The New Manager of the Insurance Division Does Not Understand

question 103

Essay

The new manager of the insurance division does not understand how the company can have so many overhead rates for assigning costs to the activities of the company's life insurance underwriters. There is one rate schedule for average assignable costs when agents write standard policies. There is another rate schedule which the agents must complete when they write special policies, and these policies are costed out differently from those that are categorized as standard policies.
Required:
a. Why might the company have different costing systems with different verhead rates for the standard and specialized policies?
b. Which rate (standard or specialized) would cross- subsidize the other if the company used only one set of overhead rates for costing its policies?

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Definitions:

Price Floor

A government-imposed minimum price for goods or services, intended to prevent prices from falling below a certain level.

Market-clearing Price

The price at which the quantity demanded by buyers equals the quantity supplied by sellers, eliminating any surplus or shortage in the market.

Surplus

The condition in which the quantity of a good or service supplied exceeds the quantity demanded at the current price.

Foreign Currency

Currency used in a country other than one's own, involved in international trade, investments, and travel.