Interest-rate cut means insurers need new profitability playbook
To undercut vulnerability from interest-rate cuts, insurers need a blueprint for reducing costs and boosting revenue.
The insurance industry, much like any other, operates on a margin basis, where profitability hinges on the balance between growing revenue and managing costs.
This balance, however, is easily disrupted by fluctuations in interest rates.
For more than a decade, the insurance industry has been challenged to eke out growth against a backdrop of artificially low interest rates. More recently, the industry also has had to contend with sharp inflationary pressures, increasing operational and labor costs.
With the recent interest-rate drop of 50 basis points, and the prospect of further reductions to come, insurers must scramble to rebalance the scale.
Rate cuts dent profitability
Consider the following formula for insurance margins:
Profit Margin = [(Premium Income + (Investment Value × Interest Rate) - Total Expenses) ÷ Total Revenue] × 100
Take, for example, a mid-sized American insurer with $50 billion in invested funds, $10 billion in premium income, and $11 billion in total expenses.
With an interest rate of 4%, the profit margin would be 8.33%, resulting in $1 billion in profit.
However, a 0.5% reduction in interest rates to 3.5% would drop the profit margin to 6.38%, reducing profits to $750 million — a significant loss from such a seemingly minor adjustment.
Overreliance on investment income
Insurers rely on investment income now more than ever, using it as a means of balancing out underwriting losses and operational challenges.
In 2023, U.S. property and casualty (P&C) insurers reported a record net investment income of $73.9 billion. However, this raises the question: Is this reliance sustainable? Some insurers derive over 70% of their income from investments.
With the Federal Reserve's recent 50 basis points cut to 4.9%, the insurance sector no longer has the luxury of slowly weaning off its dependence on investment income. While growing the top line remains a primary goal, insurers must pull all the levers available, including streamlining operations wherever possible, to improve the bottom line.
The prolonged low-interest-rate environment
Unfortunately, the past decade of historically low interest rates — averaging between 3.5% and 4% — hasn't been sufficient motivate for insurers to adapt effectively. Instead of running more efficiently, many have been over-reliant on investment income, which have made them dependent on a limited repertoire and leaves them ill-prepared for future rate cuts.
Several practices have left insurers vulnerable including:
- Over-reliance on alternative investments. Many have leaned heavily on private credit and real estate, which can expose them to higher liquidity risks.
- Dependence on long-duration bonds. Locking in low returns for extended periods limits insurers' ability to quickly adjust to interest rate changes.
- Aggressive pricing tactics. To compensate for reduced investment income, insurers have sacrificed underwriting discipline, increasing their exposure to riskier business. A McKinsey study revealed that insurers often "sacrifice long-term profitability for short-term premium growth."
For example, U.S. P&C insurers' underwriting losses hit a 10-year high of $38 billion, yet these losses are often overshadowed by large investment income gains.
On the surface, things might appear promising, but the core remains weak.
A clear strategy is needed to survive rate cuts
To address vulnerability from future rate cuts, insurers need a blueprint for reducing costs and boosting revenue. Hasty reactions to minor rate cuts can lead to relaxed underwriting standards, increased exposure to riskier investments, and greater volatility.
Instead, insurers should view this as an opportunity to achieve operational cost cuts that provide longer-lasting benefits and stability, while strengthening the core business.
Legacy systems won't let you run leaner
Many insurers are stuck using outdated processes and systems, which hinder operational efficiency and alienate Gen-Z talent.
For example, even in this digital era, we still seeing insurance companies that are onboarding producers using paper processes.
To remain competitive, three critical areas need an overhaul: Agent recruitment and onboarding; lead management; and customer retention.
- Agent recruitment: AI-driven platforms that can analyze performance data to identify the most promising agent profiles. These tools help insurers focus on candidates more likely to succeed, reducing onboarding time and costs. By automating the vetting, interviewing and training processes, these systems streamline recruitment and ensure agents are aligned with company goals, while real-time insights allow for continuous optimization of recruitment strategies.
- Lead management: AI-powered tools can optimize how leads are tracked, nurtured and converted. By automating manual processes, insurers can prioritize high-quality leads, assign them to the right agents, and track the customer journey with full transparency.
- Customer retention: Insurers should adopt data-driven tools that can predict customer behavior and enable personalized engagement. These systems use analytics to identify policyholders at risk of lapsing, offering timely interventions such as targeted communications or personalized offers. Mobile-integrated retention tools also help maintain seamless contact with customers, improving loyalty and retention.
In an environment where we expect the continuing suppression of interest rates, there are many tools insurers can turn to in order to manage and control their costs and grow their bottom line. There is no time like the present.
Thomas Hall (thomas.hall@getvymo.com) is vice president of Global Operations at Vymo, a global insurance IT platform provider. Opinions expressed here are the author's own.
