A market environment demanding improved profitability; new B2B2C business models where digitized, cost-effective operating models define the “right to play;” and new market entrants from tech and other industries are bringing productivity once again to the top of insurers’ agendas. McKinsey spoke with Ulrike Vogelgesang, a partner in the Hamburg office, to understand more about insurance productivity.
McKinsey: What has led to the imperative around productivity, and what role does technology play?
Ulrike Vogelgesang: Technology offers completely new possibilities to enhance productivity. Highly digitized and automated operating models provide a step change on unit costs. As a result of these technology shifts, new offerings and players are entering the market with completely different operating costs. And it has become much easier to leverage white labelling providers. This challenges traditional players, and some of the incumbent leaders are responding by forming collaborations—for example, a market leader in motor has recently announced a partnership with an insurance provider, to start a new motor offering.
As a result of technology shifts, new offerings and players are entering the market at a completely different level of operating costs.
Because overall profitability remains a challenge in the industry (e.g., RoE 9.0 percent in 2020 for European Insurance, down from 16.3 percent in 2005), there has been increased pressure on insurers from investors to enhance their productivity.1
McKinsey: How have productivity improvement efforts changed over time for insurers?
Ulrike Vogelgesang: The first waves of productivity improvement programs focused on reducing costs for existing products and processes—through lean methodologies or automation, for example. The next level of productivity improvements goes further; it focuses on reducing complexity in products, distribution models, operating models, and underlying IT platforms, as well as developing completely new business models that enable a step-change in productivity, such as run-offs in life insurance or building digital attackers in property and casualty insurance.
We’re seeing some clear trends in the market as a consequence of these developments.2 First, the gap between leaders and laggards on cost is widening, for example in P&C insurance. Bottom quartile players have cost ratios ~70 percent higher than top quartile players in 2020—up from a 45 percent difference in 2015.3 And this is driven not only by the entrance of new low-cost players but to a larger extent, by the high-cost players having worsening cost ratios.
Second, in some fields, notably life insurance, insurers are increasingly able to leverage their scale, meaning that large players achieve substantially better cost ratios than smaller ones, up to half as low.
Third, insurers have made significant investments in technology. In P&C, for instance, we see the share of IT costs in total operating costs increasing, from 26 percent to 30 percent between 2012 and 2019,4 while the share of operations costs is declining. In fact, there is evidence that players who invest more in IT reap the benefits from higher growth and lower combined ratios a few years down the road.
There is evidence that players who invest more in IT reap the benefits from higher growth and lower combined ratios a few years down the road.
And fourth, in parallel, the share of direct wage costs is also declining (from >45 percent in 2015 to ~35 percent in 20195) as insurers harness technology services and products, external providers, or shared service centers to a larger extent. Reaping the full benefits of this will be key to unlocking further performance improvements.
McKinsey: How should individual insurers move forward?
Ulrike Vogelgesang: To tackle the root causes of productivity, insurers need a clear strategy and go beyond tactical cost reduction levers. At a macro view, identifying areas in which price and productivity will be a key competitive factor, such as products with a high share of new business driven by aggregators, or areas in which current productivity is at unsustainable levels, such as life closed books, can provide the needed focus.
Once they’ve identified these areas, insurers need to honestly assess options to reach a competitive cost base, including radically simplifying business models, or implementing far reaching changes in operating models through partnering or outsourcing.
Ulrike Vogelgesang is a partner in McKinsey’s Hamburg office.
For more on insurance productivity, see:
- Tech-driven insurers: How to thrive in 2030
- Will your insurance IT investments pay off?
- Scale matters. . .to an extent: Playing the scale game in insurance
- The next frontier for sustainable growth: Capturing the cost advantage of direct insurance
- The productivity imperative in insurance
- Evolving insurance cost structures