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Despite a range of disruptions, global commercial P/C insurance carriers have actually delivered good returns over the last few years—mostly thanks to higher premiums, which have risen 6 to 8 percent a year since 2018. But that cannot go on forever.

Executive Summary

Shannon Varney, a partner for McKinsey, summarizes the views that he and several members of McKinsey’s Insurance Practice delivered in a 28-page report titled “Global Insurance Report 2023: Expanding commercial P&C’s market relevance,” published today. The report presents four overarching approaches to relevance, offering some eye-popping figures on the size of market opportunities, including a $100 billion cyber insurance-related growth opportunity, a $130 billion catastrophe protection gap, and at least $10 billion of insurance premiums associated with some $800 billion in annual capital expenditures (by 2030) to lower greenhouse gas emissions.

At the same time, a variety of risks—among them, inflation, cybersecurity, rising claims and geopolitics—are either intensifying or at the very least not going away. There are opportunities here as well. For example, the effort to decarbonize underwriting portfolios will be complicated, but carriers who do it best could find new channels of growth. That’s a much more sustainable business model than hoping high interest rates stick. To put it simply, carriers can up their game or suffer the greatest risk of all: becoming irrelevant.

Here are four approaches that can help.

Define a clear source of distinctiveness. As in many other sectors, being the equivalent of a commodity provider means tiny profit margins; competing on the basis of price can go only so far. The signs that this strategy are running out of road are clear: Global rate growth slowed from 20 percent in Q3 2020 to 6 percent in Q3 2022, when they declined in real terms. Price matters, of course, and always will. But experience and hard numbers show that it is not enough and is becoming less relevant. It is telling that, measured by premium growth and profitability, from 2016-2021, specialist carriers consistently outperformed diversified ones and grew three times faster. (Editor’s Note: The results are based on an AM Best, McKinsey analysis summarized in the McKinsey report, “Global Insurance Report 2023: Expanding commercial P&C’s market relevance.” Exhibit 2, p. 3.)

Essentially, this means asking: How can we offer more value to our clients? Carriers can identify areas where they can be distinctive, whether in the value chain or in specific lines, and then focus their investment to build on these strengths. The most successful ones already are doing this.

It may also be possible to develop a targeted distribution strategy across lines of business, regions, industries and client segments. This makes it possible to avoid channel conflict, understand what it takes to be brokers’ preferred carriers, and build strategic distribution relationships.

Close protection gaps. As remote work has become entrenched, the risk of cyber breaches has grown. In 2020, cyber economic losses totaled $950 billion, while the total premium market was $9 billion, according to Munich Re. There is, in short, a massive protection gap. In 2019, two-thirds of companies had some kind of cyber incident, but a McKinsey survey found that most small and medium-sized enterprises (SMEs) didn’t even know that cyber-insurance existed.

A few carriers have developed new frameworks to define cyber risk, and the first cyber catastrophe bond was recently placed. But there is a lot of white space for creative carriers to fill. We estimate that cyber-related insurance is a $100 billion growth opportunity. And it is interesting that the most advanced providers go well beyond providing coverage to work with clients on threat intelligence, data center diversification and employee training. These can all be sources of revenue and profitability.

The same is true when it comes to environmental management in general and decarbonization in particular. Extreme weather events are getting more common and more expensive. We estimate the global national catastrophe protection gap at $130 billion to $140 billion in 2021. At the same time, efforts to reduce greenhouse-gas emissions could change how the global economy operates—and require spending something like $800 billion in annual related capital expenditures to 2030. Almost all of this will need to be insured, comprising a value pool of perhaps $15 billion, mostly in property, energy and construction. There is clearly room for innovation in these value lines, as well as in renewable energy, an area that has not been particularly profitable for carriers in recent years.

