Strategic Cost Management – A Business Imperative for Middle-Market P&C Insurers

Thoughtware Article Published: Oct 12, 2020
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Improving underwriting performance through better pricing of insurance risk and digitization of the insurance value chain (quote and bind to claims settlement) is essential to driving long-term value and bottom-line growth in the property and casualty (P&C) insurance sector. We know that we’re stating the obvious, as many middle-market P&C insurers are in different phases of their technological transformation journeys. However, the potentially long-term adverse effect of COVID-19 on the general economy has made strategic cost management a critical business imperative for middle-market P&C insurers. According to a McKinsey study, “The best carriers stand out with their exemplary cost management. They closely monitor costs and enforce standards.” In fact, management of top organizations understand that strategic cost management enables long-term growth, allowing organizations to invest in their core competencies and better position their company to weather economic downturns.

Current Reality

A booming stock market, staggering decline in gross domestic product, bleak employment picture, high levels of bankruptcies, stalemate on a second round of fiscal stimulus, etc., characterize today’s economic environment, which suggests a tremendous amount of uncertainty over the next several years, according to the S&P Global’s 2020 U.S. Property & Casualty Insurance Market Report. Although the insurance sector has fared much better than other sectors of the economy over the past six months, with a stable outlook according to AM Best, the headwinds and competitive nature of the insurance industry make it critically important for middle-market P&C insurers to improve their operational efficiency through a disciplined and streamlined operating cost structure. This will allow for further allocation of financial resources to the business’s revenue-producing functions to drive growth in this environment. On average, P&C insurers with revenues ranging from $200 million to $1 billion incur an expense ratio of 29 percent compared to a sector average of 271 percent  during 2019. However, leaders in the P&C sector enjoy an expense ratio ranging from 17 percent to 23 percent2 , suggesting that middle-market insurance companies as a group have some catching up to do to achieve the level of operational efficiency generated by the top P&C insurers.

What Can Middle-Market P&C Insurers Do?

It’s no secret that declining investment income and a tight underwriting margin have heightened the focus on cost. It’s also well documented that cost management is a persistent concern of P&C insurers—and that concern is even more amplified in the current environment. The view that a company can attain a cost management competitive advantage through the traditional and archaic annual budget-setting process that seeks to reduce cost by applying a blanket expense reduction target to expense line items will likely be ineffective. We believe that a sustainable approach to attaining a competitive edge in cost management starts with making it a strategic priority that becomes ingrained in the organization’s culture, followed by investing in the right technologies and conducting an efficiency study.   

Cultural Shift

In theory, many companies have a strategy to reduce cost and improve productivity. However, more often than not, that strategy is at odds with the ingrained practices and attitudes of the company’s culture, according to a Harvard Business Review article. Because the P&C insurance sector is a fiercely competitive industry, management of middle-market insurance companies should infuse a cost management strategy mindset into its organization’s culture and its mission to drive profitable growth. While many organizations have implemented financial planning and analysis processes and budgetary protocols, those tend to be top down and disconnected from the broader organization’s mission and value proposition. For example, GEICO’s mission statement is “to provide affordable and dependable direct auto insurance to drivers across the United States, while also representing our customers in their time of need following an accident.” As a result, GEICO boasts one of the P&C industry’s lowest expense ratios of 17 percent. 

An organizational cultural shift demands buy-in from senior management to set the right tone at the top, a talent pool that’s aligned with the company’s focus and direction, and most importantly, a cost management strategic plan that takes “bad” costs out of the business to allow for investments in capabilities that further the organization’s business imperatives. 

Investing in the Right Technologies

Acquiring and embedding the right technologies into the insurance value chain to streamline the process from initial interaction to claims settlement is a strategic imperative across the P&C insurance sector. While many middle-market P&C insurers have been slow to adopt transformative technologies, many large insurance companies either have implemented or are currently implementing major system modernization initiatives to enhance business processes, increase collaboration, improve customer experience, and reduce cost. Many of these initiatives include the use of software tools, such as robotics process automation, to drive efficiency and mine big data. Insurers not actively seeking to drive efficiency through steps such as modernizing their systems to streamline their noncustomer-facing functions are putting themselves at a competitive disadvantage. The right combination of technologies should improve the experience of current and potential customers, allow for the use of big data in the underwriting process to improve pricing, and naturally take cost out of the business. To help investment in technologies generate the intended benefit, management should ensure that cost benefit analyses are performed and reviewed by the highest level of management and periodically evaluated against key performance indicators (KPI). 

While no one could have predicted a pandemic with a severe economic fallout, COVID-19 has crystalized the superiority of tech-enabled companies for most organizations. Although tremendous uncertainty still exists, it’s critical that middle-market insurers’ management and the board continue with their journey to tech-enable their insurance value chain to better prepare their organizations for success in an increasingly competitive industry. However, the pace of the transformation journey may need to be moderated to incorporate lessons learned from the pandemic’s effect. The bottom line is management of middle-market insurance companies should continue to invest in technologies that enable the insurance value chain to drive operational efficiency and improve the long-term financial performance.

Conduct an Efficiency Study

With a cost management strategy in place and a plan to invest in the right technologies, an important next step is to prune the organization of “bad” costs through an efficiency study. The objective of the efficiency study is to identify: 

  • Areas where financial resources are being directed that aren’t germane to the company’s strategic capabilities 
  • Functions and processes that aren’t being managed in the most efficient and cost-effective manner possible, including potential duplication of efforts

An efficiency study is akin to a health checkup and can be broken down into four phases:  

Phase One

An efficiency study usually starts with a KPI benchmarking analysis of the peer group and the industry’s most efficient performers to identify lagging indicators requiring closer examinations, the associated risks, and formalization of an improvement plan that’s aligned with the organization’s strategic priorities. 

Phase Two

The second phase involves a deep dive into business processes to identify areas to improve productivity as well as a scrutinization of expense line items. The key output of this phase includes the identification of redundant tasks and opportunities to execute tasks more efficiently and reduce overall effort, where possible. Another key output of this phase is the identification of quick wins—opportunities to eliminate or reduce expenditures, e.g., renegotiate service contracts or take out to bid, without sacrificing quality or adversely affecting the organization’s value proposition. 

Phase Three

Phase three involves thoroughly reviewing the findings with the management team and developing a timeline and implementation plan to embed the findings in the organization. 

Phase Four

The fourth and final phase requires organizational discipline and involves a periodic evaluation of implementation activities to assess whether findings are being implemented appropriately in accordance with the agreed-upon timeline.

Concluding Thoughts

“If you always do what you’ve always done, you’ll always get what you’ve always gotten.” It was true when Henry Ford said it and is still true today. According to data from S&P Global, the expense ratio of P&C insurers with revenues ranging from $200 million to $1 billion hasn’t changed materially in the past five years (2015 to 2019) and ranges from 29 percent to 32 percent. Moving the needle on the expense ratio won’t happen overnight, and it won’t happen without taking “bad” costs out of the business, investing in new capabilities that support the organization’s mission, and most importantly, implementing a cultural shift in how the company views and manages costs.

The views expressed above do not constitute professional advice. You should not act on the information contained in this BKD Thoughtware® article without obtaining professional advice.

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S&P Global 
Progressive annual report and GEICO’s SNL data

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