Scale matters … to an extent: Playing the scale game in insurance

Large insurers can turn their scale into a strong competitive advantage—if they recognize that fully harnessing the benefits of scale requires managing complexity.

One of the core beliefs in many strategy departments is that size is beautiful. Economics textbooks show the standard correlation between growing your size and bringing down average costs. This simple relationship has led to continued consolidation over time in most industries, where a few global leaders clearly emerge.

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Yet, there is a puzzling lack of scale advantage captured in the insurance industry. This holds particularly true in property and casualty (P&C) insurance. In life insurance, in the past few years some players have been able to realize economies of scale in sales, operations, IT, and support. Contributing factors have included the use of technology to improve productivity and a new focus on cost reduction in the face of declining premiums in many lines of business—which have only sharpened in the midst of the COVID-19 pandemic. In this evolving market environment, effective and efficient back-office processes are becoming a necessary precondition for success more than ever before.

Furthermore, while scale effects can be substantial, our research has found that they tend to eventually taper off—for example, beyond $1.5 billion to $2.5 billion of gross written premiums (GWP) for life insurers. This tapering at a relatively small size, given total GWP of leading players, is primarily due to the underlying complexity of these large organizations. In this article, we outline the nuances of scale in insurance and outline opportunities to reap the full benefits of scale.

Scale is king across life and P&C lines

Sidebar

Our research has found that, after several years of struggling to consolidate operating models following mergers and acquisitions, large insurance players in developed markets are becoming more successful at realizing their scale advantages (see sidebar, “About the survey,” for a definition of methodology). In US life insurance, for example, players with more than $1.5 billion in direct written premiums (DWP) in 2019 (26 out of a total of 89 carriers analyzed) had a 30 percent lower cost ratio than players with less than $0.5 billion DWP. Across developed markets, McKinsey’s Insurance 360º benchmark shows that larger players (more than $2 billion GWP) achieve operating costs that are one-third that of smaller players (Exhibit 1). While these scale advantages are evident across all core functions, they are most obvious in support functions such as finance, legal and compliance, and audit.

Large life insurers in developed markets realize significant economies of scale across functions compared with smaller players.
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These strong scale effects are a recent development: in 2012, the difference was smaller—particularly in the mid-tier range of $1 billion to $2 billion GWP (Exhibit 2), as many carriers were only starting to fully integrate acquired portfolios, many functions were still decentralized, and digitization was still relatively nascent in insurance. When we look at the individual products within life insurance, we find that scale effects are particularly pronounced for savings and pensions products (Exhibit 3). For biometric risk products, which have smaller average policy sizes, scale effects are only half as big.

The impact of scale on life insurers’ operating costs has increased in recent years.
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On a product level, scale effects are more pronounced for savings and pension products than for risk products.
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Surprisingly, in contrast to life insurance, the scale advantage is less clear at first glance in P&C (Exhibit 4), as differences between product lines blur the overall picture. In our Insurance 360º sample, total operating costs do not decline with size for P&C overall. However, some products demonstrate clear evidence of economies of scale in individual segments. In P&C non-motor retail in developed markets, for example, larger players (more than $600 million GWP in non-motor retail business) on average achieve 40 percent lower cost ratios in claims handling (Exhibit 5). Similarly, P&C direct players above this size achieve claims-handling costs that are, on average, 24 percent below those of smaller players. In commercial lines, the largest players achieve total cost ratios 25 percent lower than those of the smallest players. 1

Overall, P&C insurers in developed markets capture limited scale effects.
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In some P&C product segments in developed markets, such as non-motor retail, scale effects are evident in functions such as claims.
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The sources of scale advantages

One primary driver of scale advantages is technology—both in terms of advantageous IT cost ratios and digital enablement of other functions. Technology is a critical enabler for carriers to “plug into” various digital ecosystems or aggregators or to create winning direct business models. From an efficiency perspective, large players have strong advantages from the inherent fixed-cost nature of IT development and maintenance spending, regardless of GWP volume. Such fixed costs include implementation of features to ensure compliance with new regulations, the provision of interfaces into aggregators and broker platforms, and so forth. Other elements, such as hardware costs or license fees for standard software, vary more but are still typically less expensive per unit for larger players compared with smaller-scale players. Software-as-a-service and cloud solutions somewhat mitigate these disadvantages for smaller players, but, all told, IT still represents a significant source of scale advantage for larger players.

Investments into digital innovations also tend to provide bigger benefits for large players. Investments in automation of core processes, for example, pay off only for processes with a certain frequency, and the benefits of additional digital services or self-servicing tools also scale with the number of customers.

