Porter Insurance Company has three lines of insurance: automobile, property, and life. The life insurance segment has been losing money for the past five quarters, and Leah Harper, Porter's controller, has done an analysis of that segment. She has discovered that the com¬

mission paid to the agent for the first year the policy is in place is 55% of the first year pre¬

mium. The second year commission is 20%, and all succeeding years a commission equal to 5% of premiums is paid. No salaries are paid to agents, however. Porter does advertising on television and in magazines. Last year the advertising expense was $500,000. The loss rate (payout on claims) averages 50%. Administrative expenses equal $450,000 per year. Rev¬

enue last year was $10,000,000 (premiums). The percentage of policies of various lengths is as follows:

Experience has shown that if a policy remains in effect for more than two years, it is rarely cancelled.
Leah is considering two alternative plans to turn this segment around. Plan 1 requires spending $250,000 on improved customer claim service in hopes that the percentage of poli¬
cies in effect will take on the following distribution:

Total premiums would remain constant at $10,000,000, and there are no other changes in fixed or variable cost behavior.

Plan 2 involves dropping the independent agent and commission system and having potential policyholders phone in requests for coverage. Leah estimates that revenue would drop to $7,000,000. Commissions would be zero, but administrative expenses would rise by $1,200,000 and advertising (including direct mail solicitation) would increase by $1,000,000.
Required:
1. Prepare a variable costing income statement for last year for the life insurance segment of Porter Insurance Company.
2. What impact would Plan 1 have on income?
3. What impact would Plan 2 have on income?

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First year in force Second year More than 2 years in force 65% 25% 10%