In both areas—natural catastrophes and decarbonization—carriers have a chance to create new capabilities and thus build new revenue streams. In terms of the former, index-based solutions that link payouts to trigger points such as flood levels or earthquake strengths can improve the efficiency of natural catastrophe coverage, making payouts quicker and litigation less frequent. Carriers could also innovate by providing product bundles to specific industry groups, including SMEs.

The effort to decarbonize underwriting portfolios will be complicated, but carriers who do it best could find new channels of growth. That’s a much more sustainable business model than hoping high interest rates stick.

On the latter, carriers could support the adoption of carbon markets by offering alternative risk transfer solutions, including coverages for buyers (to insure against an offset becoming invalid) and sellers (to cover nature-based loss from pest infestation).

For this to work, data and advanced analytics will need to be used to update pricing models and risk analysis—e.g., is a major flood a one-off or the beginning of a pattern?

Innovate in the use of alternative capital. Based on a current premium-to-surplus ratio of 100 percent, including reinsurance, closing even a portion of the protection gaps highlighted above would require hundreds of billions of dollars of capital. However, according to a McKinsey analysis of 15 pureplay reinsurer and primary commercial carriers, their premium-to-surplus ratio has surpassed its 10-year average. And natural disaster claims have soared. This combination of increasing demand due to higher natural disaster claims and decreasing supply of reinsurance capital due to tightened capacity needs to be solved. The alternative capital market—including insurance-linked securities (ILS), collateralized reinsurance and sidecars—is also suffering. For example, public ILS natural catastrophe bond issuance fell by 81 percent in Q3 2022—to the lowest Q3 level in the last decade.

In short, to close protection gaps, the industry needs new sources of capital. This is beginning to happen. Alternative reinsurance capital grew from 6 percent of reinsurance capital allocation in 2011 to 15 percent in 2021, according to Aon. Even so, it represents less than 1 percent of global alternative assets under management.

To do better, carriers can simplify alternative capital products by standardizing structures and contract language to create a more “mass-suitable” product. They also can improve their modeling of catastrophe events, particularly by embedding climate change factors. They can issue bonds directly, rather than relying on reinsurers. And they don’t have to go it alone. Particularly in regard to natural catastrophes, they can expand public-private partnerships associated with systemic or societal risks—for instance, those related to critical infrastructure. There has been significant action in this regard: at COP27 in 2022, signatories agreed to establish a “loss and damage” fund to compensate poorer countries when they suffer climate-related disasters.

Reinvent the employee value proposition. Here are two cliches: We are in a world of change; there is a battle for talent. And both are true. One implication is that carriers need to do more than hire some new people. They need to re-think their whole culture, moving away from experience and intuition and toward data and advanced technologies. On one level, that is inevitably going to happen, with the insurance workforce aging and baby boomers retiring. But many industries are seeking out this kind of talent—and insurance carriers are not always, or indeed usually, the first choice.

The battle for talent is real. Distribution partners are faring well in this regard and have strong cards to play, with better returns, greater proximity to customers and more capital-light business models than carriers. Emerging managing general agents have successfully recruited underwriting veterans to join them. From 2010-2020, MGAs grew at twice the rate of industry premiums.

To defend their position, and to strengthen it, carriers can improve what they have to offer, which is a lot. For example, many operate around the world and across industries, so they can offer talented people the chance for a career path that features a diverse set of roles, industries, geographies and functional areas.

Successful underwriting has evolved beyond risk selection and pricing—it requires a comprehensive set of quantitative capabilities and qualitative skills across coverage lines and technologies. So, carriers can broaden their recruiting by targeting non-traditional profiles—such as those with deep technology expertise or a cyber science background.

From the days when Lloyd’s first began insuring ships in the 17th century and Benjamin Franklin helped to start a fire insurance cooperative in Philadelphia in the 18th, the industry has always been about risk, loss and protection against danger. Essentially, it is about helping to make families and communities resilient. That is an honorable role.

The bottom line is that to keep succeeding in that role, and given the backdrop of competition from new players, climate change, inflation and technological change, the industry itself has to demonstrate that same resilience in the way it operates.