What drives insurance operating costs? (2024)

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Today’s unforgiving economic climate confronts insurers with a multitude of challenges, from the low-interest-rate environment to greater price transparency, customer cost consciousness, and sweeping regulatory changes. As a result, the profitability of life and property-and-casualty (P&C) players is barely above the cost of equity, and costs are emerging as the critical element in achieving competitive advantage. Yet when it comes to explaining persistent cost gaps compared with their peers, insurers often cite factors they regard as fixed—business-model decisions such as size, sales channels, product mix, and geography. Our latest research undermines that excuse: we found that management often matters more, and that’s how a handful of players have been able to demonstrate successful long-term cost management.

To uncover how top performers keep a lid on costs, we turned to our Insurance 360º benchmarking survey and its database of 38 life, 33 P&C, and 9 health insurers.1 The results revealed significant cost differences within the sector. In fact, the differences in operational costs between top- and bottom-quartile players were consistently more than 60 percent across every business function and, in some cases, bottom-quartile players had unit costs more than twice those of top-tier players (Exhibit 1).

However, this only tells part of the story. We also found that the cost drivers that are often considered carved in stone for insurers—size, sales channel, product mix, and geography—accounted for just 19 percent of the differences in unit costs among P&C insurers and 46 percent among life insurers. In short, differences in these four cost drivers simply do not explain the bulk of the disparity among industry players. So what does?

What drives insurance operating costs? (2)

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Management matters

Our analyses of the benchmarking data, combined with insights from our discussions with industry executives, suggest that four distinct root causes explain both the large remaining cost-level disparities and why insurers fail to optimize immutable cost drivers. All come back to what we regard as issues around management: business complexity, operating model, IT landscape, and performance management (Exhibit 2).

2

What drives insurance operating costs? (3)
  • Business complexity. Business complexity related to brands, sales channels, product mix, or customer-facing processes is an important driver of operating costs and limits insurers’ ability to leverage economies of scale. As a result, insurers with very large product portfolios and multiple brands and channels are also those with the highest costs on average. One insurer, for example, had introduced numerous individually negotiated discount schemes with a large number of brokers, leading to high complexity and sometimes inadequately priced contracts.
  • Operating model. High-cost players tend not to have consolidated or optimized the setup of their operating units. They may have back-office functions distributed across numerous locations with different processes and governance structures. Workload backlogs may occur in conjunction with underutilization, leading to a drop in customer satisfaction and deteriorating financial performance.

    Addressing these issues requires a comprehensive examination of the operating model, including processes, location footprint, supporting technology, employee skills, sourcing, and organization and governance structures. There is no one-size-fits-all solution—what optimization means will inevitably depend on the context. One insurer, for example, consolidated its existing operating units in one central location to gain economies of scale, while another created six global centralized operating units to have a location-optimized footprint and be close to local business units. By digitizing its insurance processes, another managed to reduce claims-regulation costs by 20 to 30 percent, processing costs by 50 to 65 percent, and processing time by 50 to 90 percent—and simultaneously improve customer service.

  • IT systems. A fragmented legacy IT landscape is often a root cause for failing to leverage economies of scale, driving high IT costs as well as mushrooming operational costs. When comparing the number of policies per full-time employee in operations for both life and P&C with IT spending per full-time employee, we found that insurers with complex legacy systems tended to have both high IT spending and low productivity, while those with streamlined IT managed to achieve high productivity with limited IT expenditure.

    One company tackled this issue by completely overhauling its P&C IT landscape, replacing legacy core systems with state-of-the-art standard software. As a result, it dramatically reduced costs per policy and cut time to market for new products to just a few weeks. In its life business—which still used the legacy IT system—costs and time to market remained in the bottom quartile. We also found that lean IT efforts can reduce costs by 20 to 40 percent, as well as cut errors.

  • Performance management. Performance management drives cost outcomes across all areas. We identified a frequent lack of rigorous performance management, resulting in costs rising again just a few years after the implementation of cost-reduction measures. Reducing costs sustainably requires embedding cost consciousness and continuous improvement into a company’s culture: a one-off program will not suffice. A sustainable performance-management approach means simultaneously changing mind-sets and behaviors, defining new performance metrics and targets, designing new processes, and establishing performance dialogues—all of which need to cascade through the organization. At one P&C insurer, for example, improving performance management in this way led to a 20 percent reduction in back-office costs.

Insurers still have the ability to improve costs in the four areas viewed as immutable: size, sales channel, product mix, and geography. Yet our research found that most of the cost differences among companies actually relate to management. Factoring in these imperatives allows insurers to do much more than just improve their expense ratios: it will give them the freedom to make the investments they need to continue to compete on the global stage.

Download the full report on which this article is based, Successfully reducing insurance operating costs: Insights from McKinsey’s Insurance 360° benchmarking (PDF–585KB).

Björn Münstermann is a principal in McKinsey’s Munich office, Georg Paulus is a specialist in the Frankfurt office, and Ulrike Vogelgesang is a senior expert in the Hamburg office.

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The article discusses the challenges insurers encounter in the current economic environment, including factors such as the low-interest-rate landscape, increased price transparency, customer cost consciousness, and regulatory changes. The profitability of life and property-and-casualty (P&C) insurers is highlighted as being barely above the cost of equity, making cost management a critical factor for competitive advantage.

The research conducted by the authors draws on the Insurance 360º benchmarking survey, which includes data from 38 life insurers, 33 P&C insurers, and 9 health insurers. The findings reveal significant variations in operational costs between top- and bottom-quartile players, with differences exceeding 60 percent across various business functions.

