Applying Activity Based Costing to Insurance

Most Insurance companies could benefit from a more detailed and reliable breakdown of the component costs through the life cycle of a policy, from acquisition through to administration and on to settlement.

On an operational level, better information would enable companies to pinpoint where expenses are uncompetitive and where sales teams and service centres could improve their performance.

On a tactical level, better information could enable sales executives to judge whether particular customers, products or distribution channels are meeting profit expectations and whether options such as outsourcing or a different customer service model could prove more cost-effective.

Yet most insurers have been hesitant to implement Activity-based Costing (ABC) techniques because they believe that administrative costs are such a small part of the profit mix and emphasis should be placed on claims management first. But margins are being squeezed as pricing becomes more competitive and insurers are having to consider the entire cost and revenue flow to maximise returns.

ABC is particularly useful in understanding indirect infrastructure costs and on building component based profitability. The technique is based on two assumptions: resources are used to perform particular activities and a number of different activities are combined to generate products and services. Some of these activities are directly associated with the delivery of a product or service, some are associated with supporting a customer, while others are required to provide the general infrastructure of the organisation, such as finance.

ABC is only successful, however, if its application is pragmatic rather than theoretical. Our principal consultant, Julie Mabberley, has written a number of books on the practical application of activity based costing in financial institutions. The three books currently in print are:

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