Insurance Company – Case study

An auto insurance service provider incurred losses to the tune of $25 million this year. Last year the profits were recorded at $50 million. The company has hired you as the consultant to identify the reasons causing these losses and find solutions to overcome the situation.

The company provides auto insurance coverage only in one region and faces competition from several competitors. The primary source of income for the client is through premiums received at monthly, bi-annually, and annually. Claims are provided to the customers as deemed appropriate.

To simplify the situation, it can be assumed the profits = Earned premiums – claims+ Other Income -Expenses. Presently, the client has a customer base of 3 million and approximates about 25% of the total market. The revenues, costs, and profitability are measured on per customer basis.

How would you go about identifying possible solutions to address the declining profitability?

Recommended Approach:

This is a profitability case with an added section of problem solving to find the causes affecting its profitability. You must focus on trying to identifying the reasons that are leading to decreasing profits. Determine the revenues (price*quantity) and costs (fixed as well as variable costs). This should help you reach the core problem. You must ask certain pertinent questions that will help you explore the problem and identify solutions to resolve these.

The following questions show your knowledge on Insurance industry or at least ability to probe.

  • Ask if Investment Income from “float”, underwriting expenses and claims need to be considered.
  • Ask if S.G.& A need to be considered.
  • Should claims processing timeline play any role in this case.

Key Facts:

  • Number of customers last year was 3 million, which has remained constant in the current year.
  • The premiums charged per member have increased by 10% in this year to $275 per year from $250 per customer per year in the last year.
  • The sector is not capital intensive and therefore, the client has made no recent large capital expenditures.
  • The variable costs for each member have increased by $50 per year, which is primarily resulting due to the improper utilization of available resources.

Solution:

Profit = Earned Premiums – Costs + Investment Income –losses (it may include underwriting expenses)

Last Year

$50 million = (3 million customers * 250 per year) – costs

$50 million = $750 million – costs

Costs = $700 million

Present Year

-$25 million = (3 million customers * 275 per year) – costs

-$25 million = $825 million – costs

Costs = $850 million

Per customer variable cost:

Last year = $700 million / 3 million customers = ~ $233 per customer per year

Current year = $850 million / 3 million customers = ~$283 per customer per year

From the above it can be determined that per customer per year variable costs have increased by $50, which is an approximately 21% increase year-on-year. Compared to this increase the customer base has remained constant while premiums have increased only by 10% year-on-year. This is primarily the reason the company is witnessing a decline in its profitability. The client must identify the reasons within its organizational structure or operations to reduce the variable expenses and improve its profitability.

 

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P&L for Insurance company

 

Revenues

Premiums

Administrative fees

Other revenue

Total operating revenue

Net investment income

Net realized (losses) gains on investments

Total revenues

 

Expenses

Benefit expense

Selling, general and administrative expense:

Selling expense

General and administrative expense

Total selling, general and administrative expense

Interest expense

Amortization of other intangible assets

Impairment of intangible assets

Total expenses

Income before income tax expense

Income tax expense

 Net income

 

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