GCC Insurers at the Crossroads in 2012: Rebound or Collapse

GCC Insurers at the Crossroads in 2012: Rebound or Collapse Continuing declines in profit margins increase the urgency for GCC insurers to reassess operating models. A.T. Kearney s Insurance Profitability Framework provides 10 ways to halt the losses and define the path to profitable growth. 1

Profitability in the Gulf Cooperation Council (GCC) insurance market began declining five years ago, dropping from 28 percent in 2007 to 9 percent in 2011, despite continued growth in overall premiums (see figure 1). This depression in profit margins has signaled a substantial market shift, highlighting the need for insurers across the region to review their operating models, arrest further declines, and pave the way back to margin growth (see sidebar: The GCC Insurance Market in Context on page 4). Structural Drivers of Decreasing Profitability Lower technical profitability, platforms that lack scalability and suboptimal investment strategies are key contributors to lower regional profitability. Decreasing technical profitability. Overall, underlying technical profitability across business segments has reduced by 10 points over the past four years as loss ratios moved from 50 to 60 percent. Nevertheless, many insurers managed to limit their insurance portfolio losses with more efficient reinsurance programs, partially offsetting decreasing technical profitability. Leading insurers with confidence in their underwriting capabilities progressively retained higher premiums. From 2007 to 2011, the top 30 GCC insurers increased their overall retention of gross written premiums from 48 to 57 percent (see figure 2 on page 3). However, Saudi insurers have proved a notable exception to this rule, maintaining high retention rates that reflect limited reinsurance capacities. In general, a more balanced approach to treaties across the GCC has helped insurers capture greater value from their reinsurance activities and gain an overall nine additional points of profitability. However, there is still room to improve both underwriting and reinsurance management and gain additional value from policy portfolio optimization and pricing. Figure 1 GCC insurers profitability plunges in the past five years, reaching a new low in 2011 Insurers profitability evolution (Net profit, % GWP, 2007-2011) Insurers profitability across GCC countries (Net profit, % GWP, 2007-2011) 30 27.9-68% 50 51 40 20 30 34 27 25 10 10.7 9.0 20 19 15 10 7 6 4 3 7 5 0 2007 2010 2011 0 Kuwait UAE Qatar Oman Bahrain KSA 2007 2011 Notes: Insurers refer to conventional insurance providers; GWP is gross written premium. Source: A.T. Kearney GCC Insurance Benchmark, a 2012 analysis of the top 30 insurers in the Gulf Cooperation Council (GCC) countries 2

Non-scalable platforms. Lack of scalability has led to sizeable increases in operational and staff costs contributing to a three-point loss in profitability. While increased size can deliver scale benefits in decreasing costs, inefficient processes and a lack of properly integrated systems have prevented insurers from releasing these benefits. In fact, the opposite effect has been observed. For insurers, administrative and staff expenses have increased two times faster than business activity (71 percent growth in gross written premiums versus 136 percent growth in operational and staff expenses). Unsuitable investment strategies. The midterm outlook for financial investment returns may not be sufficient for firms that have historically relied on the performance of financial market assets to meet their liabilities and support profitability targets. GCC insurers do not typically have a dedicated asset liability management (ALM) strategy to lower volatility risk and meet current and future liquidity needs. Instead, they have frequently adopted aggressive risk return investment strategies with heavy exposure to local equities and property (45 percent and 35 percent respectively of assets under management). By contrast, investment portfolios of leading international insurers have a more diversified asset allocation with a significant portion of fixed income securities and international assets. Such GCC investment strategies have negatively impacted business profitability from 2007 to 2011, returning a yield of 3.3 percent in 2011, compared to 10.9 percent four years earlier. Figure 2 Declines in profitability and investment returns and increases in operational inefficiencies are partly offset by more efficient reinsurance Insurers profitability evolution and underlying drivers (Net profit, % GWP, 2007-2011) 9.8 10.1 27.9 17.5 2.8 1.7 9.0 2007 Reinsurance efficiency Technical profitability Investment income Operations and staff expenses Other 2011 Retention: 48 57 percent L/R reinsurers: 39 51 percent L/R insurer: 61 66 percent L/R:50 60 percent Investment yield: 10.9 3.3 percent GWP: +71 percent Operations and staff expenses: +136 percent Note: GWP is gross written premium; L/R refers to loss ratio. Source: A.T. Kearney GCC Insurance Benchmark, a 2012 analysis of the top 30 insurers in the Gulf Cooperation Council (GCC) countries 3