Talent acquisition and retention also benefit from scale, as large players are more likely to have the means to build substantially bigger and more specialized teams. This is particularly true in capabilities that are currently highly sought after, such as analytics and design. It is true that large incumbents don’t always win top talent over big tech firms and innovative insurtechs. But market leaders tend to have more ability than smaller players to build large teams with higher salaries and more development opportunities, as well as launch incubators and partnerships that set apart the most innovative insurers and attract members of that highly sought-after talent pool.

Beyond technology, large players can also benefit from substantial skill and operating-model advantages. Examples include a critical mass of specialist claims experts or actuaries, as well as call centers and back-office entities operating at a scale that allows effective load balancing and capacity for setting standards and managing performance.

Achieving the scale impact through reduced complexity

Today, many large insurers do not capture the full benefits of their scale. In the Insurance 360º sample of the largest life insurers (those with more than $2 billion in GWP), bottom-quartile insurers had cost ratios around 150 percent higher than top-quartile players. Similarly, large P&C insurers often have cost ratios at or above industry levels. Clearly, scale alone is not sufficient to secure a cost-ratio advantage.

To capture the full scale advantage, insurers must reduce complexity in three areas: products, operating model, and technology. Often these complexities are a result of common challenges, including redundancy introduced by M&A, insurers’ desire to offer discrete products for a wide variety of customer segments, or fragmentation hidden among legacy in-force products that continue to need servicing for decades after they’re sold. It is crucial to address the complexities found in all three areas; tackling them in isolation with lead to gains but reduced overall impact. These moves should be considered by large insurers looking to make the most of their scale, but they are also relevant to smaller and midsize players looking to optimize their operations even in the absence of scale.

Product portfolio simplification

An insurer’s commercial success stands or falls with its products, and many insurers continue to offer a wide range of products, seeing it as a necessary pre-condition to compete effectively within a market segment. However, few insurers take these products off the books once they stop being useful. Complexity of the product portfolio creates a number of challenges, including pricing leakage due to retaining products with low or negative margins; divergent, fragmented methods for processing, operations, and claims; and higher IT costs due to the need for multiple back-end applications for different products. Indeed, reducing a complex market offering is the first step in overall complexity reduction.

Product portfolio analyses at several insurance companies showed that the top ten products by line of business typically account for more than 70 percent of units sold. The remaining products often have a marginal contribution only. And yet such a variety of market offerings often comes from the belief that customers and agents demand an array of complex products when, in fact, the opposite is often true. According to a recent survey of consumers in Eastern Europe, 2 only 35 percent of respondents agree that modular 3 motor and property insurance products are simple, clear, and transparent, while more than 50 percent strongly believe this to be true for packaged products. In short, there is a mismatch between what insurers provide and what customers truly want.

Product simplification starts with a review of the existing product portfolio. Insurers should gain full transparency on each product’s profitability, volume, growth, capital consumption, and product architectures, as well as each product’s complexity in terms of service and IT support. These findings can inform elimination of selected products in both the new business and legacy portfolio through various means, including strategic divestment of portions or entire blocks.

Insurers can then turn to building a more modular product architecture that reduces complexity of the remaining portfolio by limiting the number of customization options to just a few modules that can be combined freely or made into predefined packages. This architecture can be designed to define overarching rules and structures at the customer, actuarial, and technical levels. Customer considerations include the extent of product configurations and differentiation needed to serve different channels, customer segments, and company or brand. At the actuarial level, decisions revolve around product definition, including basic structures, rules, tariffs, and terms and conditions. And at the technical level, product structure would be determined by how many contract component bundles, contract components, and coverage elements are needed across the various lines of business.

Applied to the whole product catalogue across all channels, all customer segments, and all brands, such product simplification has proven successful. In P&C, for example, the number of tariffs for HUK-Coburg, a market leader in cost, is less than half of traditional players. Another major European insurance player offers only two motor insurance products in one country, and a German insurer limits its offerings for car insurance tariffs to a few add-ons.

Operating model transformation

Convoluted operating models are the next hurdle for insurers to overcome. Leading carriers are reimagining their operating models by putting the customer journey at the center, consolidating fragmented operations, and outsourcing through strategic partnerships with service providers.

To start, reimagining operations by focusing on the customer’s point of view can improve stakeholder satisfaction while reducing costs. Insurers can define the stakeholder journey by the touchpoints required to address a specific need. Insurers can then determine weak points in the journey where customers are more likely to withdraw and focus on solving for those issues using automation, analytics, and digitization.

