The differences in operating costs between most and least competitive insurance companies are staggering
Insurance is a cyclical business. Since the end of the financial crisis and lack of robust growth in the economy, the industry has been under immense cost pressure.
Effectively staying in business and making a profit is reserved for those who can bring their costs down while providing a superior level of service to their customers. Yet, cost efficiency also requires smart investment and in the wake of the financial crisis not all insurers have been able to find the right balance between cost cutting and investment. This has resulted in a great disparity between the top and bottom performers in the insurance industry when it comes to operating costs.
Mckinsey’s Insurance 360° Benchmarking (PDF opens) reveals how dire the situation looks by comparing top and bottom quartile operating cost performance. The study suggests that there is a staggering difference in cost base, certainly for P&C (particularly in operations and IT). IT costs, for instance, are more than double for the worst performing companies. Other business functions’ cost structures are in a similar state or even worse. What are the root causes of these disparities?
Immutable costs are mostly not to blame
The insurance industry has many cost drivers and some of these are what we could call “fixed”. They include: geography, size, product mix and sales channels.
As we can see in the chart on the right, the size of the insurer, or in other words their economies of scale, do not occupy a meaningful portion of the variance between top and bottom performers. Sales channels, product mix and geography on the other hand do have an impact, but they are the cost of doing business in an industry as mature as insurance.
The remaining cost variance, things that insurers can control, can explain 54% and 81% of the cost variance experienced in Life and P&C insurance respectively. In both cases, and in P&C especially, the enormous variance comes from factors that are under the control of management. So that brings us to the question, where can managers look to equalize their potential with the top performers?
Solving business complexity is a central issue
The insurance business is in the middle of two big shifts. The first was the financial crisis, which turned the industry from easily profitable to almost insolvent. The second is the shift we also see in other industries towards a much higher level of customer service than was expected by consumers in previous decades.
The initial scramble to deal with the wake of the financial crisis left many carriers on unsure footing that did not allow many to make the transformations necessary to compete in this new customer focused environment.
One of the biggest issues to deal with is business complexity. In the interest of creating a one stop shop, many carriers have added to their business through acquisitions, additional brands, new product lines and a slew of communication channels. Yet these often hasty efforts rarely resulted in consolidated customer facing or back office processes, resulting in many departments doing duplicate work with completely disconnected processes.
Along with this, all these additions came with their own IT systems and subsystems that were often incompatible as well as difficult, and costly to integrate. This left many executives waiting for a holistic solution to replace these in the future with the costs of keeping the lights on increasing further.
Although the “one stop shop” idea is great in principle, with poor execution it leaves something to be desired. From the customer perspective, it takes only a few interactions to realize that the one stop shop is actually a façade and the carrier losses the costs synergies they thought they would achieve with lower customer acquisition costs. In the back office the story is much the same, as the operating costs for multiple systems pile up and the complexity of it all becomes virtually unamenable.
Thus, the most important task bottom quartile insures have today is dealing with this complexity. Solving the tangled mess of hasty acquisitions will serve to create holistic customer facing processes, while also leveraging the economies of scale that can be achieved in the back office when multiple systems are not required to service different brands and product lines.
Top image purchased under license from Shutterstock