The Status Quo In Insurance and the Consequences

“The immediate effects of disruption will impact the banking sector, however, the magnitude of the impact will mainly be felt in the insurance sector” - World Economic Forum

The insurance industry has awakened from its deep sleep of stale innovation to a world of low-interest rates, regulatory changes, switching demographic behavior and technological advancement. In response to these factors, the insurance industry has started to rethink their business models and processes in order to safeguard their current position and remain competitive. This is for the better because not doing anything has drastic consequences as can be seen in this article. 

Lower portfolio yields

As pictured in figure 1 P&C insurance portfolio yields have a cumulative decline of almost 2% over 10 years. One prominent reason for this are the low interest rates which have a negative impact on portfolio yields. Even if interest rates were to increase again, revenues would still be lagging behind. Second, insurance products are being commoditized through more transparency created by value comparison websites. Third, new entrants like insurtechs and large technology firms are putting pressure on traditional insurers by being more efficient.

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Figure 1: Source - National Association of Insurance Commissioners

High cost inefficiencies

In figure 2 we can observe by how much insurers could reduce their total value chain costs through technological innovation.  If an insurer were to implement all the necessary technologies over 5 years’ time, it could reduce costs with 20% in claims management and 40% in the remaining components of the value chain. Note that claims management represents more than 50% of total costs.  

Additionally, McKinsey estimates that life insurance and P&C carriers have 30% to 40% of their expenses held up in the top 20% to 30% core end-to-end processes. In other words, insurers could easily increase its profits by optimizing these processes. Furthermore, many carriers also have smaller-scale processes involving the use of paper and duplicative tasks that can be cost-effectively digitized over a short period of time.

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Figure 2: Source - Bain & Company, Google

Threat of new challengers

However, these technological opportunities go both ways. Insurtechs can pick into a certain activity and start doing it themselves. Gartner argues that P&C insurers who could not make the transition to mobile and online transactions in time, will be left behind with high costs and a decreasing market share as a result.

Luckily for insurers most insurtechs are currently focusing on the more accessible parts of the value chain, such as distribution in P&C, as can be seen in figure 3. This segment is being targeted because it has more customer interaction compared to the other segments.

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Figure 3: Source - McKinsey Panorama, Insurtech Database

Note that life insurance is substantially the largest part of an insurer’s portfolio in terms of claims and premiums. It is also the most profitable segment due to large spread between premiums and claims. (see figure 4)   

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However, some insurtechs are starting to realize that their digital offering could be expanded to the full value chain (excluding risk carriage).

Qover for example is an insurtech based in Belgium that was able to raise 7M EUR for its activities. They digitalize most aspects of the value chain (excluding distribution and risk carrying) and operates as a cover holder at Lloyds of London. They further partner up with any party well positioned to sell their products whether it be broker or car salesman. As a result, they are able to significantly reduce costs, more than what an insurer could hope for over the next years. In other words, insurtechs have the potential to make incumbent insurers obsolete.  

Before other insurtechs start to replicate Qover, incumbent insurers need to leverage their assets and speed up the digitization process. Traditional insurers nevertheless have a head start compared to insurtechs:

  • Complex regulation remains very deterrent for new market entrants.
  • Customers do not easily switch providers making it difficult for new entrants to acquire new customers. Note that millennials are more tech-savvy and are not yet bound by insurers, making them a perfect target group for insurers.
  • Large capital resources and in-house underwriting skills. Note that these skills might be based on obsolete data plus new entrant might use more accurate and modern forms of data.

Threat of existing incumbents

Another reason for speeding up the process is the uneven distribution of rewards as is shown in figure 5. A study by McKinsey has proven that digital innovation produces negative externalities in terms of value distribution between fast and slow movers. Digital technology would shrink slow movers’ revenue growth by 3.5% a year in favour of fast movers. This phenomenon can be explained by the “winner takes it all” effect of digitalization. Winners can be translated to insurers that move decisively into innovation. Those companies generated a revenue growth that was on average two percent higher than slow movers.

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Figure 5: Source - INESE, McKinsey Insurance Database Germany

As can see be seen, in all three countries the market leader is taking most of the profits for himself while the rest of the industry is making losses. From the perspective of followers, digital threats might outweigh the opportunities. This proves that speed of innovation is of the order and that a wait-and-see strategy will most probably only lead to losses in revenues and market share.  

Key Learnings

Disruption is likely to occur in processes and services that provide the largest number of friction points for customers. Technology will therefore be a very important enabler in this regard as it allows for optimization of current processes. In addition, new markets entrants and current innovators will obviously also try and target the most profitable business aspects.

Although ultra-competitive and low-profit markets might seem unattractive at first, they could however turn out to be very interesting from a strategic point of view. They could for example allow for the extrapolation of customer data, which in turn serves as a valuable asset with respect to innovation and disruption.

Insurance disruption is still in its early stages. However, speed and agility are of utmost importance due to first-mover advantages and the winner-takes-it-all effect. Another inhibiting factor for both incumbents and new players is their ability to comply with new regulations in a timely manner.

The Author

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Thibault Dubois hold a master degree in general management from the Vlerick Business School and a master degree of business economics with a specialization in finance and business strategy from the University of Leuven. He his consultant for Initio since 2017.

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