The insurance industry is beginning to face the prospect of digital innovation affecting their business models. While outright disruption to the industry remains unlikely - the industry remains complex, well-regulated and has large balance sheets - new technologies and market entrants are likely to finds ways of whittling away at value on a number of fronts – even while back-end technologies allow insurers to improve their operations.
In a new report from McKinsey & Company, titled ‘Time for insurance companies to face digital reality’, the management consulting firm explores the key trends affecting the insurance industry more widely, as well as key moves incumbents can make to avoid finding themselves lagging behind. One of the key insights of the report is that insurance companies, like companies in the wider economy, are likely to see their respective revenues negatively affected by digital technologies.
Insurance companies are likely to be able to improve their overall performance in the coming years on the back of new digital technologies that allow them to better quantify risks, improve their customer journey through, among others, improved touchpoints services, and meet their increasingly fickle expectations. Insurance firms may also benefit from creating products and services that insure customers and clients against a range of possible cyber-attacks. Further value may be found in the automation and digitalisation of front-end and back-end processes.
While insurance companies have an opportunity to create value, value may also be destroyed by digital technologies. The firm notes that digital technology across a range of industries, on average, shrinks revenue growth by 3.5% per year, and earnings before interest and taxes growth by 1% per year. Some industries are harder hit, suffering 12% revenue growth shrinkage of 12% and EBIT shrinkage of 10%.
Loss of revenue growth comes from a range of factors. One possible area is startups, which, in the case of the insurance industry, means insurance tech. The startup scene has attracted considerable venture capital support in recent years, in 2015 total investments hit more than $2.6 billion before falling back to almost $1.7 billion in 2016 – in line with wider slowdowns within the industry.
Insurance tech firms have focused their activity across a range of segments within the wider insurance value chain. The largest activity is in the distribution element of the P&C sector, with around 17% of startup scene activity engaged there, this is followed by health, at 11%, and life at 9%. Other areas in which the considerable activity is taking place includes the pricing arena of P&C, at 10%, the product arena of P&C, at 8%, and the claims segment of P&C at 7%. Areas with little interest from insurance technology firms include life products, and all marketing segments.
Three risk areas
While startups are capable of affecting the industry directly, cross sector activity – including from startups in other sectors – are also likely to see considerable value destruction for insurance, even while for other sectors, and consumers, value is created or added.
One way in which value is likely to deteriorate in the insurance industry, is through risk mitigation. A range of technologies are likely to reduce risks, particularly in the auto industry where new ADAS technologies [note!!], including collision avoidance, blind-spot assist, and adaptive cruise control, are reducing accident rates, and fully automated vehicles will see risks shifted to manufacturers rather than consumers – according to the firm the technology is likely to see risk premiums reduced by 25% by 2035. Risk prevention too is likely to be introduced in other sectors, from machinery being better maintained reducing risks, to better education across the board whereby people are less likely to take unnecessary risks.
Another area in which revenues are likely to be affect is by leveraging data to improve risk profiling, allowing insurers to better judge relative risks and thereby improve premiums. Considerable ethical and moral questions exist on the leveraging of data for this purpose however, with legislative intervention likely – the private sector, Facebook, has already begun to prohibit insurers leveraging data from its users for risk assessment in the UK.
A final area in which digital technology is likely to affect insurers, is through institutional investors seeking to generate returns on their investments by backing various insurance related instruments in the hope of finding improved yield in the current low-interest rate environment. The risk is that non-insurance companies may leverage their data and devices to sell customers related insurance services, backed up by institutional investors, thereby bypassing direct insurance companies.
Effect on automotive insurance industry
The long-term picture looks relatively grim for certain segments of the insurance industry, the firm argues, particularly if they do not keep up with rapid changes within the market segment. In the short- to mid-term digitalisation of key processes are likely to see profits double over the course of five years.
The effects of changes to the insurance market from new technologies are already being felt, with US auto insurers noting losses of already having lost $4.2 billion in underwritten profits on average over the past five years. Expenses and losses are likely to continue to see the market lose profitability, at between 0.5% and 1% if losses can’t be offset by other means.
The current market has another issue, which is that it is rapidly tracking towards a ‘winner takes all’ environment. In the US for instance, one company generates 70% of all profits, leaving other players to fight over a small pie – which, if they lack the capital to transform, may mean they cease to exist. Similar stories are found in Spain and Germany – with the latter even operating at a loss in 2015.
According to the authors of the report, “Insurers should not underestimate the changes that digital will bring to their industry and the challenges they will pose. Neither should they overlook the significant short-term profit improvements that are within their grasp if they digitise their core businesses, nor shy away from innovating to be part of an exciting future that is unfolding for the industry. If they act decisively, they will be among its leaders.”