Spotting dolphins in rough seas – claims inflation makes claims management a top issue for CEOs

Mr. Hüppelshäuser, you read and hear in the media that insurance companies are under great strain due to the current crisis situations; there is even talk of the “decline” of the industry. Is this assessment realistic?

I have been hearing – usually from self-appointed experts – such predictions on the end of the world as soon as any external changes occur for the last 25 years. In fact, however, the industry is very resistant to crises. It has come through the financial crisis well, and even sensationally well through the coronavirus crisis. One reason for this is the long-term nature with which insurance companies inherently plan. For another, customer loyalty, while declining, is still high, which, along with other factors, gives insurers a reasonable degree of planning certainty. Changes – both positive and negative – therefore have an impact in very slow waves, and crises do not hit insurance companies as suddenly as they do other industries. However, there is also a lot of brainpower in the companies, so they know how to cope with new challenges well. Take digitization, for example: it was said that many companies would not survive it. This has not happened either; the industry has adapted to change, although certainly not yet sufficiently and often too slowly. Nevertheless, the existence of insurance companies will be at stake in the near future, because new external factors will require significant reactions in the industry.

What are the factors that pose the greatest challenges for insurance companies today and in the future?

For one thing, the market is saturated. There are not significant numbers of new policyholders being added; it is more a case of retaining and redistributing existing customers. On top of this, investment income will virtually cease to be a source of income over the next ten years. But these are not new phenomena. The current rate of inflation is much more important. We have all read about it in the newspapers and witness it every time we go shopping in the supermarket. Insurance companies are not immune to inflation, especially when it comes to claims. What we are talking about here is claims inflation, or even hyperinflation, to be precise. While inflation is commonly above 7%, the claims sector has been recording 25% to 35% per year for the past three to four years, and the trend is clearly upwards. The example of car insurance makes this very clear: insurers who pay for spare parts in the event of an accident are faced with a dramatic increase in prices. According to the German Insurance Association (GDV), price increases of more than 70% for original parts have been common over the last eight years. Inflation is also having an impact on the real estate sector, which has always been loss-making, as skilled trades are becoming more expensive, according to the German Federal Statistical Office. In 2021, for example, the price of solid structural timber increased by 77.3% compared with the previous year’s average, structural timber by 61.4%, and roof battens became 65.1% more expensive.

I expect these two major segments to remain or become loss-making for the next five years. However, this price change cannot be passed on 1:1 through customer premiums. Insured persons may have become accustomed to inflation to some extent, but they would not tolerate price increases of 10% or more and would switch to less expensive providers. And as always, it’s the good (risks) that change first. Insurance companies must find other ways to absorb the increased costs. This raises strategic issues for insurance companies that did not need to be addressed in this form in the past.

What do these new strategic issues look like in practical terms? What do boards of directors and CEOs have to deal with?

Insurance companies clearly need to streamline their earnings now. If this cannot be achieved by means of higher premiums, then in my view the only option is the claims side. The fight against fraud must work and the purchasing network must be properly developed. These are standards that most insurance companies have been successfully addressing for years. But that alone is no longer enough today. Claims need to be managed in a more targeted manner. Typically, you look at how far away, for example, an auto repair shop is from a customer with a damaged vehicle. That’s history. The much more important question is: which auto repair shop will settle the claim in such a way that I, as the insurance company, have the lowest claim expense with guaranteed quality? There is enormous potential for savings here.

The same question arises when using external (and internal) claims adjusters. The key question is not “who is available right now” but “who is the best person for this claim”. Of course, it is also necessary to ask this question in relation to our own employees as well as the employees of insurance agencies – levelling down will come to an end. But this is where the wheat is separated from the chaff: only a few large insurance companies currently have the analytical capabilities and quantitative data pool to be able to answer such questions. Medium-sized, decentralized insurance companies are unlikely to be able to do this. Some CEOs or supervisory board members are therefore asking themselves whether they can still profitably operate the P&C business and, in particular, the motor vehicle and residential building business at all – and if so, how this can be achieved.

Another key aspect is that the Executive Board and the Works Council must engage in a strategic dialogue about the future of claims management. This would address what can still be done in-house in the future, and what must be outsourced. How transparent are teams and employees to be managed and what does this mean for management? The age of bad compromises in operational management is over.

Aren’t these kinds of data-based questions relatively easy to solve with AI and analytics these days?

AI and data will make the difference in claims settlement. The big tech companies would be nothing without AI and data analytics, and claims management will move in the same direction. If we look at the industry, it is also clear that insurance companies have always worked with and analyzed data. There is therefore an ideal foundation. However, the challenge is not limited to evaluating the company’s own data. There are actuaries who can handle that very well. The problem is external data. How does an insurance company obtain data from service providers? How can it combine them with its in-house expertise and figure out how best to manage claims – which repair shops, which employees – and thereby reduce its costs as much as possible? In my experience, this is where many insurance companies reach their limits because, in addition to the necessary AI expertise, they simply lack the external data basis. Of course, data quality also plays a role. The company’s own inventory may be cleanly managed, but as soon as data are added through collaborations with external service providers, redundant or even deviating results quickly arise. This means that it is virtually impossible to carry out a meaningful analysis. Up to now, the majority of insurance companies have simply not had the capability to understand their own data in conjunction with external data and have not needed it at all. However, this capability will be critical in getting claims inflation under control. Urgent action is called for!

What can insurance companies do if they want to evaluate both internal and external data and use them to achieve their strategic goals?

In my view, comprehensive professional support is needed, which can often only be provided by external parties. This is because very few insurance companies currently have their own data science and AI experts. Consequently, not even general digitization consulting will help here. The external experts must have an understanding of data and algorithms, as well as an understanding of the industry and the sector in question. They should also be familiar with the service market from which the required external data are derived. There are very few consulting companies that have such expertise as Comma Soft, for example, that can think in a networked way, link, and transfer knowledge from a wide variety of industries, and ultimately also make the transition to insurance. The latter is particularly important: not all employees have to become data specialists. However, they should not blindly trust the machine, but rather be able to understand why, for example, certain risk or claims assessments are made and how they should follow up on them in an investigative way. Good consulting firms must also provide this translation service. If insurers get the right support here, they can answer their strategic questions, counteract the effects of claims inflation, and overcome this crisis as well.

Lastly, what do dolphins have to do with CEOs?

Well, I was recently out in rough seas and suddenly I saw two dolphins calmly swimming along. CEOs should be able to stay on top of things even in the roughest of seas and have a compass to provide orientation. From my point of view, this compass consists of entrepreneurship and lots of data.

Are you looking for support to help you deal with data in your company even more effectively? Feel free to exchange ideas with our insurance expert Dr. Markus Knappitsch!