Mastering Money Management
Insurance IT executives have always been charged with the responsible use of their companies' funds, but the notion of responsibility has undergone some rapid evolution over the past few years.
The capabilities IT has brought to the industry have pushed IT leaders further into the business camp. But as the economy has slowed and competition has intensified, IT execs have been under increasing pressure to manage their budgets with discipline and foresight. Companies no longer consider IT budgets as overhead: They're making an investment—and it's the CIO's job to show a return on that investment.
The change in expectations has been felt more keenly at some companies than others. For example, in the wake of its demutualization in 2000, MetLife (New York, $302.5 billion in assets) has undergone a dramatic shift in its thinking about IT investment, according to Peggy Fechtmann, CIO, client services group. It's no longer a matter of "What projects can we make up to meet our level of spending?" she says. Rather, "we want to make sure we really work on projects, make investments in our infrastructure and build systems capabilities that speak not just to the moment, but to building our future."
Operational Cost Modeling
Spending decisions are now made by very senior executives and a standardized ROI-review process ensures uniform standards of project-vetting, according to Fechtmann. Gone are the days when tech people advanced solutions in search of a problem, or "ideas whose time has not come," as Fechtmann calls them. Technology executives will succeed in securing budgeting—and delivering ROI—on projects whose time has come, says Eric Miller, senior principal, Highpoint Consulting (Charlotte, NC), a project management consultancy. Cost-avoidance, or efficiency-gaining projects, can successfully be sold to management by first identifying the business' needs, defining the benefit, and then finding the solution for the benefit, according to Miller. "An approach many people are taking is going through a modeling process to set a baseline that says, 'If we do nothing, here's what the headcount is going to be within a certain process," he says.
"You can go in and say, based on the vice president's sales forecast, that is going to translate into so many applications, and it's going to take so many people to process them," Miller explains. "If you then say, 'If we implement technology to receive them electronically we'll only need 50 full-time employees instead of 150, and the savings associated with that is X,' suddenly selling it becomes a slam-dunk."
Such operational cost modeling (OCM) is put into practice at Mutual of Omaha (more than $15.4 billion assets under management) by Mike Lechtenberger, vice president, IS applications, who describes it as "a process of developing a comprehensive model or operational flow to understand capability and activity relationships at the lowest level in business process."
Once a coherent "straw man" model is created, "scenario analysis" can be performed to see how the model will work under a variety of possible conditions. "The goal is to reduce your errors or bad assumptions by iteratively testing the model," Lechtenberger says. "It can be a very effective technique as you do more of it, because you understand that many of your activity relationships—especially in an insurance company—are fairly similar across your operating units."
Form over Substance
Lechtenberger explains that scenario analysis serves to validate the business case by testing assumptions, to identify sensitive variables in the benefit model to determine whether the right risks are being managed, and to manage intermediate benefit outcomes to ensure a project is on-track to achieve the ultimate benefit.
Describing the OCM discipline may be easy, but executing it is not. "It's a lot of work," Lechtenberger acknowledges. "You really have to dig in and talk to a lot of people; you have to get a lot of metrics of historical performance and historical activity, and you're trying to get all this stuff at the lowest level of business process that you can."
Today's economic and competitive climate makes such diligence necessary, but there are still ways of overdoing it, according to Highpoint's Miller. Past carelessness and gullibility regarding vendors' exaggerated claims led insurance companies to costly IT disasters, but at many firms the pendulum has swung the other way. Increased fiscal and project management discipline is essential, but companies must be careful not to emphasize form over substance, Miller counsels. "The CFO might have this huge, elaborate ROI calculation worksheet, focusing on depreciation, appreciation, etc." Miller's message is: "Guys, stop fooling yourself on appreciation. Everybody's talking about EBITDA earnings before interest, taxes, depreciation and amortization; forget about EBITDA—do it on cashflows." Generally, "when you see somebody looking at amortization or depreciation, they are trying to goose up the ROI so they can make the hurdle rate."
Miller recommends a simpler process, where the cost model is "set up on the left-hand of the decimal point, not six places to the right. Then you look at monthly cash flows derived from that, and then discount back," he says. Smart companies are "looking to the break-even point, from a monthly point of view," according to Miller. "What's the payback period? What's the net present value? What's the internal rate of return? These are metrics people tend to look at because the financial people are looking at alternative places to put money, and these are the type of measurements they use."
Companies can also benefit from a cost/benefit analysis, including a preliminary phase called a quick cost/benefit analysis (QCBA), which can serve as a gate to a more intensive or in-depth look (ICBA). "So many people start a project and they're four months into it before they can even do any analysis, which doesn't make any sense," Miller observes.
Project proposals coming through the front door can benefit from a total cost of ownership (TCO) analysis, according to Mutual of Omaha's Lechtenberger. "In the past, the up-front license cost was the primary consideration in a cost/benefit model. Often the initial purchase expense is only the tip of the iceberg when maintenance fees, training and upgrades are included to the cost stream," he says. "It's a similar discipline to OCM, in that you're thinking through in a chronological sense, carrying out your true cash flow a few years. That's what you're doing on the OCM-cost/benefit side: You're modeling out your true cash flow."
One of the benefits of TCO is its usefulness in helping avoid nasty surprises farther down the line. "In any project situation you want to identify problems as early as possible—it's easier to fix things earlier than later," Lechtenberger says. "Using these types of techniques will help you do that—and in this day and age, you can't afford to screw up."
Anthony O'Donnell has covered technology in the insurance industry since 2000, when he joined the editorial staff of Insurance & Technology. As an editor and reporter for I&T and the InformationWeek Financial Services of TechWeb he has written on all areas of information ... View Full Bio
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