Shifting cost curves to stay in the commercial insurance race
Article Synopsis :
Despite ongoing efforts to cut costs, U.S. commercial lines loss adjusted expense and underwriting expense ratios have not improved over the last 20 years. Over two-fifths of every dollar of U.S. commercial lines premium collected is used not to pay claims but to fund loss adjustments, commissions and brokerage, and underwriting expenses.
Cost management is not a new phenomenon. According to this report from PwC 75% of insurers have undertaken cost cutting programs in the last three years and 61% of insurance CEO’s plan to launch cost reduction initiatives this year alone.
While so many insurers have cost management on their agendas, few are achieving sustainable cost savings. Business complexity and fragmented technology environments often get in the way. Also, when cost cutting efforts fall short of tackling strategic and structural issues—not to mention cultural dynamics—costs tend to creep back up as leadership focus fades.
In light of the challenge, what should commercial lines insurers do? The report suggests four points of advice:
- Don’t try to shrink your way to greatness:
Driving toward the lowest possible expense ratio is not the key to long-term success. Underwriting is still king and likely always will be; you cannot sacrifice your underwriting prowess in favor of stringent cost reduction tactics or policies. Acquiring and developing strong underwriting talent and having appropriate data, analytics, and governance to guide decision-making are fundamental to strong performance.
Costs can be shifted from fixed to variable in order to a) align more closely with the size of the business and b) provide necessary market agility. Partnerships with MGAs can enable quick stand-up of new underwriting operations (with appropriate underwriting expertise) without having to build them from the ground up. This also allows for a quick exit if the new endeavor isn’t profitable.
- Manage costs for the enterprise, not one function:
Insurers should approach cost management at the enterprise level, setting targets for the organization and challenging the business units and functions to work together to identify opportunities to hit them. When tackled function by function, cuts may be made at the expense of other functions, thereby cutting capabilities others need to perform well (e.g., eliminating required fields at the first notice of loss may impact the granularity and timeliness of underwriting analysis), or simply shifting costs from one area to another (e.g., eliminating information gathering in the underwriting process means processing will have to do it, likely resulting in inefficient back-and-forth when gathering information).
- Cut features and services, not just costs:
Choosing where not to invest can be difficult; defining a strategic “way-to-play” is the first step in understanding which products, services, channels, and/or capabilities can be eliminated to better manage costs. For example, continuing to support legacy products and features (e.g., pay plans) can add significant complexity to an insurer’s operating environment, which adds cost and can stall efforts to upgrade platforms or add new features for future products. Choosing to transition existing customers to the latest products and features (or even exit certain markets) can be difficult, but it can be the right move to unlock growth, profitability, and cost savings across the rest of the portfolio.
- Put new technologies front and center:
When it comes to cost cutting, the traditional levers have not changed. Commissions, headcount, and IT remain significant areas of spend for insurance companies. However, there are innovative ways to reduce these costs. Offering certain value-added services to agents (e.g., taking on servicing) can indirectly bring down commission expense, artificial intelligence and robotics offer new ways to reduce headcount, and the cloud lowers IT costs and enables a more variable ‘pay-as-you-go’ model.
- Although a cost advantage has not driven commercial lines performance to date, times have changed.
- In the short-term, cutting costs will help insurers fund strategic initiatives that better position them for growth and profitability in their target markets
- In the mid-to-long term, insurers with a sustainable cost advantage empowered by efficient operations and a flexible cost structure will be able to compete more aggressively on both price and service and have the flexibility to allocate capital to the most promising market opportunities
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Digital Insurer's CommentsSo insurers have tried in vain to cut costs over the last twenty years. With the cloud, AI, and the sensor-driven digitization of risk itself, we’re sure the next twenty years will be completely different.
Radical new tools for cost reduction entering the insurance mainstream also bring incredibly exciting capabilities for improving overall operational performance. As manufacturers flocked to robotics over the last twenty years to boost efficiency and improve overall product quality on assembly lines, insurers will embrace RPA and AI to optimize core processes.
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