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As Combined Ratios increase, What Can Insurers Do to Improve?

Vince O. Valenzuela

December 5, 2022

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For the first time since 2017, the combined ratio for the entire property and casualty industry will pass 100% in 2022 due to inflation, supply chain challenges, and rising interest rates - just to name a few. 

The combined ratio is the ratio of claims paid and operating expenses to an insurer’s total earned premium.  This is a key indicator of an insurer’s overall financial health and profitability.  Ideally, the combined ratio should always be below 100% because expenses should be less than premiums. 

It is important to note that the combined ratio is expressed as a percentage. A ratio below 100% indicates that the insurer is generating an underwriting profit, yet a ratio above 100% means that the insurer is paying out more money than it is receiving from premiums.  

How Did We Get Here? 

What led to this increase? The trend clearly started in late 2020 due to COVID-19 and supply chain-related issues, but it only got worse.  For example, according to an article from S&P Global Market Intelligence,  in 2021, State Farm Mutual Automobile Insurance Co., saw its ratio worsen to 72.2% from 54.6% in 2021, as inflation and higher severity and frequency pushed up claims cost. 

State Farm wasn’t alone. According to the same article,  Allstate’s CEO reported that costs “took off” in the second and third quarters as a result of changing driving behavior in the COVID-19 pandemic, the most expensive used cars, and the higher costs of settling bodily injury claims. Allstate saw its loss ratio increase to 67.3% in 2021, up from 51.7% in 2020. 

There are other factors, too. For example, personal auto accident severity, total vehicle miles traveled, and claims frequency per mile traveled all increased in 2021.  

Yet clearly inflation may be the biggest culprit. The U.S. is currently experiencing the highest levels of inflation in the last 40 years. In turn, this leads to much higher prices for everything including the cost of replacement parts for vehicle and home repairs and as well as replacement vehicles for total losses. Insurers did not anticipate these additional costs, and in turn, did not price premiums appropriately. 

Unfortunately, the industry may continue to face these issues, especially in the near term. Here is a statement from Tim Zawacki, lead insurance analyst at S&P Global Market Intelligence, who cautiously hopes for the best in 2023, but is still unsure what the future holds:  

 “We expect that growth rates in the commercial lines will pull back from 2021’s torrid pace of 13.6%, but any retreat will be mitigated by upward pressure on personal line premiums. The personal lines segment could see overall growth and increases in rates due to the negative impact of supply chain-induced inflation on claims costs. Our outlook anticipates a return to a sub-100% combined ratio in 2023, but factors such as persistent inflation and the U.S. economy potentially slipping into recession create considerable uncertainty.” 

What Can Insurers Do to Improve their Combined Ratios? 

The first answer – admittedly a big concept – is that insurance carriers need to examine all facets of their business and operations and look to transform as many as possible to become more efficient, more intelligent, and productive. In short, they need to change traditional operating models and approaches into proven ways to increase revenue growth, engage and retain customers, and maximize bottom-line profitability.  

Clearly, now is the time to act. Until now, the entire industry has been significantly outpaced by other sectors – especially technology, automotive, and even financial services – that have adopted new technologies and operating models.   

There are many recommendations for where to start and what to focus on. For example, this McKinsey & Company article estimates that insurers stand to gain a significant point improvement in their combined ratios in just one year by focusing on eight different strategies. 

We believe it comes down to one major initiative: updating technology and ensuring it supports business strategies and goals. This is not an argument for technology for technology’s sake. The entire insurance industry is notorious for its slow adoption of new technology and continues to cling to legacy systems, siloed applications, and monolithic architecture. None of these is well suited to support innovative new strategies – such as real-time insurance personalization or telematics for UBI – or to automate existing processes to increase productivity or accelerate an insurer’s time to market.  

Two Ways to Influence the Numerator and the Denominator in Combined Loss 

For example, consider personalization. Insurers can (and should) take advantage of innovative, real-time personalization strategies to attract customers with creative and compelling new offers. Solutions such as Earnix’s Personalize-It enable insurance companies to use seemingly futuristic capabilities – such as machine learning and artificial intelligence and advanced data insurance analytics – to create highly personalized offers and add-on bundles. As they do, they’re more likely to win and retain more business and stay a step ahead of competitors who may not have figured it out yet.  Based on Earnix’s Price-It analytical and cloud-based rating engine, insurers can do real-time A-B testing and what-if analysis to update rating factors and create new rating structures in record time. This would enable insurers to get new products to market faster and adjust pricing in a fraction of the time, yielding the flexibility today’s conditions demand.  

When it comes to strengthening the bottom line, insurers can look to improve traditional claims management practices. Today, claims management is critical to the success of any insurer and plays a big role in reducing combined loss ratios. Great claims experiences lead to customer acquisition, retention, increased profitability and market share. Yet poor claims management practices lead to wasted time and effort, unhappy customers, turnover, and even litigation. Insurance technology can now automate many steps in the claims process, which helps keep costs low and maximizes overall profitability.   

Act Now to Stay a Step Ahead 

Clearly, the last two years have been difficult for the entire insurance industry and the latest news about combined loss deterioration reflects this. Yet as insurers look ahead to more favorable market and economic conditions, they should also take proactive steps to evaluate and update their technology. Aligning the right technology with specific and targeted business strategies gives insurers the best chance for success – now and into the future.  

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Vince O. Valenzuela

Business Solutions Consultant at Earnix

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