TowerGroup forecasts point to emphasis on closing the gap between IT spending and strategic business operations.
Special Report: 2004 Tech Investment Preview
TowerGroup projects IT spending in the U.S. insurance industry to increase slightly in 2004, up 2.5 percent from 2003 levels. However, there will be marked differences in each business line. TowerGroup forecasts a 10.4 percent increase in total IT spending for property and casualty insurance (P&C) from its 2003 estimates. This increase is due, in part, to a 230 percent projected increase in P&C net written premium from 2002 estimated results.
TowerGroup anticipates IT spending in life and annuity insurance (L&A) will be flat from 2003 to 2004. L&A insurers are not likely to increase IT spending due to financial market pressure, which makes it difficult for L&A insurers to raise revenue and, consequently, a challenge for them to consider bigger IT budgets.
TowerGroup estimates that insurers will budget a zero to 10 percent increase in IT spending from 2003 to 2004 and will spread budgeted dollars to various insurance operations in infrastructure, maintenance, and development. Typically, insurers allocate 30 percent of their IT budgets to infrastructure costs such as software, hardware, and networking. Insurers then usually split more than half of the remaining 70 percent of the budget to maintenance activities such as regulatory changes, production support, and minor enhancements to existing applications; and the balance to new development-such as major enhancements to existing applications and new projects (see Exhibit 1 on this page).
Shift on New Initiatives
TowerGroup projects that approximately 20 percent of the development allocation or approximately six percent of the total IT budget at insurance organizations will fund 2004 new initiatives. A closer examination of the development budget demonstrates how difficult securing new projects will be in 2004. Typically, in insurance 50 percent of the development budget is for major enhancements to existing systems and 50 percent is for actual new development projects. Of the 50 percent spent on actual new development, 60 percent funds prior-year projects, leaving just 20 percent of the development budget to fund current year new development (see Exhibit 2 on page 44).
Carry-over initiatives include projects in distribution, such as agent portals for application submission and service; projects in cost containment, such as claims efficiencies; and projects to upgrade or replace existing applications. In 2004, actual new development will include projects to reduce costs, streamline operations, and improve effectiveness in core systems, distribution, service, and data migration (see Exhibit 3 on this page). For example, P&C insurers must improve underwriting results to increase net income and reduce operating costs in claims. L&A insurers must expand distribution to increase scale and reduce operating costs in policy administration.
The leaner-and-meaner IT organizations will continue to feel pressure from their boardrooms to reduce overhead and administrative costs associated with IT. In 2004, insurers must introduce similar budgetary control measures to the maintenance budget that are resident in managing the development budget. The discipline put forth to control new development project costs and measures to value return on investment must be replicated in the maintenance budget in order for insurers to accurately assess total IT expenses. Many insurers report excessive IT costs in maintenance of existing systems, and many would spend more on new projects if overhead costs were under control.
However, few insurance companies can accurately classify maintenance costs and pinpoint areas for improvement. Consistent budget controls in maintenance and development are necessary for insurers to parlay their budgets in both of these areas.
Infrastructure Improvements Bring Savings
Certain areas of an insurer's IT operation will deliver more cost-effective benefits when compared to other options. For example, insurers can find hard dollar savings in infrastructure improvements such as system software, hardware, and networking devices. Other savings come from application and server consolidation and utility computing.
Another area, core system reengineering, is imperative for insurers to address escalating maintenance costs connected with aging systems and processes. As a means to further control maintenance costs, TowerGroup expects insurers to take a closer look at business transformation outsourcing in business processes and technology infrastructure.
TowerGroup does not anticipate any aggressive technology investments in insurance over the next 12 months. The information technology spending environment will remain controlled and allocations will be limited to short-duration projects of 12 months or less. The focus on controlling costs and maintenance by use of flexible IT architectures will be of utmost importance.
Insurers are planning for the next market cycle of growth and for many organizations, 2004 will be a critical year to close the gap between IT spending and strategic business operations.
JAMIE BISKER is a director and CYNTHIA SACCOCIA is a senior analyst in the insurance practice at TowerGroup (www.towergroup.com), a Waltham, Mass.-based research and advisory services firm focused exclusively on the global financial services industry.