The Road to Rebound: 10 Pillars of Insurance Profitability Although the market continues to present growth opportunities, insurers across the GCC need to strengthen efficiency across their businesses to meet the sustained and continuous pressure on profitability. To improve overall profit performance and succeed in such a market, insurers should leverage the A.T. Kearney insurance profitability framework (see figure 3 on page 6). Client portfolios can be optimized with a detailed assessment of performance such a portfolio review can deliver as much as four points in additional profit. Based on the 2012 GCC insurance benchmark study of the top 30 GCC insurers, the A.T. Kearney insurance profitability framework is built on 10 core pillars to achieve immediate impact across the entire organization and create a platform for sustainable, profitable growth. 1. Sales effectiveness. An effective sales and account management strategy begins with sales force performance management transparency to close performance gaps across sales operations. Through management-by-objectives and performance tracking, a controlled sales force (with a defined account development strategy and standardized lead-generation processes) can achieve 40 to 50 percent more revenues than an average sales force. Optimizing the role of branches and their operating models is a strong value creation lever. Branches must be dedicated to sales and supported by a central operations platform with underwriting, The GCC Insurance Market in Context The GCC is experiencing pressure on profits across all insurance segments and lower financial returns. These market pressures are expected to continue for the foreseeable future. Motor premiums, for example, have decreased by 23 percent over the past three years in the United Arab Emirates as insurers compete on prices to grow market share, at the expense of profitability. In medical insurance, healthcare provider costs have increased by as much as 50 percent over the same period. The absence of a structured approach to managing healthcare provider networks is limiting insurers ability to manage costs and they are struggling to pass on the full increases to clients. In general insurance, intense competition has produced various trends, depending on the lines of business. For example, prices are falling in the property, liability, fire, and marine cargo segments, where insurers are competing aggressively. In heavily reinsured business segments, such as energy, aviation and, in some cases, engineering, price decreases are less pronounced where reinsurers underwriting guidelines have prevailed. Investment returns remain low with local financial markets still 70 percent below 2007 levels. 1 1 Dubai stock market and real estate index 4

administration, and claims management. Underwriting and policy administration policy should not be branch functions as happens frequently in the region, where sales and sales support personnel regularly account for only 50 percent of the branch staff. 2. Portfolio optimization. The overall portfolio strategy must guide the makeup of insurers books to ensure longer-term, balanced performance. Multiline insurers must review their exposure by business and product and manage risk with sufficient diversification by progressively rebalancing portfolios where required. The portfolio rebalancing must take into account the historical performance combined with a view of likely future industry segment and client trends based on available data and prospective expertise. Client portfolio review can deliver as much as four points in additional profit. Lean and standardized processes provide more efficient operations and a scalable platform to absorb growth. 3. Product design and pricing improvement. Again, contrary to customary practice in the region, the best product design approaches are underpinned by a formal process. A formal process ensures input from all relevant parties including sales, underwriting, and claims and the optimal combination of benefits and pricing. Pricing should be based on actual cost of risk of the insured object, segment risk, and future potential contribution. A structured process between claims, network management, and sales must align pricing with actual benefit consumption, particularly in medical insurance. 4. Underwriting improvement. Regional underwriting must capture a detailed understanding of client and industry segment performance to better define pricing guidelines and regular updates. The underwriting process should also ensure the consistent application of rules. As the market matures and portfolios start to deliver intelligence on past and future potential, this wealth of knowledge must be leveraged throughout the process to provide insights on valuecreating and value-destroying segments in the portfolio. In addition, working in tandem with major reinsurers can provide mutual benefits through local market knowledge and the sharing of underwriting capabilities. 5. Network and claims management enhancement. Sustainable growth is derived from structured management of provider networks (for example, motor repairers, healthcare providers, surveyors, and others), effectively leveraging a viable procurement strategy and well-defined negotiations. Strategies based on a clear picture of provider competitiveness and opportunities for claims and volume concentration permit rate alignment across providers, networks, and insurers to negotiate systematic volume discounts. Further, more efficient network management and a significant reduction in providers can decrease net claims costs by 10 to 15 percent for motor segments and 5 to 10 percent in medical market segments. In addition, developing standardized and industrialized claims management processes fed with enriched 5