For many insurers, transforming the operating model will involve consolidating disparate operations and reconsidering outsourcing options and strategic partnerships with service providers. Many insurers have already centralized core functions or consolidated them in separate, lower-cost service centers. A recent example includes QBE, which implemented global operating-model improvements on top of technology consolidation as core means to achieve a reduction in their expense ratio.

In some cases, service providers can offer access to distinctive skills and services at lower costs than could be achieved with internal teams. These can be either smaller, highly specialized providers or large IT or busines process outsourcing players. Recent examples include sourcing of highly specialized capabilities—for example, within claims management or analytics-driven sales programs. At a larger scale, comprehensive outsourcing for IT and operations, or insurance- and platform-as-a-service models, is also growing. Sourcing models are also evolving away from traditional outsourcing and toward gain-share models and partnerships. Examples include the rise of insurance-as-a-service or white-labelling models such as ELEMENT or Neodigital in Germany.

Technology transformation

When it comes to individual players, one consistent theme emerges: almost all large players with cost ratios above the scale curve face substantial issues with legacy IT. As an example, one player has more than 300 active IT systems, with more than 40 percent slated to be decommissioned, leading to cost ratios that are twice as high as the market average for other players of its size. Another player is currently implementing a new core system for new business while continuing to run the in-force business on legacy IT with a history of underinvestment. The combination of a high share of manual processes with additional resource needs for the new implementation project lead to cost ratios 40 percent above peers of comparable size. On top of this, new business volume declined, leading to a reduction in market share and an increasing fixed-cost burden for the remaining book. Early evidence from COVID-19 pulse surveys indicates a strong positive influence from digital capabilities and growth—further exacerbating the disadvantages of legacy IT.

Significant value from system modernization is derived from the business impact (for example, policies per full-time equivalent), not just IT cost reduction. A small survey of nine leading insurance companies found that the more complex the IT system, the higher overall operations and IT spending (Exhibit 6). IT costs per GWP and operating costs per GWP are lower if the insurer has one life core system instead of multiple systems.

A study of nine leading life insurers found that the more complex the IT system, the higher overall operations and IT spending.
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A similar statement holds true for the number of systems that are necessary to view the full customer profile: in our sample of nine life insurers, those with one customer data system have IT costs that are 29 percent lower per annum as a percent of GWP; and for operating costs, both cost ratios are 12 percent lower. These trends suggest that insurers hoping to address issues of cost and agility across IT should review the state of their IT and tackle needed modernization and consolidation.

Pursuing application rationalization can be one of the core steps in this. It helps carriers cull their application portfolios and, as a result, reduce costs, increase IT system quality, and enable agility. For example, HDI Germany recently announced the decommissioning of 220 systems. Another major global insurance company identified that roughly 30 percent of its applications were ripe for decommissioning using an application-rationalization program. The outcome: an IT cost base reduction of 15 percent after the global rollout.

Some carriers also leverage the scale of their groups across different markets. Allianz, for example, is building a European direct player based on one common IT platform and one master product model across all countries. It is already leveraging one core platform, the Allianz Business System, across many of its markets. Axa is leveraging the Guidewire platform for many of its markets across different global regions. The potential benefits from such a consolidation can also be seen, for example, from the value capture that life insurance closed-book consolidators manage to achieve. All leading players follow a “no exceptions” policy of migrating each and every newly bought book on their own platform to then shut down the legacy IT and capture synergies from shared IT run and change costs. From an aggregated view across multiple case examples, we find that the best closed-book players manage to increase return on equity by between 1.0 and 1.5 percentage points through cost reductions in operations and IT alone. Similarly, the Insurance 360º benchmark finds that the mature life insurance closed-book players in the United States achieve 30 percent lower operations and IT costs than their regular insurance peers. The IT consolidation is the core enabler for this shift.


Business complexity is the root cause of puzzlingly high cost ratios among even the largest scaled insurers. As a starting point, insurers of all sizes need to critically review their own potential to operate at competitive levels, both regarding cost ratios and the necessary internal capabilities. In which areas can they capitalize on scale, given both size and ability to run a function in a highly streamlined way, achieving both efficiency and effectiveness?

Cutting costs is mission critical for insurers to remain competitive and become more agile in the face of market pressures. By identifying unnecessary complexity inherent in their businesses, insurers can begin to unwind their complicated products, processes, and IT. The added benefit is a more agile business that can outpace the competition in the pursuit of new opportunities. By simplifying product offerings both externally and internally, optimizing processes, and modernizing and strengthening the IT landscape, insurers will be able to make decisions and act on them quickly, a critical advantage in a sector with rising competition. It won’t be simple, but insurers can look to those companies that have already made inroads for a path forward.

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