Activity-Based Costing for a Service Company

Safety First Insurance Company carries three major lines of insurance: auto, workers' compensation, and homeowners. The company has prepared the following report:

Safety First Insurance Company Product Profitability Report For the Year Ended December 31
	Auto		Workers' Compensation		Homeowners
Premium revenue	$5,750,000		$6,240,000		$8,160,000
Estimated claims	4,312,500		4,680,000		6,120,000
Underwriting income	$1,437,500		$1,560,000		$2,040,000
Underwriting income as a percent of premium revenue	25%		25%		25%

Management is concerned that the administrative expenses may make some of the insurance lines unprofitable. However, the administrative expenses have not been allocated to the insurance lines. The controller has suggested that the administrative expenses could be assigned to the insurance lines using activity-based costing. The administrative expenses are comprised of five activities. The activities and their rates are as follows:

Activity	Activity Rates
New policy processing	$120 per new policy
Cancellation processing	$175 per cancellation
Claim audits	$320 per claim audit
Claim disbursements processing	$104 per disbursement
Premium collection processing	$24 per premium collected

Activity-base usage data for each line of insurance wereof insurance were retrieved from the corporate records as follows: retrieved from the corporate records as follows:

	Auto			Workers' Compensation			Homeowners
Number of new policies		1,320		1,500				4,080
Number of canceled policies		480		240				2,160
Number of audited claims		385		120				960
Number of claim disbursements		480		216				840
Number of premiums collected		8,400		1,800				15,000

a. Complete the product profitability report through the administrative activities. Determine the income from operations as a percent of premium revenue, rounded to the nearest whole percent. Enter all amounts as positive numbers.

Safety First Insurance Company
Product Profitability Report
For the Year Ended December 31
	Auto	Workers' Comp.	Homeowners
Premium revenue	$	$	$
Estimated claims
Underwriting income	$	$	$
Administrative activities:
New policy processing	$	$	$
Cancellation processing
Claim audits
Claim disbursements processing
Premium collection processing
Total administrative expenses	$	$	$
Income from operations	$	$	$
Income from operations as a percent of premium revenue	%	%	%

b. Interpret the report.

All three insurance lines have percentage of underwriting income to premium revenue. The differences among the insurance lines are in the way they consume activities. The insurance line has the profitability because it has and frequent claims that require more auditing and disbursement processing than do the other two lines. In addition, the Homeowners line has a much higher rate of cancellation relative to the other two lines (over 50% of new policies). Lastly, the Homeowners line has more premium collections compared to the other two lines. Possibly, the Homeowners line is collected in smaller amounts from more customers than the other two lines. In contrast, the line consumes the administrative activities, causing it to be very profitable. The Auto line is in between these two.