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How to manage the cycle

Neil Baxter
PA Consulting Group
Post Magazine
15 July 2009

With the cyclical difficulties faced by commercial insurers, Neil Baxter reports on lessons they can learn from other industries to boost long-term prospects and profitability.

The Eurozone is officially in recession and, despite government rescue measures, a shortage of capital is damaging every sector. All the signs point to a prolonged downturn.

Extraordinary economicconditions have also deepened the current trough of the insurance cycle, while corporate customers are demanding lower premiums, increasing the pressure on insurers' technical standards. There is mounting pressure for upward movement in rates but it is far from clear that the downward trend will be reversed imminently (see graph).

So, how should corporate insurance companies respond to this crisis? The usual responses" belt-tightening, postponing innovation and investment, or cutting prices to win or retain business" may not be enough. There are many other cyclical industries in which companies' fortunes are tied to the growth or decline of the wider economy and insurers should learn from these cyclical industries. For example, they should focus on: optimising the product portfolio; managing the supply chain; and positioning for growth.

Optimising product portfolio

As commoditisation in the sector continues, it is vital insurers fully understand product profitability, and take the tough decisions on propositions that may be required to deliver the right product at the right price.

Corporate insurers have often failed to understand across customer segments where value is either created or lost, often because they have not recorded the necessary management information. In addition, insurers often fail to think strategically during a downturn. They can be guilty of only looking to short-term product changes rather than making more informed judgements about long-term strategy, economics or customer segmentation.

The issue of commoditisation is not unique to commercial insurance. Firms in the tobacco industry regularly review their existing product portfolios to make sure their brands meet the demands, trends and price-points of the market place. While still mindful of consumer needs, organisations have simplified the products offered" for example, using common blends, paper and packaging. By strictly rationalising operations some companies have then found room to innovate, creating differentiation in the niche brands.

Recently customer behaviour has been one driver behind the commoditisation of the market. Yet insurers must look at the long-term strategy rather than just short-term survival in order to realise additional competitive benefits. For example, loss prevention and post-loss mitigation capabilities can be attractive differentiators in an increasingly price-competitive property insurance market.

Supply chain management

As customers radically rethink discretionary spend, demand for some 'value-added' services is falling and, for many insurers, this should prompt them to review aspects of their supply chain strategy.

Despite the automotive industry suffering casualties in previous downturns, some companies developed innovative models to combat the market volatility. For example, in 2006 Fiat embarked on an initiative forging partnerships with suppliers, encouraging them to increase their investment in its supply chain, and this led to increased flexibility and greater control over profitability. In one instance the reduced exposure to a fluctuating market provided savings that offset a 60% increase in some commodity prices.

For insurers, areas such as customer acquisition, retention and value-added services offer opportunities to lower costs and improve profitability. For example, by developing propositions to bolster non-core activities and reducing reliance on price-based channels, or by encouraging suppliers to share costs by offering to share the savings, thereby engendering a common cause.

Growth positioning

For those insurers with money, there will doubtless be bargains to be had, but 'land grabs' are probably out of the question now for many insurers. There are other strategies that can provide firm platforms for growth" two examples being investing in capability and generating customer demand.

Again, the automotive industry serves to illustrate the benefits of investing for future growth. VW, as part of a restructuring programme, invested heavily in its pipeline and on reducing the vehicle running costs for customers. The company now has a healthy pipeline of new models ideally suited to the current market and concerns over the availability of oil. Meanwhile, its major European and US competitors are facing financial meltdown because of a lack of demand for their existing models and limited replacement options under development.

Arguably, therefore, insurance companies could invest in emerging territories; responding to regulation such as Solvency II or treating customers fairly; or developing new products addressing the minefield of international insurance programme compliance. Surely, there is also an opportunity to develop the capability to serve global clients" whose needs are often discussed but rarely met.

To take compliance on international programmes as an example, some insurers, such as Zurich and XL Insurance, have developed specific propositions in response; propositions that have aroused considerable interest among customers, despite being launched at an extremely competitive point in the cycle.

Developing demand

As for generating customer demand, getting the right products to market at the right time is only part of the equation for success. To take full advantage of a rising market, or to protect market share in a declining one, insurers also need to develop sales skills and deepen their customer relationships so they can influence the purchasing decision. Too often, commercial insurers wait for a target's incumbent insurers to slip up. Rather than 'loitering' in this way, they should actively promote their products and differentiate their brands.

In addition, commercial insurers must become better at identifying the sophisticated and profitable customers that warrant the time and effort involved in building close relationships. These relationships can be forged in collaboration with the distribution channels but, critically, should be done at the appropriate level within the customer's organisation. Insurers often fail to make the connections with decision-makers at senior treasury or boardroom level" which may result in both failing to win new business or losing existing business, even with a superior product. Recruiting the employees capable of managing large and profitable accounts will be a big challenge.

At this point in the cycle, and in a deepening economic downturn, the temptation for insurers is to withdraw into their shells. But this will produce poor performance" and the few that act, and have the courage of their convictions, will develop a platform for sustainable competitive advantage and potentially enhance their profitability, irrespective of the point in the cycle.

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