INTRODUCTION

This case is based on a real$-$life project and takes place in

$2010$ at the New York City headquarters for the United

States operations of AC Global, Inc. $($The real name has

been changed.$)$ AC Global is a multinational insurance

company with its headquarters in France and annual

revenue ranking in the top $10$ companies globally. The

company has significant operations in the United States,

Europe, Japan, and Australia, and the operations in each

country are separate insurance companies and operate with

a large degree of autonomy. Recently, AC Global established

insurance operations and a servicing center in India. The

servicing center in India primarily provides some information

technology $($IT$)$ support for the insurance operations in the

United Kingdom $($U$.$K$.),$ Belgium, and France. The ongoing

global recession has significantly decreased the profitability

of AC Global, increasing the importance of reducing costs.

AC Global$$s operations in the U$.$S$.($AC$-$US$)$ sell life and

annuity products and represent approximately $20\%$ of the

group$$s life and annuity revenues. AC$-$US has approximately

$3,000$ employees, with about $1,000$ employees based in the

New York City headquarters. The remaining employees

are located at the company$$s service centers in New Jersey,

Pennsylvania, and North Carolina.

IMPACT ON SHORT$-$TERM PROFITS

For an insurance company, there are four key line items

on the income statement: premium revenue, investment

income, benefits$/$claims expense, and operating expenses.

Operating expenses provide the greatest opportunity for

short$-$term improvement in earnings since the other line

items are less controllable or the impacts of changes emerge

over a long period of time. Investment income is primarily

composed of interest and dividends on bonds and common

stock investments and is not changed through operating

actions. Premium revenue is composed of fees collected

for providing insurance coverage and is only modestly

impacted by current sales. Benefits and claims are paid to

policyholders and their beneficiaries and are also difficult to

impact in the short$-$term.

The global economic downturn that began in late $2008$

put intense pressure on the financial services industry.

During $2009,$ U$.$S$.$ sales of annuity products decreased

by $30\%$ while life insurance sales fell by $15\%\mathrm{.}1$

Like the

industry, AC Global has been negatively impacted by

the economic downturn. AC$-$US premium revenue fell

$8\%$ cumulatively between $2007$ and $2009.$ In $2010,$ the

company$$s operations remained stable, but revenue was

expected to be similar to $2009.$

AC Global$$s operating earnings decreased over $80\%$ from

$2007$ to $2008,$ and AC$-$US suffered an operating loss in $2008.$

IMA EDUCATIONAL CASE JOURNAL $1$ VOL. $9,$ NO$.3,$ ART. $3,$ SEPTEMBER $2016$

ISSN $1940-204$X

Costs for Decision Making: An Instructional Case of Relevant

Costs and Differential Analysis of Cost Reduction Alternatives

Scott McGregor, DPS$,$ CMA, CPA

Assistant Professor of Accounting

Fairleigh Dickinson University

$2016$ IMA

Although operating earnings recovered somewhat in $2009$

$($shown in Figure $1),$ the earnings for AC Global consolidated

and AC$-$US are still $36\%$ and $40\%,$ respectively, below those

in $2007.$ As a result, the company$$s stock price is down nearly

$50\%$ since the beginning of the crisis in $2008.$

AC$-$US measures operating efficiency based on the

expense ratio, which is operating expenses divided

by premium revenue. In $2004,$ AC$-$US went through

a restructuring that reduced personnel overlap and

inefficiency. Through the restructuring, AC$-$US reduced the

workforce by $4\%,$ reduced operating expenses by $5\%,$ and

improved the expense ratio from $12\mathrm{.}7\%$ in $2004$ to $10\mathrm{.}1\%$

by $2007,14\%$ better than the expense ratio of $11\mathrm{.}7\%$ for AC

Global. While operating expenses have grown modestly at

$2\%$ since $2007,$ the expense ratio for AC$-$US increased from

$10\mathrm{.}1\%$ in $2007$ to over $12\mathrm{.}5\%$ in $2009,$ worse than the $12\mathrm{.}1\%$

for AC Global. AC$-$US has underperformed AC Global in

earnings and cost efficiency during $2009,$ which is concerning

for the management of AC$-$US $($see Figure $2).$

COST REDUCTION ANALYSIS PROJECT

Peter George is a vice president responsible for financial

planning and analysis $($FP&A$)$ at AC$-$US in New York.

In his role, George and his team evaluate all significant

projects with financial implications. George led the team that

analyzed and recommended the restructuring six years ago

that significantly improved the expense ratio.

George met with Brian Thomas, the chief financial officer

$($CFO$).$ Thomas had reviewed the first quarter preliminary

revenue and earnings and told George that it is imperative

for the company to find ways to reduce expenses to improve

earnings. He set a goal of a $10\%$ reduction in operating

expenses. If AC$-$US achieved that goal, he estimated that

the company would return the expense ratio to a value below

$11\%$ and operating ear