Insurance and reinsurance companies face a conundrum. Driven by their need to modernise, innovate, digitalise and generally shift towards technology driven risk transfer business models, re/insurers are spending increasing amounts of money, causing their expenses and costs to rise as a result.
You cannot innovate without investment and technology is expensive, so increased expense ratios and higher costs are to be expected, as an industry like the insurance and reinsurance sector tries to keep up with the pace of change within financial markets and broader society.
But in an industry where expense ratios are already averaging roughly 30%, higher in some cases, increasing costs even further, through initiatives that are not bringing in much in the way of premium revenues yet, could be an especially risky strategy.
Herein lies the conundrum.
Insurers and reinsurers face a marketplace in flux, where technology and efficient access to underwriting capital are set to change (are already changing) the game, and new entrants from insurtech start-ups as well as capital markets players are squeezing them from either side.
But they still need to try to keep up with the pace of change at least, leading to the need to spend more to hire experts, consultants, invest in insurtech start-ups, buy technology, develop it in-house and find the most efficient way to get paid in future, raising expenses at a time when underwriting margins are increasingly slim and getting squeezed all the time.
Of course, it would be preferable to be ahead of the pace of change, but there are very few re/insurance players that can claim to be ahead of any of these modernisation trends today and even the very largest are in largely reactive modes, playing catch up as fast as they can.
Spending more could mean you can catch up faster, or at least prevent yourself from falling even further behind. Hence the motivation is there to keep on pouring cash into these efforts, so we should expect to see expense ratios rising before they begin to fall thanks to the introduction of more efficient processes.
PwC noted the desire to spend in a new report on the UK re/insurance sector, highlighting that despite threats and competition faced by the industry, “insurers continue to invest in tech and their people to deliver transformation.”
“Looking at general insurers, competition both domestically and internationally is on the rise, with increasing pressure from other sectors of financial services and new entrants. To stay ahead, general insurers are continuing to invest in IT to provide new services and reach new markets. As a result, general insurers report rising operating costs in part driven by ongoing regulatory changes, but also a marked increase in headcount and training,” PwC explained.
The same goes for the broker community, which is also looking to invest, as PwC explains, “Optimism is down, profitability and volumes are up, but firms can see opportunities to grow, in particular through organic growth activities and investment in IT.”
Jim Bichard, UK insurance leader at PwC, explained, “Under pressure and threatened by growing disintermediation, firms are looking at technology and new talent to help show and add value to their offerings. This drive to invest and evolve their businesses is leading to increasing operating costs.”
Bichard did note that the rising expense trend has slowed somewhat, after its initial burst of activity, but the general expense trajectory does remain upwards for most companies at the moment.
“More insurance CEOs are concerned about the pace of technological change than in any other industry. Therefore it is reassuring to see insurers maintain focus on their people and technology, looking beyond the uncertainty of today to grow their businesses,” Bichard said.
But is it possible to spend your way into a more efficient future, when results are already under pressure and in some cases profits are marginal at best?
Execution is key.
Change is always a difficult process for any company to undergo and a sector steeped in as much history as insurance and reinsurance faces more challenges in its evolution than sectors with less history and more flexibility built-in.
It’s often easier to strip back the conceptual view of a sector to its raw fundamentals, which in the case of re/insurance would be using its deep expertise to match risk and capital, then finding the most efficient way to use the first in order to match the second and third.
But if you’re a company of hundreds or thousands of staff, with offices in numerous locations, a balance-sheet supported by shareholders, with legacy systems, paperwork, old processes and employees with decades of experience, moving in the direction that is now required of you is fraught with difficulties.
All the while that spending increases the expense ratios are not coming down. In fact all that is happening, in a lot of companies cases, is that the margins are being steadily eroded by initiatives that bring in no volume business or profit at all (to date).
Fail to reverse that trend, turning the money spent into a decent volume of new business or a significant reduction in the cost of doing existing business, and re/insurers could face a slippery slope towards becoming unprofitable, destroying their valuations and risking shareholder ire in the process.
Leadership at re/insurers face a really tricky balancing act here, in how best to manage shareholder expectations while spending more on initiatives that deliver less at first.
The risk of bad PR and shareholder fury is perhaps one reason that we see industry-led initiatives to modernise becoming one of the preferred routes to achieve greater efficiency, despite the fact these types of efforts have typically failed in other sectors of financial markets.
Getting competitors to pull together towards a common goal and understanding of market efficiency is really hard.
Industry-sponsored or open?
The London insurance and reinsurance market is a prime example, where over the last twenty years there have been numerous efforts to make doing business more efficient using technology, which have largely come and then gone a few years later, only to be replaced by the next, newer initiative with a less burnt out team behind it.
Whether industry-sponsored efforts to make the matching of risk and capital more efficient (as that is ultimately what the industry needs to achieve) can be successful remains to be seen and it will be interesting to compare how more independent efforts to achieve the same goal take shape over the coming years, as the insurtech wave continues to spread.
As we wrote last week in an article on the Lloyd’s market business model becoming unsustainable in its current form, “open channels developed specifically for their efficiency, not owned by bits and pieces of the market itself,” may be the best way for the re/insurance sector to secure its future.
But the predicament facing many re/insurers is that the evolution of the transfer of risk and its matching with capital, to where the industry really needs to be a decade or more down the line, will see companies putting themselves at risk of going out of business in the process, as their own models become obsolete or just don’t fit with the newly created marketplace reality.