Why productivity should be top of any insurer’s priority list today, according to Cytora’s CEO Richard Hartley
Productivity is about doing more with the same.
It’s a word often used in conversations about industry and the economy, and for a country, productivity is closely linked to living standards. But for a company, it is directly tied to performance.
With improved productivity, a company can produce more goods and services with the same amount of relative work. In business terms, productivity is about expanding the numerator – the output – to deliver greater top-line growth from the same workforce.
A powerful example of this in practice is agriculture over the last two hundred years. In 1800, four people were required to work in the fields to feed five. But now, a single American farmer can feed three hundred people. In the same way, for businesses today, producing more products at the same expense allows them to serve more customers, to grow revenue and increase profitability.
Over the last decade, a broad range of industries have harnessed technology to reduce unit costs allowing them to produce more units of product per employee, at the same cost base. In turn, this has enabled them to serve more customers and increase revenue. Reducing unit costs enables the number of units of output to increase, which in turn drives expense ratios down. In these industries, advantage in unit economics quickly translates into market leadership.
For example in banking, the cost of producing a core unit of product – in other words, bank accounts – has dropped sharply. This has allowed commercial banks like OakNorth and retail banks like Revolut to acquire and serve more customers at the same cost base, while reducing their expense ratios. We have seen the emergence of economies of scale where, for a bank of average size, an additional $1 billion in assets reduces noninterest expense by $1 to $2 million per year.
Likewise in mortgage lending, Quicken Loans have achieved the same productivity-led acceleration: a reduction in unit costs, rapid increase in volume of mortgages produced, and profitable growth. Through this approach, Quicken Loans wrote £145 billion of mortgages last year at £893 million in profit on a path to establishing durable market leadership in the US.
We are seeing this secular trend of productivity-led growth play out across a multitude of industries as diverse as ecommerce, cloud computing, communications, music, film, navigation, banking services, lending and mortgages.
The activity at the core of these examples is the use of technology to systematically increase total unit output. It strips away the obstacles to higher production and enables teams to dramatically increase the rate of producing new units of product at a given quality level.
However, in commercial insurance we are seeing the opposite trend occurring. The industry has seen high – and increasing – Expense Ratios over the last decade, and no sustained improvement in the production function. In insurance, that’s measured by the number of policies per underwriter at a given quality level (EY 2020 UK Insurance Outlook).
This is in part because, unlike many other industries, the insurance industry has not succeeded in improving productivity over the past decade. Combined with persistently low interest rates, the result is many insurers not earning their cost of capital.
Despite all of the investment into digital transformation in insurance, this has not – so far – resulted in concrete improvements in the premium produced per underwriter. And this is the root of the problem for insurers.
Underwriters are the production engine of the insurance company, where the unit of production (or the policy) is made, shaped and delivered. The number of policies per underwriter, which typically combined to generate £500k to £1 million in new business premium per year, has not changed. That’s because at the core, technology investments have not targeted and removed the barriers to productivity that underwriters face today, holding back their productive potential.
The exception of commercial insurance to the unstoppable trend of productivity-led growth is explained by the peculiarities that distinguish it from other industries and mean standard horizontal technology does not apply.
Three peculiarities stand out, which stem from the fact the unit of production for insurance companies is the contingent transfer of risk – contingent on the customer’s risk profile matching the appetite and value threshold of the insurer.
Insurers will only maximise the production of profitable policies when underwriting capacity is used in a way that sits within the risk appetite and above the threshold of lifetime value.
Against each of these peculiarities, commercial insurers incur a productivity penalty.
1. Selectivity: You don’t want to serve all customers, given that many of them are outside your risk appetite. Today that’s between 30-40% of total submissions. To be productive is to stringently segment customers into the ones you want and ones you don’t want, ahead of any underwriting cost and capacity being expended. As such, increasing the unit of output is contingent on both risk and price.
2. Value asymmetry: The customers you serve have a vastly different value, which differs from most other industries with a fixed margin per customer. This means that you need to intelligently prioritise both the customers you want to win and the costs you are willing to incur, relative to the customer you engage with. Where profit per customer in other industries tends to be even, in insurance it is radically different.
3. Customer proximity: Commercial insurers are not in control of the customer journey. In other industries, the customer journey is designed by the company that the customer interfaces directly in the purchasing process. However in insurance, brokers tend to represent the customer and the insurer has an indirect relationship with that customer as a result. This means insurers have less visibility of where demand originates, exists and is distributed across different customer segments – a prerequisite to maximise their market share across different products.
Only certain insurers will be successful in reshaping their economics to drive more premium at the same cost. These insurers will write more policies and more premium than competitors, at their desired risk threshold. They’ll do this by intelligently targeting their resources exclusively towards the right risks, in terms of appetite and value. Then, month by month, year by year, they’ll see a systematic increase in policies bound per underwriter.
The insurers that are successful will see a compounding downward trend in their Expense Ratio and will capture market share at the expense of their competitors.
They will be able to reduce the premiums quoted to the most attractive customers. And enter new lines of business with higher structural Loss Ratios, given their advantage in their Expense Ratio.
They will also be able to attract the most talented underwriters who will see them as a platform to realising their growth ambitions.
In subsequent blog posts, we will explore the path to productivity that commercial insurers can take, to ensure they are a market leader in the ongoing productivity-led wave.
For more further reading on the underwriter view of productivity, you can read our previous post here.
