Effective insurance cost management strategies

Challenges for the insurance industry

In the insurance industry, cost allocations are critical due to two trends. First, tightening margins and increased competition heighten the need to scrutinize expenses; second, insurers’ highly intermediated distribution models and regulatory requirements for granularity and transparency drive insurers to develop complex cost allocation models. 

These are the factors pushing insurance cost allocation models toward high complexity:

• Complex business model: For the business to obtain a full picture of profitability, distribution channel and reinsurance information need to be integrated into allocation models. These views add to standard cost hierarchies, including nature of the cost (acquisition versus renewal), geography, business unit, legal entity, and product.
  
• Role of regulators: Insurance companies trading under different jurisdictions face multiple regulations. Requirements on expense reporting include the presentation of fully allocated expenses across numerous lines of business and accounting destinations. Portions attributable to contracts and deferred acquisition costs also need to be distinguished.
  
• Reliance on high technology spend: Insurance companies need advanced technology to obtain insights on the high volume of business and actuarial data. Insurance leaders overwhelmingly consider information technology as the greatest cost and expense management challenge—far outpacing the challenge of regulatory and accounting compliance.
  
• Focus on combined ratio: Combined ratio has been deteriorating over the past few years, with an increase in incurred losses and loss adjustment expenses bringing down the net income to almost one-third for the non-life insurance market. The major reasons for an increased combined ratio for other types of insurers are a surge in catastrophic events such as hurricanes, wildfires, floods, and earthquakes that can lead to higher claim payouts.
  

Download the full report to learn more about the factors contributing to complexity and the cost allocation challenges faced by each insurance subsector, adding even greater complexity to their cost allocations.

Distinctive business challenges for insurance subsectors

With increasing expense pressures and complex market dynamics, transformation in insurance industry cost allocation processes has never been more critical. Different subsectors often face unique challenges and need to evolve their cost management strategies to maintain profitability and compliance: 

• Property and casualty (P&C) companies should focus on cost efficiency, invest in digitization, and enhance customer experience while balancing increased demand with rising costs.
• Life and annuities (L&A) companies can focus on profitability improvements and streamlining the applications process. 
• Reinsurers should navigate the cost structures of their insurance markets while managing internal costs.
• Composite companies, which combine L&A, P&C, and/or reinsurance businesses, often face the intricate task of aggregating diverse business specifics into a universal cost model.
  

Allocations: Self-inflicted complexity

In a finance team’s efforts to develop business insights and comply with regulators, one common pitfall is to propose cost allocation models that are extremely complex and lack transparency. There is no transparency in the process—who is allocating to whom, and how, is a mystery for various customers of cost allocations.

Several challenges may be faced when insurance companies try to transform cost allocation models:

• Lack of a transparent cost allocation framework
• Inaccurate financial forecasting
• Inefficient expense management 

When an insurer allows its expense allocation model complexity to increase, the result is an absence of transparency—the reason expense allocations are considered the ultimate “black box” in most organizations.

Solution: A thoughtful, measured approach

The allocation framework, including cost pools and drivers, should be designed with an expense management mindset. An expense management mindset prioritizes efficient distribution of expenses across departments, units, or projects within an organization to improve transparency into expense drivers, and provides the business with tools to understand, plan, and influence expenses throughout the year. When firms approach the allocation process, they should consider the following framework:

• Philosophy: Allocation process goals should align with business goals. 
• Methodology: Consistency and governance should be more important than trying to achieve precision for cost allocations. 
• Drivers: Various statistics and metrics used to push down expenses should be clearly defined and reflect actual usage.
• Systems and tools: Tools and technologies should be scalable and efficient.

Leading allocation practices aim to link allocated costs to business drivers that are controllable and actionable by the business. They consider process, people, and technology:

• Process: Design with the end in mind and lay a foundation that is not only effective today, but also scalable and adaptable for future needs.
• People: When designing a new allocation solution, companies should prioritize governance, involve stakeholders early and often, and avoid overly complex methodology.
• Technology: Reporting, data visualization, and simulation tools can help support better decision making and allocation processes.

Key takeaways

The complexity in expense allocations for the insurance industry is expected to increase, given the importance of indirect costs, the diversity of insurance products, the high level of intermediation in the distribution process, and the regulatory push for granularity and transparency.

Insurance companies should take a fresh look at their allocations processes and systems through a dedicated assessment project and evaluate if updated capabilities and practices would be right for them. In today’s insurance industry, managing allocations effectively and efficiently is no longer simply a “nice-to-have” capability—it is foundational.