Today I am writing on this subject especially as a reaction to the new regulation that the Insurance Regulatory body in India has passed. It says that for the Unit Linked Insurance policies, the Insurance Company cannot charge of more than 9% of the premium as the expenses in the first year and may be 6% in the next and even less in the following years. Earlier this amount was up to 40% in the first year and so on. My experience had been that 90% of the premium income for the Life Insurance companies used to come from selling the Unit Linked Products. With this ruling, it will be difficult for the Life Insurance companies to provide for the commission to the agent and their own expenses. Naturally, they have to shift to alternate products and/or manage their costs. In both the cases they have to understand the cost of selling as well as servicing the various products. This is where, according to me, Activity Based Costing (ABC) will be a great help to the Life Insurance Companies.
While designing an ABC model for the objective, ‘to find out cost of various processes in the Life Insurance Company’, we can design the model which can deliver cost of a process for various products using various channels across regions within a Life Cycle Event of the customer. Let me explain you this statement. There are various processes in a Life Insurance Company like ‘Acquire Customer’, ‘Collect renewal premium’, ‘Pay claim amount’ etc. It has various products. We may go to the level of individual product but at least up to the product grouping according to their portfolio management. For example participatory products (where the insurer can get some bonus), non-participatory (typical Term Insurance) or Unit Linked (where one gets back sum assured or market value of the units invested, whichever is less) etc. The channels could be acquisition channels like agent, bank, corporate agent etc. or servicing channels like branch, internet, telephone etc. Regions are various geographical parts may be like South, North, East and West. The Customer lifecycle events are Acquisition, Service, Retain and Close. You will find more in detail in my earlier post at http://activitybasedmgmt.blogspot.com/2009/06/activity-based-management-results-in.html
Once we have created this type of ABC model, we can visualize the cost at least as per the following points:
• Quite a few times it is argued that in Insurance industry most of the expenses are for paying the claims as well allocating alternatively allocating to the various reserves for the future payments (claims or bonuses etc.). If it so, then why go for such a detailed calculation. Generally it is added as ‘Administrative overheads’ to the product cost.
My argument is that, even if it is a small Insurance company in India, it will be having Rs. 500 crore (approx. USD 100 mn) per annum as expenses other than the claims and commission. It observed across the globe that ABC can improve at least 3-5% of the overheads. This means it can save
• The first level of segregation is at the Customer lifecycle event. It can be seen that almost 45-50 % of the costs are for acquiring customers. When we say cost of acquisition, it is excluding commissions paid. In addition to this almost 30% of the costs are for managing the channels. This is a cost that is spent on various branches, people and infrastructure there. Approximately 10% of the cost is unutilized. This is across the organization and can be more or less for various departments.
• The Cost of acquisition can be in various processes of acquisition like straight through process-STP (where for some products and sum assured combination if the proposer falls into certain category, the policy is issued directly) or non-STP with underwriting and with or without medical tests. For any process within the organization the costs are calculated for a ‘clean process’ and rework or any non-value added activity cost is separated. We can use the cost of completing the process cleanly as standard cost and use it in the product costing or internal benchmarking. The rework and non-value added activities can be eliminated to improve the margins. The amount of rework in the acquisition process is due to either lack of knowledge of the agent or the haste with which the proposal is logged into the system.
• If the cost of managing the ‘Direct Agent’ channel is divided by the # of policies sold in a period then it is four times the cost of the process of acquisition. For example if the cost of the process of acquisition is around Rs 1200 (USD 24) then the cost of managing channel per policy sold is Rs. 5000 (USD 100). This cost is even more for the various alternate channels like BankAssurance, Database sharing partners or other corporate agents where the cost goes up 15 times.
• Generally it is perceived that there are selling agents or partners and they are doing the selling part. But one would be surprised to see how much of time is spent by the line managers in actual selling the policies. One can almost say that agents are only for lead generating and rest of the work is done by the employees. There are very few agents those are selling policies on their own. Most of the agents are merely bringing the leads and the line manager from the Company has to fulfill the rest of the process. The other major activity is recruiting. The attrition of the agents as well as the staff is so high that almost everybody in the channel management is recruiting people one level below. Another major activity is managing on-going Incentive schemes. There are various schemes, themes; activities are floated every now and then. There is set of people at the region and HO those are constantly busy with recording data for the scheme, declaring the winners and calculating the incentives.
• The cost of issuing a policy ‘straight through process (STP)’, where the process is introduced for certain type of products, sum assured and profile of the proposer matches the requirement then the policy is issued automatically. The assumption behind this is that all this should happen using some software application and almost without human intervention. But if this is not the case then the cost of STP type of process is more than the issuance with underwriting.
