Steps to consider when creating a cost allocation system for your company:

1. Outline the objectives (e.g., penalizing/rewarding according to each department's costs)
   
   
2. List the cost categories for each major loss exposure (e.g., insurance premium, risk control expenses, administrative overhead, loss retention and related expenses)
   
   
3. Decide between prospective (e.g., insurance experience rating) or retrospective allocations (e.g., insurance retrospective rating)
   
   
4. For each cost, determine its value and how it will be allocated
   
   
   
   • exposure base (e.g., sales, annual budget, floor space, payroll, number of full-time-equivalent FTE employees, square footage, property values, number of vehicles, number of miles driven)
     
   • experience base (e.g., claims frequency / severity, retained losses, loss reserves)
     
   • per-occurrence limit (e.g., $10,000/claim or $25,000/claim, etc.)
     
   • aggregate limit (i.e., accounting for numerous small claims)
     
   • experience period (e.g., prospective plans 2-5 years, retrospective plans 1-3 years or weighted averages)
     
   
   
5. Perform trial calculations - make adjustments as necessary
   
   
6. Determine any minimum / maximum costs for each allocation time period
   
   Consider additional aspects such as how cost allocations may affect individual locations, departments and managers. Enlisting their input and support is critical to the success of the system. For example, a department with higher risks should be allocated more charges (e.g., product liability premium) than those with fewer loss exposures. Do the results have a significant adverse affect on a particular department's budget?
   
   Will your company's accounting system support your proposed cost allocation system? Is the system easy to understand and to administer? Is it subject to manipulation?
   
   Is it flexible enough to account for inflation or other anticipated changes such as expected company acquisitions? Does the proposed system have senior management support?
   

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