Digital pricing innovations for a post-COVID-19 transformation
A recent analysis by McKinsey & Co. identified five levels of insurance-pricing innovation and transformation.
With the global economy reeling from the COVID-19 pandemic, the pressure on the revenues of property and casualty (P&C) insurers has intensified. The expected dramatic decline in global GDP and the strong correlation of GDP with gross written premiums (GWP) imperil the P&C insurance industry’s financials. As a result of the crisis, the shrinking economic pie will spur fierce competition.
Insurance carriers have already launched aggressive marketing campaigns to reduce customer churn and attract new business. Some are lowering future premiums, others are returning a portion of current premiums to customers, and still, others are offering customers free temporary add-ons, such as new policies or extended coverage periods. P&C insurers are likely to roll out further sales strategies in the next normal.
In the face of aggressive competition and price wars, pricing will be a primary differentiator for long-term value generation in P&C and should be an integral part of every insurance carrier’s COVID-19 response strategy.
Five levels of pricing innovation and transformation
Based on our analysis of multiple pricing transformations at global insurers, we identified five levels of pricing innovation and transformation. Each reflects an insurance carrier’s maturity as well as the strategic priority of its pricing program.
Consistent application of generalized linear models (GLMs)
The majority of insurers in different markets have consistently prioritized the application of GLMs for all risk models and product types. This approach serves as the starting point for most pricing innovations and transformations.
Based on our pricing-capability assessment benchmark, a bit more than half of all P&C insurers in Europe and the United States have already attained this stage. This level still marks a step up from the current risk modeling practiced by the lower half of the market, which typically still uses combined frequency and loss-risk modeling as well as static pricing rules. For example, several small regional insurers use the same motor- and home-rate plan they did more than ten years ago. Insurers that master the rollout of GLMs invest heavily in up-skilling and hire actuarial personnel with the requisite modeling skills.
A large book of business and the potential pricing effects of renewal contracts pose a significant challenge for many insurers since even a small pricing mistake can have an outsize effect as it works its way across a multi-billion-dollar book.
Artificial intelligence and machine-learning pricing tools
A smaller group of global insurance carriers has leapfrogged the first pricing level or has built upon existing GLMs. The exponential increase of data over the past decade, more processing power (of cloud computing, for example) at reduced costs, and recent advances in explainable artificial intelligence-enabled the wider adoption and more efficient use of iterative AI-based tools and approaches.
AI-based, automated pricing tools offer the advantages of high-quality, high-validity risk and pricing models (as gauged by the Gini coefficient, a measure of the inequality among values of a frequency distribution) and significantly reduced time to market.
While these tools can help insurers quickly achieve tangible impact, they shouldn’t be implemented in a stand-alone fashion. Organizations that do so risk failing to develop the capabilities they need for long-term competitiveness.
Implementation of robo-pricing
Historically, insurance carriers have struggled to incorporate price sensitivities and customer behavior, customer lifetime values, and external market data in their pricing processes. In particular, continuously screening market price movements and including that information in market-based pricing have been challenging. For the past couple of years, insurers around the globe have been integrating robotics into two areas of the pricing process: market understanding and transparency, and automatic and dynamic price adjustment.
While the former (for example, web-crawling robotics) can be used by insurance carriers in many major markets, the opportunity to harness robo-pricing varies by market. For example, in the United States, local regulators need to approved price changes, making dynamic and real-time price adjustments difficult (or impossible) to implement. Therefore, insurers should assess robo-pricing capabilities based on the regulatory environment in which they operate.
Product simplification as a prerequisite for optimized pricing
An increasing number of insurance carriers are pursuing product simplification, which forms a basis for enhanced pricing. By analyzing customer demand and by eliminating unused offerings, an organization can reduce complexity and costs for IT, operations, and claims.
In most cases, removing product variations enhances diversification, which also improves loss ratios. This simplification positively affects risk capacities, premium levels, and pricing competitiveness. In addition, by implementing new product features that customers actually want, some may be able to charge price premiums.
A pricing strategy that builds on a simplified product portfolio depends in part on a thorough end-to-end optimization of the entire product value chain. This effort includes the systematic integration of external market data from customer insights and competition screenings in addition to the collaboration of operations, claims, and IT to estimate the savings realized from reduced product complexity. Last, insurers must also educate their sales teams on the benefits of simplified products to ensure their adoption.
Full-scale pricing transformation
A full-scale pricing transformation focuses on building the right infrastructure across all organizational functions to achieve substantial and sustainable pricing improvements.
Our market observations suggest that pricing excellence can be achieved through improvements in seven areas: underwriting strategy, risk selection, execution, governance, and technical, market-based, and behavioral pricing. Organization and talent, as well as advanced analytics and digital capabilities, support these foundational building blocks.
A full-scale pricing transformation typically involves establishing an organization’s current capabilities as a baseline, setting the vision, and developing and prioritizing a comprehensive set of use cases. Insurers should proceed with creating the initial road map, designing the operating model and governance, and evaluating any potential shifts in the operating model.
Positioning your organization in the pricing race
Every insurer has the potential to significantly improve its pricing strategy and capabilities. The path forward depends on insurers’ prerequisites and strategic priorities. A three-step self-assessment can help executives identify the best type of pricing innovation and transformation for their company’s current position:
- Start with diagnostics. Evaluate the maturity of current pricing capabilities, including pricing and underwriting processes, tools (such as AI and advanced analytics), and organizational structures.
- Get insights on market opportunities. Compare the organization’s pricing maturity with that of the market environment. Local market interviews with experts and anonymized comparisons can be helpful sources of insight. In addition, insurers should identify potential partners for supplying services such as robo-pricing and AI-based pricing.
- Select the pricing level that best suits strategy. Consider the available amount and types of resources, competitiveness of current tariff and risk models, any regulatory restrictions, and level of urgency. The road map for the pricing transformation journey can be developed based on the selected level. The total amount of time required for implementation will vary by pricing level and the products included in the transformation’s scope.
COVID-19 has put substantial pressure on the global economy and the insurance industry. The majority of P&C insurance carriers have already launched initiatives aimed at boosting top-line revenues. However, insurers that make a sustained commitment to pricing and underwriting excellence regularly create the most value—and generate a self-perpetuating competitive advantage.
Doug McElhaney (Doug_McElhaney@mckinsey.com) is a partner with McKinsey & Company.
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