Pandemic Adds to Insurance Industry's Value Creation Challenges

Prior to the onset of the COVID-19 pandemic in 2020, the insurance industry already faced numerous challenges. Now, according to a new report, those challenges have taken on greater urgency.

Among those challenges are several factors hindering revenue growth, according to the report titled Creating Value, Finding Focus: Global Insurance Report 2022 from McKinsey & Company (February 2022). The report identifies three factors holding back growth: persistent low interest rates; pricing pressures driven by fee transparency, digital competitors, and lower-cost options; and slow organic demand in maturing markets.

As InsurTechs drive digital innovation and disrupt the insurance industry, insurance industry companies are also facing an ongoing "fight for the customer," the McKinsey report says. The report notes that more than 40 percent of InsurTechs are focused on marketing and distributing insurance products, allowing them to provide customer solutions through digitally enhanced experiences that could present a threat to incumbent companies.

"We believe that a distinctive digital customer experience—from attackers or incumbents—will be a prerequisite for industry-beating growth," the report says. "And beyond distribution, superior technology and healthy margins in insurance service businesses will challenge the traditional approach of many insurers to own the whole value chain—they will be forced to form partnerships or make outsize investments to keep up."

The insurance industry is also experiencing a value shift toward intermediaries, McKinsey reports. Brokers have emerged as the industry's clear winners over the past 5 to 10 years, the report says, with total shareholder returns much higher for brokers than for other insurance industry segments.

"Because insurers do not control their distribution channels as tightly as other financial sectors, they might run an even greater risk of becoming pure balance-sheet providers, while intermediaries keep an asset-light client relationship model," the report says. "The shift toward digital is perhaps the last chance for insurers to regain the upper hand in this 'fight for the customer.'"

Another growth challenge facing the insurance industry is the industry's limited productivity improvement, McKinsey found. Though insurers have undertaken cost-cutting initiatives, those moves haven't delivered significant results, the consultant says. Between 2014 and 2019, expense ratios fell for only 45 percent of global property-casualty insurers, the report says, with expense ratios actually increasing for some. "That's a disappointing outcome for an industry that has communicated so much on the need for productivity improvements," the report says.

The impact of those challenges is that the insurance industry's profit after its cost of capital is essentially standing still, McKinsey says. More than half the world's insurers don't earn their cost of equity, according to the report.

In addition to the existing challenges, the insurance industry will be affected by a number of megatrends that have emerged or accelerated since the COVID-19 pandemic began, the report says.

One such megatrend is a decoupling of macroeconomic environments among Asia, Europe, and North America, according to the report, whether as a result of geopolitical or trade tensions or different interest rate trends between the regions.

Another is the COVID-19 pandemic creating a dichotomy between winners and losers as the economic impact of the crisis has varied by geography and industry sector.

The pandemic's role in increasing digitalization leads to another megatrend in the potential for a remote-interaction model with customers becoming the norm. "The frequency of interactions and the level of personalization have dramatically changed, and insurers need to ensure they stay relevant and can craft truly personal, needs-based contextual experiences," the report says. "This situation will probably provide tailwinds for InsurTechs and other digital attackers, raising the risk of disruption for incumbents."

In that climate, insurers will need to make additional information technology investments to digitalize and automate processes, perhaps even modifying distribution models if necessary, according to McKinsey.

The growing awareness of sustainability; climate change; and diversity, equity, and inclusion issues are other trends that will have a direct impact on insurers, the report says, particularly in their investments and underwriting. The increased frequency and severity of natural catastrophes is a related factor, with insurers having to determine whether existing pricing models are adequate.

Insurers also face new challenges to their purpose and relevance, McKinsey says. The pandemic and insurance issues it raised might prompt insurers to rethink their societal purpose and economic relevance as a risk-taking industry, according to the report.

Changes in working models and the rise of hybrid work across various businesses will be a factor for the insurance industry as well, McKinsey suggests. Insurers will have to learn how to manage remote and hybrid teams and re-assess their real estate needs, both in terms of their own changing workforces and geographic shifts among clients and customers.

In response to these challenges and trends, the McKinsey report suggests nine "value levers" to improve the insurance industry's value creation.

• Making environmental, social, and governance (ESG) considerations a core feature of the business model
• Regaining relevance through innovation and by covering new risks
• Enhancing and personalizing customer engagement and experience
• Engaging with ecosystems and InsurTechs
• Developing new businesses for the digital age
• Scaling impact from data and analytics
• Modernizing core technology platforms
• Addressing the productivity imperative
• Reimagining culture, diversity, and ways of working to attract and retain talent

Addressing the nine value levers will help insurers answer strategic questions about "how to play," the report says. Beyond those questions, however, trends facing the industry will also force some insurers to think about where they want do business, rebalance their portfolios of business, and review their capital allocations, according to McKinsey.

"Insurers that can develop a tightly defined business model and take advantage of the trends and currents unleashed by the global pandemic can restart growth, expand performance on multiple dimensions, and renew themselves through value creation, securing an industry-leading position in the years to come," McKinsey says.