In a new report, analysts at management consulting firm McKinsey have warned that insurance industry profits are “practically at a standstill” due to longstanding economic challenges.
Examining the industry in the wake of the COVID-19 pandemic, McKinsey concludes that half of insurers globally are not earning their cost of capital, and half are trading below book value.
“After decades of stable returns, insurance is now a value-destroying industry in which half the players do not earn their cost of equity,” it asserts.
The impact of the pandemic on insurers was clearly noticeable in 2020 as COVID broke out, when premium growth slowed from more than 4% annually to just 1.2% and profits fell by 15%.
Declining profits were particularly pronounced in Asia Pacific, where insurers suffered a 36% decrease due to challenges on the life side of their business.
But in addition to the pandemic, McKinsey argues that insurers are also coming under pressure from several other longer-term trends.
Foremost among these is disruption caused by insurtechs, more than 40% of which are targeting the marketing and distribution segments of the insurance value chain.
With superior digital capabilities, these insurtechs are posing a competitive threat to incumbents, meaning insurers are increasingly having to form partnerships or make outsize investments to keep up.
McKinsey also sees a clear shift of value towards intermediaries, meaning insurers risk becoming balance-sheet providers, while intermediaries keep an asset-light client relationship model.
And while many insurers have undertaken cost savings programs, McKinsey believes that only limited productivity improvements have been made, with some firms even seeing expense ratios increase in recent years.
In response, analysts recommend that insurers focus on a number of strategic areas to improvement business going forward.
These include making ESG considerations a core feature of business models, regaining relevance through product innovation and coverage of new risks, and enhancing and personalizing customer engagement and experience.
McKinsey also urges insurers to engage better with ecosystems and insurtechs, adapt business models to digital requirements, scale up data and analytics capabilities, modernize core technology platforms, and address the imperative for greater productivity.
“Over the past two years, COVID19 has accelerated some trends that look certain to reshape the way insurance is underwritten, distributed, and managed. At the same time, some of the problems that have challenged the industry over the past decade have not gone away, and the complexity of the macroeconomic environment has increased,” McKinsey stated in its report.
“Revenue growth is limited in most regions; intermediaries are capturing more value; scale economies are proving elusive; and productivity is quite stagnant. As a result, economic profit—that is, profit after cost of capital—in the insurance industry is practically at a standstill.”
“To form a strategy that addresses the challenges of this period of intense flux, carriers will need to put focus and local scale at center stage,” analysts concluded.
“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.”