Gibson Insurance Company

Gibson Insurance Company

Case Analysis

Melissa Hanesworth

October 13, 2015

Gibson Insurance is committed to a growth strategy that targets corporate acquisitions to grow customer base and assets under management (AUM).  The recent acquisitions of Compton Insurance Services and Midwest Mutual Insurance Company fit well into our strategy as both companies offer annuities and life insurance products with varying prices and features.  Our decision to consolidate all support services into Gibson Insurance corporate headquarters should have yielded synergies and cost savings.  However, results reveal increasing revenues but declining profitability. Corporate support costs are increasing and our current cost allocation system does not provide us the clarity necessary to gain control.

In order to execute our growth strategy successfully, we must have better clarity regarding costs to improve profitability by entity and product line. At an annual cost of approximately $14 million, corporate support services are a significant financial expense.  Historically, we have utilized the number of policies to allocate support services.  However, as we have discovered with our two recent acquisitions, this method does not reflect the actual resources consumed by entity and product line.

Under the current system, each policy is allocated $82.25 for corporate support services.  This system fails to properly reflect the true cost of the activities associated with each product line and entity.  As a result, we may be sacrificing market share due to our inability to accurately set prices.  Besides inhibiting our ability to effectively establish pricing, lack of clarity on true costs also prevents us from identifying inefficient processes.  Both of these issues result in decreased profitability.  

There are many ways to improve our cost system.  We could establish separate offices and support personnel for each separate entity.  While this would result in easier segregation of costs, it would also increase the costs of support services for Gibson Insurance overall.  Since improvements in cost tracking never justify further decreases in profitability, we rejected this option.  We could allocate each support departments costs individually.  This would likely provide improvement but only marginally. Finally, we could implement an activity based cost allocation system.  The resulting cost allocation system would match employee activities to the proper product line and entity.  This is the only option of the three that will optimize pricing, profitability and process efficiency.

The clear choice is to implement an activity based cost allocation system.  The value in activity based costing is the matching of the cost of activities to a product based on the actual consumption of the activity resource.  Our proposal consolidates our 50 different corporate cost accounts into four cost categories:  policy acquisition, customer service, sales and marketing and other corporate support.  Exhibit 1 summarizes our current year policy portfolio by type and entity.  Exhibit 2 defines the cost categories, cost base to be allocated, and appropriate cost driver. After identifying the actual activities required by support function for each product line, we were able to quantify a more realistic allocation rate by product.  The results summarized in Exhibit 3 reflect the disproportionate amount of resources required for each product type. The allocation rate now reflects the greater amount of resources required to secure and service a new policy vs the minimal ongoing maintenance consumed by existing policies.