Familia Insurance Company (FMC) specializes in offering insurance products to the Hispanic com-munity. It has its own direct sales organization of agents that sells three lines of insurance: life insurance, auto insurance, and home insurance. FMC is organized around three profit centers (Life, Auto, and Home) and several cost centers ( Sales, Accounting and IT, Human Resources, and Underwriting and Claims). Each agent sells all three insurance lines. Accounting and IT processes all transactions, including customer billing, claims, payroll, and so forth. Human Resources hires employees and manages the employee benefits plans. Underwriting and Claims sets the rates forthe three types of policies, calculates the insurance premiums for each policy written, and processes insurance claims. The three profit center managers are responsible for designing their marketing materials, train-ing the common sales force to sell their policies, and designing their policies to appeal to their market demographics. Each profit center manager is compensated based on net income before taxes in their profit center. The sales strategy of FMC is to heavily market the auto insurance and then sell the customer life and home insurance products. The following statement ( in millions of dollars) summarizes opera-tions for the last fiscal year:

Policy premiums are invested in securities and income from these investments is reported as “ Investment income.” “Insurance losses and loss adjustments” represent the actual insurance claims paid plus anticipated losses not yet paid for policies written that year. “Policy acquisition expenses” are the costs of the direct sales force. Operating and administrative expenses (in millions) consist of the following:
Operating and Administrative Expenses Underwriting and claims $ 90.00 Accounting and IT 70.00 Human resources 40.00 Advertising 120.00 Profit center expenses 30.00 Corporate office 50.00 Total O& A expenses $ 400.00
In the statement of operations for last year, “Investment income,” “ Policy acquisition expenses,” and “ Operating and administrative expenses” are allocated to the three profit centers based on premium revenues. “Insurance losses and loss adjustments” are based on the actual and estimated losses on each policy written as calculated by the actuaries in the Underwriting and Claims department. Profit center expenses consist of the salaries and benefits of the management and staff operating the profit centers and other direct costs incurred by the profit center. The $ 30 million consists of $ 6 million in the Life Insurance profit center, $ 15 million in the Home Insurance profit center, and $ 9 million in the Auto Insurance profit center. Corporate office expense consists of FMC’s senior managers and their staff. They oversee all the profit and cost centers and design FMC’s advertising campaigns. FMC management and the board of directors worry about the large losses being reported in the Auto Insurance profit center and question the methodology being used to allocate both the investment income and the expense items. A consultant hired by senior (corporate) management to analyze these items finds the following relations:
• Investment income generated by each insurance line depends on the difference between premium revenues and insurance losses and loss adjustments.
• Policy acquisition expenses are driven by the time each agent spends on selling a particular line of insurance. Based on a questionnaire sent to FMC’s agents, the consultant reports that on average agents spend 30 percent of their time selling auto policies, 30 percent selling home policies, and 40 percent selling life policies.
• Underwriting and Claims expenses are driven by the number of policies in each area. There are 150,000 life policies, 375,000 home policies, and 225,000 auto policies. • The number of policies in each insurance line is a reasonable approximation of what causes resource consumption in Accounting and IT.
• Human resource costs are driven by the number of employees at FMC. Most of the employees at FMC are in either “Policy Acquisition expenses” or “ Profit Center expenses.” A reasonably accurate proxy for human resources consumed by employees is salary and benefit expenses of the direct sales force (policy acquisition expenses) plus the profit center expenses.
• Advertising and Corporate office expenses represent firmwide common resources. All FMC ads promote the FMC brand and not individual lines of insurance. After much discussion, management agrees the most commonly accepted allocation scheme for these two expense items is premium revenue.

a. Based on the consultant’s recommendations, prepare a revised statement of operations for the current year that reports revised net income before taxes for each of the three profit centers.
b. Should FMC replace its current methodology for computing net income before taxes with the statement of operations you prepared in part (a)? Present the advantages and disadvantages of the two methodologies and make arecommendation.

  • CreatedDecember 15, 2014
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