The second chapter of the recently published Global Insurance Report 2023 dives deep into the trends shaping commercial property and casualty insurance and the opportunities available to this market as a result. In this episode of the McKinsey on Insurance podcast, three authors of this chapter—McKinsey partners Susanne Ebert, James Polyblank, and Shannon Varney—discuss what insurers should consider to be successful in the current market landscape and what the future holds for the industry. The following transcript has been edited for clarity.
Shannon Varney: In the report, we talk about a number of external pressures that the market is facing, some familiar and others new. James, can you talk about these challenges and the changes that you’ve seen as a result?
James Polyblank: It has been a tremendous couple of years for commercial-lines carriers. The results from 2021 and the early results from 2022 suggest that most insurers had combined ratios of less than one hundred—and that’s following some terrible years. This is a cyclical industry, however, and we do see some challenges ahead: rate growth is starting to slow, inflation is driving up lost costs, and brokers continue to move up the value chain. At the same time, there are a lot of opportunities. The nature of risk is changing faster than it ever has before. If you think about the rise of cyber risk, natural catastrophes, climate change, and the new technologies that will help combat climate change, there are many roles for insurance to play in these spaces. The challenge is that there is not enough capital and not enough talent.
Shannon Varney: Do you consider now to be the time to actively address the growing protection gap as well? How can insurance leaders help serve as conveners to address the protection gap, and how should they strengthen their resilience in these volatile times?
James Polyblank: The easy answer would be “grow.” But my advice to insurance carriers is to think about their source of distinctiveness as they grow, and they should focus on a few areas when doing that.
The first is where they are competing. That will allow them to build distinctive products and services to attract clients based on more than price. Second is technical excellence. With a deep knowledge of a particular product or sector, it’s easier to think about, for example, the effect of inflation and to factor that into technical pricing models.
Third is distribution strategy. Once you’re clear on your source of distinctiveness, you can decide which products you want to play in the open market and underwrite yourself or go direct with, as well as in which markets you want to follow others or use managing general agents because you want exposure but don’t have the capabilities. And finally, knowing their source of distinctiveness helps carriers concentrate their decarbonization efforts because if they’re clear on where they focus in the market, they can think about how decarbonization efforts affect that product or sector.
Susanne Ebert: Let’s not forget one critical lever to strengthen resilience. If commercial-lines carriers want to navigate the fast-changing nature of risks, they must fundamentally transform their capabilities in functions such as pricing, underwriting, claims, and risk engineering. Many insurance carriers are investing heavily in data and analytics to develop underwriting workbenches that enable more data-driven underwriting. To bring the value from these investments to life and succeed in insuring new emerging risks, insurers have to expand their talent pools beyond traditional insurance to target profiles with deep tech expertise or a science background and focus on mentorship, coaching, and training for new tools and capabilities. Transforming capabilities goes hand in hand with transforming the organizational culture. Many underwriters and claims handlers rely on their experience rather than on data-driven approaches and advanced technologies, so managing the shift from art to science is becoming even more important.
Shannon Varney: We mentioned before that insurance firms are growing, but a lot of this growth has been driven by rate hardening. After adjusting for rate growth, we can see that global premiums are behind global GDP growth during the same period. How should we view that dynamic in the context of commercial lines’ relevance to the global economy?
James Polyblank: When we looked at what was happening to commercial-lines gross written premiums as a percentage of GDP in 2018, we found that GDP was shrinking. When we compared these in 2022, we found that GDP was growing. But of course, we’re in a hard market, so we stripped out the effective rate to find out how the underlying risk exposure that insurers were taking on was affecting GDP, and we found GDP was dropping. To quantify that, in North America, GDP went from 1.8 percent to 1.6 percent—that’s a decline of more than 10 percent. In Europe, GDP went from 0.9 to 0.7, which is a decline of 25 percent. These are quite alarming drops in the relevance of commercial lines in the economy.
Shannon Varney: What are some actions that are important for insurance carriers to do right now to expand their relevance in the industry?
Susanne Ebert: Product and policy design can play a big role in expanding the relevance of the commercial-lines industry. For instance, to provide coverage for the net-zero transition, insurance carriers need to build the muscle to underwrite prototype-like risks, such as for decarbonization technologies. Because historical data is lacking, this is not trivial. Products could also be tailored more to certain segments. For instance, smaller companies within a specific industry often face similar types of risks and prefer a more hands-off approach to their insurance coverage. Simplified wordings and products tailored to bakeries and carpentries, for example, could help.
“Underwriting the future” requires more than just a narrow product and policy focus. Services to prevent and mitigate risks play an increasing role in expanding the relevance of commercial-lines insurance. For instance, in cyber, the most engaged carriers help clients reduce cyberthreats by providing threat intelligence, consulting, and employee training, and many insurance carriers partner with specialized cybersecurity firms.
James Polyblank: With regard to cyber, one fact that alarmed me as we did this research was that economic losses from cyber in 2020 were $950 billion globally, according to McAfee. The cyber insurance market was $7 billion in the same year, in which there was a protection gap of about 99 percent. Part of closing that gap will mean focusing on risk mitigation, but it also requires capital. Closing the entire gap would mean doubling the size of the global commercial-lines industry. In terms of alternative capital, what else could the industry do?
Shannon Varney: First, it’s important for insurers to think about capital and capacity in a holistic way that fully contemplates the capital markets in addition to their own balance sheets. Alternative reinsurance capital as a percentage of the total has nearly tripled over the last several years, but we still find that it’s relatively untapped in its potential. Second, insurers should think about alternative capital to help them close the protection gap that exists even beyond the natural-catastrophe market. Investors are wary of participating in the market now because of recent losses and trapped capital, but alternative capital will be an important part of the solution. For example, the coverage gap for cyber is upwards of $80 billion, and capital markets will play an important role in addressing that gap.
It’s also encouraging to see the launch of innovations like the cyber catastrophe bond, which is an example of an innovation that brings in third-party capital to provide new coverages. Last, we’re also encouraged by the growth of these new digital-first platforms that are building more-efficient marketplaces to bring together the cedent side and institutional investors. These players will be important in prompting greater participation of institutional investors in the insurance market.
James Polyblank: There’s also an opportunity to make these products simpler. Most investors are fairly smart and institutional, so making products simpler so it’s clear what risks they are exposing themselves to may be a way of broadening the investor base.
Susanne Ebert: Also, many investors are still cautious about entering new markets because of limited historical data, untested models, and high volatility. Recent developments that help insurers monitor their exposure are a sign that the industry is increasing transparency, thereby improving the value proposition for investors, laying the foundation to raise capital, and increasing capacity for risks beyond natural catastrophes.
Shannon Varney: While the market today is complicated, it creates an exciting opportunity for insurers, whether it’s through the role they play in accelerating decarbonization or how they help address new, emerging risks.