As there is no prescribed methodology to define profitability, the approach to profitability varies dramatically across the insurance industry. Having the ability to understand the underlying details of profitability provides insurance organizations with valuable insight to optimize operational efficiency, evaluate potential risks to the organization, and pursue opportunities to adapt or transform the business.
Key drivers of earnings in the insurance industry
Insurance companies create revenue through insurance and investment operations from underwriting and investment activity, as well as fee-based income. From the underwriting operations, they manage both short and long duration policies, which carry an inherent risk that could result in losses that could be attached to a specified horizon or go beyond the life of the policy. The management of these short and long duration policies and the associated underlying risk for losses over a given horizon drives the decision around the duration of the company’s asset allocation within the investment portfolios. While it is critical that insurance companies manage their balance sheets to ensure solvency and the ability to manage future claims, it is also critical to understand the profitability of its operations in order to evaluate opportunity for growth, ensure sustainability, adapt to market changes, and improve decision making.
Optimizing profitability analysis for risk management
The insurance industry faces peaks and troughs with earnings due to market and interest rate volatility, hardening of pricing, material loss events, market disrupters, and other factors. Understanding profitability should not be based solely on a view of consolidated or segment underwriting gain/loss, operating income, or net income. To be able to understand profitability and proactively manage operations, companies need a deeper grain of detail to be able to anticipate and react to change. A systematic, defined understanding of profitability affords insurance organizations the opportunity to swiftly analyze, evaluate options and opportunities, and react. Additionally, as we have seen, market volatility can occur suddenly; therefore, having the ability to quickly analyze and adapt profitability models with varying scenarios is vital for proactive risk mitigation.
Below, I have outlined six benefits to modernizing and integrating the view of profitability for insurance organizations into key business analysis, decisions, and processes.
1. Improving performance with transparency
Having transparency into profitability provides an opportunity to assess pricing methodologies, organizational costs, costs to offer certain products, the performance of underwriters, and the impact of certain clients or channels. Additionally, it allows for an opportunity to evaluate the effectiveness of marketing campaigns to drive new business and retain customers. Additionally, understanding performance allows insurance companies to evaluate potential profit leakage due to operational inefficiencies.
2. Streamlining planning and forecasting processes
In many insurance organizations, the planning and forecasting process is siloed to the point that the output is used more as a financial tracking tool, rather than support key business decisions or a fully integrated planning process. By using profitability analytics and understanding the key drivers in the company’s premiums, losses, and cost structure (i.e. operating costs, cost containment, or claims costs), insurance companies can more accurately plan and forecast premiums, losses, and operational expenses. Additionally, utilizing profitability analytics to create metrics, assumptions and drivers provides for a rationalized approach that can be benchmarked against historical data, ensuring better financial planning.
3. Mitigating risks through scenario-based analysis
An impactful profitability study affords insurance companies the ability to perform what-if and scenarios-based analysis to leverage trending market data to interpret the potential impact on the company’s financial performance. Additionally, it allows insurance companies the ability to proactively monitor risks and integrate a full vision of profitability and predictive analytics into its operational performance.
4. Driving strategic decisions with profitability insights
Understanding performance and where there are potential opportunities or a change in approach to the market is critical for insurance companies. It provides the data needed that helps insurance companies to adapt as the market evolves. Profitability analysis helps make key business decisions about strategic investments or changes in the approach to the market (such as a change to an agency model, sidecar business offering, or selling through a third-party administrator). Additionally, it can help support an organic transformation model, as well as understanding the potential impact of key people or asset acquisitions, ensuring long-term competitive advantage.
5. Improving market penetration through competitive analysis
When it comes to improving profitability, understanding how insurance companies compete against each other is important. While there is sensitivity around peer analytics, insurance companies can perform competitive analysis to understand if they are performing above or below competitors and to interpret market trends. This alignment of competitive performance allows insurance companies the ability to evaluate market penetration and potential opportunities to expand, contract, or transform their approach.
6. Identifying leaders and addressing laggards for optimization
In consolidation, an insurance company can appear to be profitable, but, in reality, there is a balance between the products, channels, clients, counterparties, etc. that are driving profits and others that are not as profitable or are producing losses. Having the ability to understand how each component impacts performance allows insurance companies to refine and optimize product offerings, sales channels, pricing strategies, and target audiences to ensure greater operational efficiency and increased revenue.
Modernizing profitability analytics for improved transparency and decision making
Understanding performance, profitability, and outlook is important for all stakeholders, as investors, policyholders, and regulators have a vested interest in the financial sustainability of the organization. Having the ability to gain transparency into organizational performance allows insurance companies the ability to assess the potential impact of various scenarios, proactively react to the impact of changes, and to strategize on ways to improve operational performance and mitigate risk.
As mentioned, having the ability to standardize the view of profitability across an insurance organization allows for a repeatable process that provides transparency into potential risks and opportunities to the organization. Having an understanding of the product, channel, client, etc. contribution to underwriting results is a critical element of managing an insurance company’s book of business and also provides the opportunity to proactively assess the company. Additionally, having an understanding of the profitability of an insurance company’s investment portfolio is also critical to provide clarity into investments that are driving results and those that are not driving returns to the company.
Ask yourself these questions:
- Do you have a systematic, repeatable process for understanding profitability?
- Do you have the ability to drill back into the details of results to understand what drives profits and losses?
- Do you have reports and KPIs that monitor profitability?
- Do you use your profitability analysis to enhance the planning and forecasting process?
- Do you use your profitability analysis to enhance risk and strategic analysis?
- Do you leverage predictive analytics to anticipate future profitability trends?
- Are you optimizing your operational efficiency to minimize profit leakage?
- How well does your profitability analysis align with your organization's digital transformation goals?
Alithya has a proven, comprehensive methodology to help our clients reap the benefits of their technology investments. Our technical and functional knowledge of the insurance industry helps us to provide clients with actionable ways to gain transparency into the profitability to further benefit the company, while also gaining a technology solution that is scalable for future change. Contact us today to arm your agency with critical insights into your bottom line.