• The rework cost is almost up to 10 - 15% for all processes across the organization. This include collecting the document multiple times, movement of the documents back and forth, re-scanning, re-underwriting, re-issuing, re-posting the policies etc. The major reason is the haste with which the proposal is logged in.
• The cost of conducting a medical test is obviously known, but the cost of managing the entire medical activities is not surfaced. The activities are like creating the medical network, addition and deletion of the doctors, managing the appointments, receiving the reports, analyzing the reports, receiving the invoices, checking invoices, payments to doctors etc. This cost of internal management of medical network can go up to 25% of the average cost of the medical tests. This is not generally visible.
• The utilization of the various functions is also an eye opener. The industry has cyclic nature across the year. Even in a month most of the sale happens in last few days. This is the ‘peak period’. Most of the times the staffing is done to match the work load during this ‘peak’ period and hence, we can see the non-utilization of the staff up to 20%.
• All this information is used to identify the non-value added activities as well as the opportunities to outsource the activities. The organizations can outsource the activities like managing the medical network, dispatch, customer service etc.
Various reports can be generated for the management decision purpose. These reports can be classified under 1) Cost reports 2) Profitability reports. Some of the examples are:
• Cost reports
o Customer Lifecycle costs - Total overheads of the organization for a period can be seen grouped as i) Cost to Acquire ii) Cost to Serve iii) Cost to retain iv) Cost to close v) Cost to sustain channel vi) Cost to sustain business vii) Cost available to use.
o Transaction costs – ABM model gives you information about cost of each transaction grouped under various lifecycle events. This is cost is provided as a’ Clean process’ and ‘Rework’. This information can be used to understand and improve the cost of the transactions. It can also be used to have internal benchmarking across products or across various regions.
o Department Costs – The cost of the departments are not the cost center accounting costs but costs added from the shared services like HR, Admin, IT etc. This report also shows the ‘cost per minute’ for the department. A department is seen as costly when the costs are higher for that department, but sometimes this is department is not costly on per minute cost, because of the available resource capacity is higher. This cost of department is shown as per their top 5 activity costs. This gives the information on the focus of the department. This report also tells about the utilization of the department.
• Profitability reports – The format of this can be like (Insurance premium + Investment income + other income – Reserves – Cost of customer services – cost of claims – Cost of capital)
o Profitability of Line of Business (LOB) by Customer Segment
o Profitability of Customer segment by region
o Profitability of Channels by Product group
• All this information is used to identify the non-value added activities as well as the opportunities to outsource the activities. The organizations can outsource the activities like managing the medical network, dispatch, customer service etc.
Various reports can be generated for the management decision purpose. These reports can be classified under 1) Cost reports 2) Profitability reports. Some of the examples are:
• Cost reports
o Customer Lifecycle costs - Total overheads of the organization for a period can be seen grouped as i) Cost to Acquire ii) Cost to Serve iii) Cost to retain iv) Cost to close v) Cost to sustain channel vi) Cost to sustain business vii) Cost available to use.
o Transaction costs – ABM model gives you information about cost of each transaction grouped under various lifecycle events. This is cost is provided as a’ Clean process’ and ‘Rework’. This information can be used to understand and improve the cost of the transactions. It can also be used to have internal benchmarking across products or across various regions.
o Department Costs – The cost of the departments are not the cost center accounting costs but costs added from the shared services like HR, Admin, IT etc. This report also shows the ‘cost per minute’ for the department. A department is seen as costly when the costs are higher for that department, but sometimes this is department is not costly on per minute cost, because of the available resource capacity is higher. This cost of department is shown as per their top 5 activity costs. This gives the information on the focus of the department. This report also tells about the utilization of the department.
• Profitability reports – The format of this can be like (Insurance premium + Investment income + other income – Reserves – Cost of customer services – cost of claims – Cost of capital)
o Profitability of Line of Business (LOB) by Customer Segment
o Profitability of Customer segment by region
o Profitability of Channels by Product group
Insurance companies can understand the costs and the drivers for those costs. With this knowledge they can now look for which alternate products they can look for, in the scenario of Unit Linked not being so profitable. As well they can improve upon the operational efficiency to add to their bottom line.
The analysis put here is related to the various eye-openers for the Insurance Company regarding the cost management. Once these costs are calculated the same information can be extrapolated to calculate the Customer Segment P&L for various periods. This will show the customer segments that are most profitable to the Insurance Company. Also we can perform an analysis that which acquisition channel is bringing most of those profitable customers and which are not. Then the knowledge transfer can happen to improve upon the selection of the customers.
