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Managing insurance cost allocations effectively
Navigating the complexity of expense allocation
In today’s world of bundled pricing and shared services, insurance organizations must actively manage profitability and accountability across products, customers, regions, and channels. The result is highly structured and often overly complex allocations. Here, learn more about best practices for managing cost allocations effectively.
Challenges for the insurance industry
In the insurance industry, expense allocations are critical due to two trends—first, tightening margins and increased competition heighten the need to scrutinize expenses; second, insurers’ highly intermediated distribution models and regulator requirements for granularity and transparency drive insurers to develop complex allocation models.
These are the factors pushing insurance expense allocation models toward high complexity:
- Complex business models: For insurance businesses to obtain a full picture of profitability, distribution channel and reinsurance information need to be integrated into allocation models. These views add to standard cost hierarchies. Additionally, insurers may allocate to activity, process, and service to enable profitability analysis.
- Regulators: Insurance companies trading under different jurisdictions face multiple regulations. Requirements on expense reporting also include the presentation of fully allocated expenses across numerous lines of business and accounting destinations. Portions attributable to contracts and deferred acquisition costs also need to be distinguished.
- Reliance on high-technology spend: Insurance companies need advanced technology to obtain insights on the high volume of business and actuarial data and meet regulatory requirements. Insurance leaders overwhelmingly consider information technology as their greatest cost and expense management challenge.
These complexities lead to difficulty and a lack of transparency for reporting end users trying to understand the expense origins and drivers. Additionally, both IFRS 17 and long-duration target improvements to US GAAP translate into requiring additional details and transparency of expenses. New standards require companies to project future cash flows for the whole duration of contracts.
Download the full report to learn more about the expense allocation challenges each insurance subsector is facing, adding even greater complexity to their ability to allocate costs effectively.
Allocations: Extreme complexity
In a finance team’s efforts to develop business insights and comply with regulators, one common pitfall is to propose expense allocation models that are extremely complex and lack transparency.
To begin with, there are several challenges that must be faced when trying to transform cost allocation models for insurance companies, including:
- Lengthy execution time requiring a significant amount of effort and coordination
- Lack of transparency and traceability viewed as a “black box” with no drill-back capability
- Significant internal debate on results equals more time lost
- Lack of reporting and decision support that limit ability to conduct analytics
- Legacy systems are inefficient, with data volume limitations that disrupt the process
- Lack of focus on managing and reducing costs in favor of making contra entries across an organization
- Lack of governance that results in unstructured hierarchies and drivers for allocation
When an insurer allows its expense allocation model complexity to increase, the result is an absence of transparency—the reason expense allocations are considered the ultimate “black box” in most organizations.
Download the full report for a deeper look at the complexity of cost allocation processes.
Solution: A more thoughtful, measured, and streamlined approach
An allocation framework, including cost pools and drivers, must be developed holistically with organizational consensus and an appropriate governance model. When firms approach the allocation process, they should consider the following framework:
- Philosophy: Allocation process goals must align with business goals.
- Methodology: Consistency and governance must be more important than trying to achieve precision for cost allocations.
- Drivers: Various statistics and metrics used to push down expenses must be clearly defined and obtained.
- Systems and tools: Tools and technologies used must be scalable and efficient.
- Reporting: Reports and the output of the allocations framework facilitates better decision-making.
- Roles and responsibilities: Roles and responsibilities should be clearly defined, documented, and understood.
Most enterprise resource planning (ERP) and financial solutions support basic allocation features. But only some solutions are purpose-built for allocations and enable the design of advanced models with a high level of flexibility, traceability, and performance for the required volumes, complexity, and level of detail observed in the insurance industry.
The complexity of expense allocations for the insurance industry is expected to increase, given the importance of indirect costs, the diversity of insurance products, the high level of intermediation in the distribution process, and the regulatory push for granularity and transparency.
Insurance companies should take a fresh look at their allocations processes and systems through a dedicated assessment project and evaluate if updated capabilities and practices would be right for them. In today’s insurance industry, managing allocations effectively and efficiently is no longer simply a “nice-to-have” capability—it’s essential for survival.