claims data will increase claims transparency, provide efficient cost controls, improve fraud management, and increase service quality and claims management productivity up to 20 percent while decreasing payment time by up to 50 percent. 6. Reinsurance optimization. Taking a strategic management approach to all reinsurance treaties provides a centralized view of performance and capacity and prevents parallel and multiple parties from establishing new arrangements that lack coordination and can lead to higher reinsurance costs. In addition, establishing a standard process for tracking and managing the underlying profitability of all treaties and relevant policies allows for a better understanding of the actual profit contribution and acquisition costs of the policies, and allows adjustment to treaties as necessary. Figure 3 The 10 pillars of insurance profitability build a platform for sustainable, profitable growth Insurers profitability Distribution Underwriting and claims Operations Investment 1. Sales effectiveness 2. Portfolio optimization 3. Product design and pricing improvement 4. Underwriting enhancement 5. Network and claims management enhancement 6. Reinsurance optimization 7. Business process reengineering and organization optimization 8. Capacity management 9. IT process and infrastructure optimization 10. Asset liability management optimization Develop channel, account, and performance management strategies Improve the branch model and associated processes Create optimal cross-selling opportunities Optimize business lines and product portfolios Develop the client portfolio Address risk and geographic spread Define segment and client base pricing Align pricing and benefits Strengthen underwriting guidelines Expand the underwriting engine Optimize provider management and the network Improve fraud management Restructure and coordinate all treaties Make adjustments as necessary to understand profitability and acquisition costs Eliminate non-value adding steps, adjust spans of control Rearrange process sequencing Improve automation Expand front office staff capacity Optimize branch network Build optimal back-office and support structure Develop optimal project portfolio Improve IT delivery process Align investment strategy and liquidity Enhance asset allocations Source: A.T. Kearney analysis 6

7. Business process reengineering and organization optimization. Lean, automated, and standardized processes supported by comprehensive systems will provide more efficient operations and a scalable platform to absorb strong growth. They will eliminate redundancies, decrease rejections, and align productivity across the organization. Such platforms allow insurers to limit increases in operations and staff costs to 30 percent while growing the business by 100 percent and providing better service. 8. Capacity management. A clear and consistent capacity management strategy will ensure that firms have the necessary resources to grow business, underwrite policies, manage claims, and provide administrative support. Such a strategy ensures the right levels of staffing with the correct skills and responsibilities along the entire value chain. Across the region, 30 to 40 percent of capacity can be optimized in different functions with a transparent and structured capacity management. 9. IT process and infrastructure optimization. IT operations must be considered as strategically important as other key functions. An efficient IT function provides the necessary infrastructure to support processes and sound management of the business. It is crucial to align project and IT management with the business and growth priorities (for example, the development of alternative channels versus strengthening underwriting through consolidated repositories with a view on policies, reinsurance, or claims). 10. Asset liability management optimization. Investment strategies must be thoroughly reviewed with an eye to the optimal long-term asset allocation and level of diversification necessary to meet short- and long-term liability needs. At the same time, investments must be managed in a way that anticipates as much as possible potential market corrections and allocates assets to maximize short-term returns to secure targeted returns. In addition, thirdparty asset managers will strengthen and support the investment strategy. For general insurers, investment strategies should be focused on the midterm and expected to deliver 4 to 6 percent returns consistently per year, regardless of market conditions. The combination of the 10 levers above will bring comprehensive value improvement to insurance players. To ensure this journey brings maximum value, approaching the business overhaul in five main phases is recommended: Phase 1: Begin the journey with network and claims management enhancement (#5). This initiative will bring valuable claims experience and profitability driver understanding to inform future strategies. Phase 2: Build on the stronger claims and network platform with portfolio optimization (#2) to identify the pockets of value creators and value destroyers in the portfolio. Product design and pricing improvement (#3) should follow closely to ensure the offer matches the valuable customer segments identified in the portfolio optimization. Phase 3: Underwriting enhancement (#4) and reinsurance optimization (#6) should be implemented next to ensure effective processes support target segment acquisition and value is extracted from reinsurers' improved portfolio performance. 7

Phase 4: Operational effectiveness is completed with sales effectiveness (#1), business process reengineering, and organization optimization (#7) together with capacity management (#8). These levers will complete the strengthening of the future operational platform from front to back office. Phase 5: In the final phase, IT process and infrastructure optimization (#9) ensures the realization of required systems to support more efficient operations together with the elimination of redundant spending. Lastly and, perhaps, most importantly, asset liability management optimization (#10) protects the long-term stability of the insurance business. Rethink and Restructure If margins continue to deteriorate and insurers do not take action, exits from the regional insurance market can be expected. However, this reduction in the number of players is not expected to restore margins alone. Building the pillars as discussed will prevent further profitability declines in the future and, if addressed comprehensively, will prime insurers for a rebound. A number of leading insurers in the GCC have started progressively re-engineering their operations by investing in and developing scalability, while others have focused on the efficiency of their underwriting and reinsurance programs. However, only very few have truly re-thought and re-structured their profitability models. As current market trends combined with inefficient operations are expected to erode insurers capital across the GCC, now is the time to create a road map for sustainable growth and continued profitability and to steer clear of the very real danger of profitability collapse. Authors Cyril Garbois, partner, Middle East cyril.garbois@atkearney.com Alexander von Pock, partner, Middle East Cyril Gourp, principal, Middle East cyril.gourp@atkearney.com 8

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