Interestingly, the article challenges the commonly cited reasons for persistent cost gaps, such as size, sales channels, product mix, and geography. According to the research, these factors only account for a small percentage of the differences in unit costs among insurers.

The core argument of the article revolves around the importance of management in explaining cost-level disparities. Four key root causes are identified as business complexity, operating model, IT landscape, and performance management.

  1. Business Complexity: The complexity related to brands, sales channels, product mix, and customer-facing processes is identified as a driver of operating costs. Insurers with large product portfolios and multiple brands and channels tend to have higher costs.

  2. Operating Model: High-cost players often lack consolidated or optimized operating units, leading to issues like workload backlogs and underutilization. Optimizing the operating model involves examining processes, location footprint, technology, skills, sourcing, and organization structures.

  3. IT Systems: Legacy IT systems are highlighted as a cause for failing to leverage economies of scale, resulting in high IT and operational costs. Streamlined IT efforts and modernization can significantly reduce costs and improve productivity.

  4. Performance Management: The lack of rigorous performance management is identified as a factor driving cost outcomes. Sustainable cost reduction requires embedding cost consciousness and continuous improvement into the company's culture.

The article emphasizes that while factors like size, sales channels, product mix, and geography are considered immutable, most of the cost differences among companies are actually attributed to management. By addressing these management imperatives, insurers can not only improve expense ratios but also gain the freedom to make strategic investments needed for global competition.

What drives insurance operating costs? (2024)

FAQs

What are the operating expenses of insurance? ›

Operating Expense means salaries, wages, cost of maintenance and operation, materials, supplies, insurance, and all other items normally included under recognized accounting practices, but does not include allowances for depreciation in the value of physical property.

What are the cost drivers for insurance companies? ›

The cost structure at most insurance companies is driven by four major factors, i.e. the size of the company, geography, product lines and the sales channels used.

What is the largest expense for insurance companies? ›

- Loss payments arising from claims – this constitutes the major expense category for most insurers.

What are the drivers of profitability in insurance? ›

An insurance company's profit depends on the number of policies it writes, the premiums it charges, the return on its investments, business costs, and claims. Net profit margin (NPM) can help define a company's overall financial health and measure how much net income is generated as a percentage of revenue.

What are common examples of operating expenses? ›

The following are common examples of operating expenses:
  • Rent and utilities.
  • Wages and salaries.
  • Accounting and legal fees.
  • Overhead costs such as selling, general, and administrative expenses (SG&A)
  • Property taxes.
  • Business travel.
  • Interest paid on debt.
  • Research and development (R&D) expenses.

What is not an operating expense? ›

Key Takeaways. A non-operating expense is a cost from activities that aren't directly related to core, day-to-day company operations. Examples of non-operating expenses include interest payments and one-time expenses related to the disposal of assets or inventory write-downs.

What is the major driver of cost? ›

The number of customers is a significant driver for most companies that provide services to their customers. If your company provides more products or services, your costs will increase based on the number of customers you have to serve.

What are the drivers of costs? ›

Cost drivers are the direct cause of a business expense. A cost driver is any activity that triggers a cost of something else. An example of this could be how the amount of water your office uses in a month determines the price of your water bill. The units of water are the cost drivers, and the water bill is the cost.

Who is the #1 insurance company in USA? ›

State Farm

Who is the richest insurance company? ›

By net premiums written
RankCompanyNet premiums written (US$ Billion)
1UnitedHealth Group201.5
2Ping An Insurance118.8
3China Life Insurance111.2
4Centene Corporation107.4
21 more rows

What is the most profitable insurance product? ›

Life insurance is the most profitable—and the hardest—type of insurance to sell. With the highest premiums and the longest-running contract, it brings in cash over a long period of time. In the first year, agents make the largest annual sum on a policy, bringing in anywhere from 40–120% of the policy premium.

What are the 4 profitability drivers? ›

Each of these improvements slots into one or more of the four profit drivers (Sales volume, Sales price, unit cost and overhead costs – See below for fuller explanation).

What do insurance companies make money by? ›

Insurance companies make money primarily from premium income, but they also invest the accumulated premiums in financial instruments to generate investment income. They also earn revenue from sources such as fees for policy services and commissions from partnering with agents and brokers.

What is the major driver of change in the insurance industry? ›

From a technology perspective, the Internet of Things and Hyperconnectivity emerge as key drivers of change in the insurance industry, alongside Artificial Intelligence and the related technology Robotic Process Automation. Other key technologies include Data Sharing, Distributed Ledger, and Edge Computing.

What is operating expense in healthcare? ›

What is included in hospital operating expenses? Hospital costs breakdown into expenses that include numerous line items, including but not limited to: Construction and renovation. Food service. Hospital salaries for doctors, healthcare providers, hospital executives, and support staff.

Is insurance a fixed operating expense? ›

An operating expense can be fixed or variable. A fixed cost is the cost that incurs no change when there's an increase or decrease in the quantity of goods or services sold. Typical fixed costs are recurring payments like interest, loan payments, insurance, rent, and bank charges.

Is health insurance an operating expense? ›

Another common expense category for employee health insurance is 'operating expense'. This is because employee health insurance is typically considered to be a cost associated with the business's operations, and so is recorded as an operating expense on the business's financial statements.

Is insurance an operating or administrative expense? ›

All executive compensation and benefits are considered an administrative expense. Building leases, insurance, subscriptions, utilities, and office supplies may be classified as a general expense or administrative expense.

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