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Cynthia Saccocia, Research Director, Insurance, TowerGroup
Cynthia Saccocia, Research Director, Insurance, TowerGroup
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Managing in the Best and Worst of Times

How can insurers shift the concentration of their IT budgets away from internal spend and maintenance toward innovation?

The business of insurance clearly has become more complex. The interconnected risks that companies face in today's world are nearly unprecedented. Never before has the linkage of risks such as terrorism, hurricanes and other natural disasters, stability in credit and equity markets, fluctuations in interest rates, and the scrutiny in legislation and capital requirements been more intense.

Nor have the expectations for success and excellence been higher. But with focused discipline and good decision making, select insurance companies are delivering financial strength and stability to shareholders and policyholders alike.

The industry leaders - from megaglobal insurers to small regional or niche carriers - are achieving excellence by concentrating on profitable growth and competitive advantage. Each objective involves a host of strategies to design discrete products, make a profit on underwriting, advance business processes, use technology to exploit process improvements, derive benefits from regulatory change and minimize the costs of each. Leading insurers are distinctive because of their disciplined approaches to fundamentally changing behaviors in business process, as well as open and realistic approaches to deploying technology.

In terms of overall performance, the property/casualty and life insurance industries are doing well in a year riddled with catastrophes and challenging capital markets. Because of strong first-half operating results, property/casualty underwriting performance points toward a moderately profitable year that was interrupted, unfortunately, by catastrophe losses in the third quarter. The life insurance business becomes increasingly stable as large diversified companies dominate the market and maintain financial flexibility and capacity to withstand tough market environments. The circumstances and challenges resident in each industry, however, create one of the most challenging environments through which insurers have ever managed their businesses and one that will persist for the foreseeable future.

Where's the Spending Going?

Property/casualty insurers are beginning to show signs of change by integrating technologies across product silos toward functions and processes enterprisewide. There is an increased emphasis on profitable growth, so focused attention on underwriting and agent automation in both personal and small commercial lines will attract a large proportion of the resources. Other areas of focus will include claims, data warehousing, and the expanded use of business intelligence and predictive analytics.

We expect to see similar activities in the life insurance business, but also some key differences. This is because of a relative maturity in annuities and the underlying technologies to support them. Therefore, the annuity business will focus on reengineering operations, and the life business will focus on product development, underwriting and agent automation. We also expect group benefits to receive renewed attention for self-service Web portals.

There will be certain differences in the way each business line directs its resources. Therefore, predicting spending trends in the insurance industry is complicated by the complex matrix of the insurance regulatory environment; the lines of business covered; regional, national and global competition; and internal power struggles. It is important for each insurance company to evaluate its own needs and closely align its business and technology plans to have a strong impact on both expenses and the bottom line.

Business strategies and technology investments in 2006 will focus on providing high-quality, personalized service to remain competitive, and on delivering high-quality, disciplined underwriting for profitable growth. TowerGroup (Needham, Mass.) projects a modest increase of less than 5 percent in U.S. technology spending, or $38.2 billion with a fairly equal weighting between property/casualty and life insurers. Technology spending will remain controlled and project scopes will be limited to durations of 18 months or less. As executives in both markets evaluate enterprise needs, some may determine that a 5 percent to 10 percent technology budget increase is necessary to tackle substantial enterprise improvements. However, enterprise initiatives will be broken into tactical projects of similar durations to meet milestones, adjust for changes in scope requirements and demonstrate return on investment throughout the project life cycle.

Tackling the Internal Spend

Approximately 50 percent of the total technology budget is allocated to internal resources that support business operations for infrastructure, maintenance and development. TowerGroup expects this to change slowly over the next five years, as large-scale insurers adopt strategic resource management principles.

Strategic resource management is based on a blend of internal and external services, and offers a means for insurers to extend operational capabilities in both human and technology capital. Insurers direct an array of activities with a combination of internal and external resources in business and technology services such as domestic or foreign investment in captive sites, flexible alignment of internal resources, IT outsourcing and business process outsourcing. As a result, TowerGroup estimates external spending for software, services and outsourcing - now accounting for 30 percent of the budget - will increase gradually because of an ongoing focus on buying software applications, along with the overarching trends of added support from consulting and select areas for outsourcing services.

Insurers also will lower internal spend by reducing the overhead to support operations because of gains in efficiency. The use of advanced technologies and developments in service-oriented architecture will provide flexibility in back-office operations. A flexible back office lowers expenses and makes many other growth capabilities possible. The legacy issue that many insurers deal with is the result of the companies' complex histories in products and services, so reengineering and integration probably is the greatest challenge that companies must tackle if they are to advance their operations. The other reason to embark on a strategic plan for core system replacement is to flip the ratio of spending on infrastructure and maintenance to development.

A majority of insurance companies have moderated their technology spending to focus their efforts on reducing infrastructure and maintenance costs so that they can increase their discretionary spending on innovation. This is because most insurers spend less than 10 percent of the technology budget on innovation, which is defined as truly new development. Strict discipline in the maintenance and infrastructure budget, coupled with strict discipline in project scope management, is the only way that insurers will find remedial, hidden costs so that there is more money available for development and discretionary business needs.

It is clear that 2006 will be a year of focus on the future and on enhanced capabilities. The risks are clear and the cost of waiting is too high for a company to sit on the sidelines and wait for another to pave the way. Insurers must extract all the benefits from this complex and challenging environment and minimize the costs to support the business. Business discipline, focus and behavioral change are necessary to define strategic advantages. Clarity in priorities for those areas that are of strategic importance, as well as solid business architecture, are the key components to focusing technology in ways that enable the organization to achieve its goals. Technology does not create process change, so the business needs to own innovation and fund major issues in the technology environment that hinder a company's ambitions for growth and differentiation.

High-quality, personalized service to remain competitive and high-quality, disciplined underwriting for profitable growth are fundamental for insurance companies to deliver performance, stability and transparency to those parties that demand it. Spend effectively, maximize your resources and reduce the complexity in the business to be distinctive for the long term.

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