Gibson Insurance Company

Company Overview

Gibson Insurance Company (Gibson) is a successful financial company which mainly sells two financial products: annuities and life insurance. With a focus on expanding their customer base and its assets under management (AUM), Gibson has recently acquired Compton Insurance Services (Compton) and Midwest Mutual Insurance Company (Midwest). However, the current cost system does not truly reflect the real supporting cost of these products. This analysis of different cost allocation method can help Gibson to choose the best one in order to better assign the costs attributed to different products and business units.

Gibson Insurance Company used to allocate corporate support costs solely based on the number of policies. However, each legal business unit entity has four different kinds of policies; they are annuities and life insurance, and they can be either new policy or in-force. It is not fair to assume all policies will incur the same corporate support costs. Thus, Hampton decided to change their supporting cost allocation method; direct method has been adopted. According to the direct method, all the supporting cost will directly allocate to the production department (i.e. the department who is responsible to generate insurance policies). Under this method, none of the supporting cost will allocate to any other supporting departments. For instance, the cost incurred by the policy acquisition department is assumed to have no relationship with the customer service department.

Hampton has grouped nearly 50 different corporate cost accounts into four categories, policy acquisition, customer service, sale and marketing, and other corporate support. Each category has its own unique allocation basis. For instance, number of steps involved in moving new policy applications to an in-force status is the basis used for allocating policy acquisition costs. Each new annuity has two steps, and each new life insurance has five steps. Midwest Mutual Insurance Company has 10,000 new annuities and 1,250 new life insurances; therefore, the total number of steps involved is 20,000 and 6,250 respectively. Similarly, the total number of steps involved for new annuities and new life insurance in Compton Insurance Service both equal to 17,250 steps. Lastly, Gibson Insurance Company has 2,430 steps for its new annuities and 40,500 steps for its new life insurance. Under the direct method, Midwest shared 19% (20,000 steps/ 103,680 total steps) policy acquisition costs for its new annuities and 6% (6,250 steps/ 103,680 total steps) for its new life insurance. This also meant that $843,943 and $263,732 is allocated to Midwest's new annuities and new life insurance respectively; the aggregated policy acquisition cost is $4,375,000.