Question

An insurance company has the following profitability analysis of its services: Life Insurance Auto Insurance Home Insurance Revenues $5,000,000 $10,000,000 $3,000,000 Commissions (1,000,000) (2,000,000) (600,000) Payments (3,000,000) (7,300,000) (2,000,000) Fixed Costs (500,000) (500,000) (500,000) Profit $ 500,000 $ 200,000 ($ 100,000) The fixed costs are distributed equally among the services and are not avoidable if one of the services is dropped. What is the profitability of the remaining services if all services with losses are dropped?

Answer 1

This means that home insurance service are dropped. Then, there will be only two services available.

Thus, the fixed cost have to be distributed to life and auto insurance: 1500000/2 = $750000

                        Life Insurance     Auto Insurance  

Sales revenue     5000000              10000000               

Commissions      (1000000)             (2000000)              

Payments           (3000000)             (7300000)     

Fixed costs (750000)    (750000)         

Profit                 250000                    (50000)

After dropping home insurance service, the auto insurance become a loss making service.

The overall profit for the company as a whole drops from $600000 to $200000.

Hope this helps!