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Combined Ratio Magic

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2 January 2023
Rob Norris

These are interesting economic times for insurance companies. Opinions vary about whether a recession will be a reality in 2023, but no one is resting easily—especially in the face of major geopolitical threats. Inflation is rising, which will stretch budgets and increase claim costs. It's hard to say whether consumers will be willing or able to pay corresponding increases in premiums. On the investment side of the house, most equity portfolios lost about a fifth of their value last year and yet stock valuations remain high by historical standards.

Meanwhile, the bull market in bonds came to a depressing end. For over 30 years, declining interesting rates have enabled insurance companies to harvest capital gains on bonds, which could smooth the bottom line during times of lumpy underwriting results. Many a chief investment officer was an unsung hero in years when the combined ratio came in too high. In 2023, carriers have fewer rabbits left in their hats. Instead, insurers will be looking for new magicians: people who can bring the combined ratio back to sustainable levels.

There is no mystery in how to produce a sub-100 combined ratio, but muscle memory may be weak for some carriers, especially those with youthful leadership teams not previously tested by multiple insurance cycles of boom and bust. As our industry lurches through a period of digital disruption, some executives will be unable to resist the siren song of big ticket technology solutions. You have to spend money to make money, right? Why think twice about dropping a few million dollars on a project proposal if it promises big gains down the road?

Of course, thinking twice about any project is exactly what a carrier should do. With scarce time and resources, someone should be asking: Is this the best solution among several options to solve a specific business problem? The best path forward usually emerges from a competition of ideas, not a passionate plea for one approach. An even more important question might be: Is this the right problem to solve? When resources are scarce, fixing nuisances may not be worth the effort—we need raging dumpster fires to douse.

Perhaps the better metaphor would be chimney fires—big problems close to the core that can be hidden from view but still have the potential to burn down the house. For insurers, chimney fires often stem from inefficient distribution, inadequate pricing, or ineffective claims handling. Technology can improve these processes, but only if the processes themselves are not horribly broken.

Thankfully, we see increasing traction for technology solutions that help carriers fix their business processes. The new year could be a tipping point for business process management systems, robotic process automation, and low-code/no-code platforms. These could turn out to be the magic beans of combined ratio improvement, worth trading the family cow for if a carrier is stuck with inflexible systems and a backlogged IT department.

The journey of process improvement usually begins in physical and virtual meeting rooms, where leadership teams and advisory committees conceive and coordinate initiatives. But people should remember to get out of their Zoom rooms once in a while and go where the work is actually done. In Lean philosophy, it's called going to the gemba (the Japanese word for actual place). By closely observing the work when and where it actually occurs, leaders can spot ineffective processes and wasteful activities.

Leaders also should also look outside their own walls and see how they compare with other carriers. Plenty of well known providers of industry benchmarks and competitive data would be happy to help. Another approach is to study other carriers’ financial statements. In the United States, the standardized annual reports for property and casualty insurers are especially helpful. Known as Yellow Books because of their covers, they contain a rich amount of data about what drives combined ratio results.

The richest data source of all may be a carrier's own employees--the people at the gemba. They know where the waste is because they see it and feel it every day. They field the complaints of agents and customers. They are the hands-on operators as well as the unintended victims of ineffective and inefficient business processes. As a result, they are in the best position to identify problems worth solving and whether the promise of technology solutions are real or illusory.

The bottom line is that no amount of technological trickery will tame the combined ratio. It will require working hard and innovating smartly. The smartest move may be to create a culture of continuous improvement in which the hearts and minds of all employees are engaged in making the business better. Building such a culture is not easy, but the results can be transformative. And when that culture becomes self-sustaining, it will almost feel like magic.

Happy New Year!