How insurance companies can squeeze the full benefit from general and administrative costs

 Getting more for less
  • Blog post
  • November 17, 2021

Tim Braasch | Partner, Strategy& Germany

Saving costs has ranked alongside the pursuit of digitization and growth as a major strategic priority for insurance companies in recent times. Although much progress has already been achieved, further cost optimization is still called for. Moreover, greater cost savings are certainly attainable, particularly in relation to general and administrative (G&A) expenses, an area which has been largely neglected for too long and offers great potential for optimization. By clearly distinguishing between good investments and bad G&A costs, and carefully selecting the expenses that can be reduced or eliminated, insurance companies can free up substantial resources to spend on differentiating activities that distinguish them from competitors.

G&A expenses typically account for approximately 20% of total operating costs in a property and casualty insurance company, and 30% in a life insurance company. The legal and finance functions swallow up around two thirds of these expenses. This proportion has been on the rise over the last few years largely as a result of burgeoning regulation, such as the new Solvency II, IFRS 17 and General Data Protection Regulation (GDPR) rules, which has led to a threefold increase in compliance costs and a sizeable growth in finance-related costs too. There is little sign of any respite either, as the regulatory trend responsible for this growth is only likely to become more pronounced.

As G&A costs typically account for ~30% of operating costs, they offer enormous optimization potential

Many insurance executives see little light at the end of the tunnel. Indeed, our conversation with decision makes suggest that fewer than one in five are confident about stemming the tide and fully achieving their goals from G&A cost optimization.

We believe that the one-size-fits-all approach widely followed in the past, in which insurance companies strive for a 10-20% reduction in G&A costs across the board, is contributing to this pessimism. This approach is foundering because, crucially, it does not draw a marked distinction between good and bad costs. The time has come, therefore, to adopt a clearly differentiated approach.

Differentiating expenditure

The starting point for increased effectiveness must be to align G&A costs with the bigger picture of corporate strategy. Insurance companies need to distinguish between investment in capabilities that are necessary to stimulate profitable growth (good costs), and expenditure on low-performing areas of the business and inefficient operations (bad costs).

Good costs are devoted to capabilities that set the business apart from competitors, move it closer to customers, and allow it to develop new value propositions relevant for today’s marketplace. Bad costs denote redundant spending that can be overhauled, or even eliminated entirely.

Before embarking on the task of differentiating costs, it is first necessary to change the mindset of the past. Rather than becoming fixated by benchmarks or limited percentage gains, insurance companies should be ambitious and set the bar far higher.

The 10x concept, pioneered in the digital and InsurTech sectors, seeks to explore all possibilities and achieve tenfold improvements rather than settle for marginal gains. Aspiring to boost efficiency by just a few percentage points probably means that the company is doing what it has always done, while all its peers are very likely to be doing much the same. Why continue rather aimlessly on a path that could not deliver the desired results, when a more forceful ambition can change the way customers perceive the company and take it ahead of its rivals?

Justifying what to keep

Indeed, instead of justifying what should be eliminated, the emphasis now should be on justifying what should be kept. There has to be a very good reason to maintain current expenditure on a particular activity.

Such a process is known as zero-basing, which looks at costs with fresh eyes and without prejudice. Zero-basing examines all activities based purely on their strategic priority, whether they add value to the business or are commercially necessary. Budgetary precedent, on the other hand, is discounted as a factor.

In the zero-basing exercise, G&A activities are effectively divided into four, with each activity assigned to any one of these categories. First, there are investments and activities launched in the past which are no longer required, as they do not fit with current corporate strategy. These can be eliminated.

Second, there are the bare minimum activities that are needed to keep the lights on or maintain the company’s critical business operations. In this instance, the company should aim to spend less than their competitors.

Next come the table stakes costs, expenditure on basic competencies or activities that all players require in order to participate in the industry. The focus here should be on cutting costs while maintaining a sufficient level of quality.

Finally, there are the differentiating G&A activities that have the potential to set the company apart and provide a competitive advantage. To secure that advantage, the company should invest more heavily in these activities than its peers do.

If, after due consideration, all G&A activities are reallocated to each of these categories, insurance companies could alter their G&A cost structure in a powerful and fundamental way. Up to 30% of overall current G&A costs could be eliminated, and up to 20% can be newly designated as a lights-on activity, rendering them appropriate candidates for more robust cost cutting. Significantly, the percentage of costs devoted to differentiating activities could be raised to up to one quarter of total G&A expenditure. Examples differentiating activities would be investing in digitally enabled processes or services provided by state-of-the-art artificial intelligence.

Justifying what to keep, not what to kill

The what and the how of G&A cost reduction

We have seen that legal services are responsible for a sizeable chunk of overall G&A costs, and that this proportion is set to rise rapidly. Any serious attempt to reduce G&A costs must therefore examine current expenditure on compliance, and then identify potential savings or opportunities for improved effectiveness.

Personnel costs currently constitute the overwhelming majority (80%) of spending on compliance. Most legal services are currently carried out internally, with only selected legal support services purchased in addition on a case-by-case basis, perhaps because the relevant expertise is not available internally or in order to obtain a second opinion.

As the focus on compliance intensifies still further, insurance companies need to decide which legal services will still be performed internally, and which can be delegated to external suppliers. One possible vision of the future sees most legal issues resolved externally, with lean in-house legal teams coordinating and managing those external suppliers and selecting the most suitable law firm to answer increasingly complex compliance questions.

Within our projects, we have seen that insurance companies should identify redundant investments and activities that can now be purged without ill effects. However, the most powerful way to reduce G&A expenses is to eliminate “redundancies”.

Our experience shows that more than 20% of current costs on internal services could be cut completely without noticeably affecting the organization’s performance. Redundancies can either be obvious or hidden. Examples of obvious redundancies include superfluous process, excess production, or time spent waiting for essential information. Hidden redundancies might incorporate surplus participants in a given process, overcomplicated decision-making cycles, or the supply of excessive or irrelevant information.

A proven approach for identifying potential cost optimization is to ask business units for a subjective evaluation and prioritization of the services which G&A functions provide to them. Which work processes do they think could be simplified, and what bureaucracy could be minimized?

The results of this feedback are then set against an objective KPI assessment of G&A activities, conducted in tandem by business units and G&A functions, based on specific hard facts. At the end of the process, potential targets for cost elimination and reduction, from the short term to long term, are included in a budget proposal from G&A functional managers.

By examining G&A costs wholly afresh, insurance companies can dispel the pervasive, resigned view among their leaders that little can be done to fight the upward trend in expenditure. With the help of a positive mindset, companies can transform their G&A cost structure and secure a major advantage over their rivals.

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Tim Braasch

Tim Braasch

Partner, Strategy& Germany