT
Number of systems/projects
All
Assets
Managing financial systems
Number of systems/projects
All
Assets
Manage HR systems
Number of systems/projects
All
Assets
Managing life claim system
Number of systems/projects
Life
Assets
Managing life systems
Number of systems/projects
Life
Assets
Annuity Systems
Managing annuity systems
Number of systems/projects
Annuity
Assets
Annuity Projects
Projects for annuity products
Project hours
Annuity
Assets
Policy Issuance
e-Issuance
Annuity Inforce Maintenance
Annuity Surrenders
Information Technology
IT Management
Financial Management Systems
Human Resource Systems
Life Insurance Claims Systems
Life Policy Systems
Life Insurance Projects
Projects for life products
Project hours
Life
Assets
Project for upgrading financial system
Project hours
All
Assets
Controller
Accounting staff
Number of reports
All
Assets
Actuarial
Actuarial staff
Number of reports
All
Assets
Financial analysts and budget analysts
Number of analysis and reports
All
Assets
Cost accounting staff
Number of reports
All
Assets
Financial Systems Update
Financial Planning and Analysis
Expense Management
IM A ED U C ATIO NA L C A S E JOURNAL
5
VOL. 7, N O. 3, ART. 1, SEPTEMBER 2014
Table 1. Panel D: Cost Driver Information, Current Allocations (continued)
Department/Function
Description of Activities
Cost Driver
Products Supported
Allocation
Manage staff
Employees
All
Assets
Executive and employee compensation
Employees
All
Assets
Recruit for all company positions
Open positions
All
Assets
Human Resources
HR Management
Compensation and Payroll
Staffing and Recruiting
Sales
Sales Management
Manage sales function for company
Sales
Life and annuity (all)
Sales
East coast sales staff and management
Sales for region
Life and annuity (all)
Sales
Midwest Region
Midwest sales staff and management
Sales for region
Life and annuity (all)
Sales
South Region
Sales staff and management for south
Sales staff and management
for west coast
Sales for region
Life and annuity (all)
Sales
Sales for region
Life and annuity (all)
Sales
East Region
West Region
Facilities
Facilities Management
Facilities Staff
Corporate Unallocated Rent
Manage staff for Facilities
Number of employees/sq. ft.
All
Assets
Maintenance and other Facility staff
Number of employees/sq. ft.
All
Assets
Rent for entire corporate office
Number of employees/sq. ft.
All
Assets
Manage staff for Treasurer’s dept.
Assets
All
Assets
Manage cash & banking relationships
Number of bank accounts
All
Assets
Manage investments
Invested assets
All
Assets
All
Assets
All
Assets
Treasurers
Treasurer
Cash Management and Banking
Investments
Executive & Corporate
Office of the CEO
Corporate
CEO and support staff
Expenses not chargeable to
any business area
IM A ED U C ATIO NA L C A S E JOURNAL
6
VOL. 7, N O. 3, ART. 1, SEPTEMBER 2014
In discussions with his team, Greg finds that the team
does not fully understand how the information is used and
its importance. Also, he learns that they are frustrated with
the time required to complete the expense allocation process
and complain that they do not have adequate time to review
results or maintain the inputs for the expense allocation
process. Greg believes that the expense allocation process
could be accomplished in one business day instead of three.
If processing time can be reduced, Greg anticipates the
staff would be afforded more time to analyze the results and
maintain the cost allocation information used in the process.
Sal further explains that the product expenses are a critical
component in determining the appropriate pricing for each
of AXE Life’s existing products. Additionally, when new
products are developed, the actuaries rely on the historical
unit costs for similar products. Thus, if the product expenses
are inaccurate, they could over-price or under-price a product,
which would hurt AXE Life’s long-term profitability.
Sal believes that the cost information is inadequate in
meeting the needs of his department and AXE Life. Sal
expresses concern that the cost system is inaccurate, and
the information is not available in a timely fashion. As a
result, Sal’s staff spends hours analyzing the data and making
adjustments, all within a compressed time frame. He outlines
the format the actuaries would prefer the cost information to
be organized, with the following broad categories of expenses
organized along the major activities associated with a product:
OBJECTIVES OF THE PRODUCT COST
ALLOCATIONS
In his discussion with the staff, Greg learned that they receive
limited information after recording the monthly product expenses.
Their understanding is that the product expense allocation
is coupled with claims information and premium revenue
information to determine the profitability of each product. This
process of reporting on product profitability is completed within
the Actuarial department. To better learn what the objectives of
the expense allocation process should be, Greg meets with the
actuaries to find how the product expense information is used
and gathers their concerns with the current process.
Sal Enrich, the company’s chief actuary, discusses how
his department uses the expense allocation information.
Sal explains that the product-based expenses are critical for
determining product profitability and for setting the pricing
for products, both of which are vital to the company’s success.
The Actuarial department is the sole provider of product
profitability information for the company. Sal explains that
no individual manager is directly responsible for individual
product profitability and that his department is in charge of
monitoring product profitability, and the results are shared
with executive management. Sal emphasizes that executive
management looks to his department to ensure that products’
profitability information is correct. Executive management uses
the information to determine which products to emphasize
in the sales process and the insurance agents receive larger
commissions on the sale of more profitable products.
Sal details how the actuaries take the product expense
information, revenue, mortality results (death benefits), sales
commissions, and other nonoperating expenses to determine
the profitability of each product. Since the product expense
information is a significant component in determining the
profitability of each product, misstating it could lead the
company to cease selling a profitable product or to oversell an
unprofitable product.
IM A ED U C ATIO NA L C A S E JOURNAL
•
Cost to develop the product
• Cost to market the product
• Cost to sell the product
• Cost to issue the product
• Cost to service the product
• Overhead expenses (other administrative expenses)
•
One-time expenses (such as special projects) and
nonrecurring expenses
After the meeting, Greg decides that the expense
allocation system needs immediate attention. He assembles
a small project team and, during the first meeting, outlines
the features of a useful cost system:
•
Timely, accurate information
to use the information for product pricing, product
profitability, and management decision making
•
Ability
Greg also lists the shortfalls of the current system:
•
Requires
significant manual intervention using
spreadsheets
•
Long processing time
•
Expense allocations based on general factors
(e.g., sales at the functional level)
•
Outdated or nonexistent cost driver information
for cost centers
•
Lack of reporting (limited monthly information, no
comparison of budget to actual results)
•
Lack of cost information based on activity
•
Lack of information on the time to complete each activity
•
No identification of direct costs vs. indirect costs
•
No identification of expenses as variable or fixed
7
VOL. 7, N O. 3, ART. 1, SEPTEMBER 2014
PROJECT OVERVIEW
Greg explains the importance of the information to the
company and the value of the involvement of the financial
support staff. He also seeks management’s input as how
to best implement a process to ensure the information is
consistently updated on an ongoing basis.
The group is receptive and agrees to the following actions:
Greg and two staff members make up the primary project
team. The team decides that the first tw...
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Rating:
/5
Solution: ISSN 1940-204X Product Costs: Application in an Insurance Company Scott McGregor