IT Strategy and the Financial Crisis

How will the current financial crisis affect insurance information technology growth? A recent Celent report examines how the economic crisis will affect technology strategies in the insurance industry and gives advice on how to react.
By Tammy J. McInturffThe economy is one everyone’s mind right now. Insurance companies, like most other organizations, are wondering how bad it is going to get. How is the financial crisis going to affect your company’s bottom line? What actions should you take?
Recent events prompted Celent to publish the report, “Bad News on the Street: Insurance IT Strategy and the Financial Crisis.” The report, written by Mike Fitzgerald, Donald Light, Catherine Stagg-Macey, and Craig Weber, looks at the global financial crisis and how it will affect insurers and their information technology (IT) strategies.
Boston-based Celent is a research and consulting firm focused on the application of information technology in the global financial services industry. Celent tracks insurance and technology developments very closely.
Senior Analysts, Donald Light and Catherine Stagg-Macey, recently presented a Webinar based on the findings of Celent’s “Bad News on the Street: Insurance IT Strategy and the Financial Crisis” report. “It has become clear that the turmoil in the housing market and the credit markets from banks to investment banks is becoming global and systematic,” Light said. “It is going to create a set of challenges that insurance companies both on the business side and the IT side are going to have to deal with.”
Riding the Roller Coaster
The markets have been a roller coaster of action lately, leaving companies unsure of what to expect in 2009. Although companies may not be planning any radical changes yet in their spending plans for 2009, most know those plans could change quickly in this volatile economy. “No one knows how all these situations in the financial markets are going to play out but you have to start somewhere,” Light said, during the recent Webinar. “We think in the near term there are going to continue to be severe stresses both on the global financial systems and on the national financial systems. We also make the assumption that there will continue to be disruptive failures, acquisitions of banks, investment banks and to a more limited degree insurance companies. We believe there will be a mild or moderate economic recession both globally and among leading major national economies. This recession will last at least through the beginning of 2010. However, we do not believe that there will be an extended and severe global financial or economic crisis. In other words, there won’t be a global financial system meltdown or severe depression in terms of national or global economies.”
How Did We Get Here?
How exactly did insurance companies get caught up in this mess? It has been well publicized that a lot of bad mortgage loans have been made, primarily in the U.S. Light discussed the root cause of the situation and how insurance companies became involved. “After these bad mortgage loans were made, they were securitized, bought, traded and even often guaranteed by various financial institutions,” he said. “Insurance companies make both explicit and implicit choices regarding their relationship between their liabilities—which is mainly the insurance policies and contracts they have issued, and their assets—which is basically their investment portfolios. So what has happened is the results of these bad mortgage loans and the securitization of these bad loans have been seeping through into the assets side. A lot of insurance companies have fixed income assets that are tied to the real estate values and those mortgage loans and the securitized version of those mortgage loans. Some insurers have had equity stakes in financial institutions whose well being was tied even more closely to those real estate values. We have seen some spectacular failures of financial institutions and also some insurers primarily on the life and annuity side have guaranteed the investment performance of some of their underlying products, which they will have to account for either now or later. A few insurance companies have been specifically in the business of guaranteeing mortgage debt or other financial obligations which has lead to a great deal of misfortune.”
Impact on the Industry
Given the recent events, Celent identified six different sectors of the financial crisis that will impact the insurance industry in the U.S. over the next year. First, Celent believes that losses are going to go up. “One reason for increased losses is what is sometimes called morale hazard,” said Light. “This is policyholders either engaging in soft fraud or even hard fraud in lines like health, auto insurance, workers compensation and so on.”
Celent also predicts that the soft market will continue to impact insurers. “You might think that increased losses would be an opportunity for pricing practices to harden, but we don’t think that is going to happen. We think there are too many other factors at play,” Light said.
Celent also believes that overall financial results for P&C and general insurance carriers will deteriorate. “There is going to be less value out there to insure. There will be fewer employees for workers compensation and health insurance and the demand for variable life and annuity products is going to go down,” said Light. “In terms of capital and solvency, the good news here is that within the U.S. most of the property & casualty, general, and life & annuity industry had started from a very strong capitalization position; there have been and will continue to be however hits to those positions with possibly a limited number of additional insurancecompany failures.”
Celent predicts that regulation and rating scrutiny is going to be both broader and tighter. “It will be broader in the sense that not just the insurance activities but other financial commitments at the holding company level will come under scrutiny. It will be tighter in the sense that there will be a lot more aggressive examinations and more probing questions by rating agencies and much more willingness to pull the trigger earlier on rating downgrades,” Light said.
In terms of mergers and acquisitions, Celent believes there will be an increasing level of consolidation in the industry.
According to Catherine Stagg-Macey, the impact will be similar for Europe but probably not as intense. “Europe is really going to be impacted by what I consider to be the third ripple effect of the subprime crisis in the U.S. which is really the economic slowdown,” she said. “We are also going to see increased claims and fraud which is typical of a slowdown. We will also see pressure to keep prices down. It is always harder to increase prices in difficult times which will obviously erode financial results. In the area of capitalization and solvency there will probably be less of an impact for a European insurer than for a U.S. insurer. In regards to mergers and acquisitions, I think that European insurers may acquire some of the American assets that are for sale.”
How Should Insurer’s React?
Given the challenges that insurers are facing and will continue to face how should they react? Light cautioned that IT groups within insurance companies should not overreact to the current crisis but at the same time they should not under-react either. He added that it is important for these groups to take both a midterm and long term view of the situation.
According to Celent, the basic options for business strategies for insurers have not really changed. Insurers can still use the same operational strategies that they have been using for years. Celent identified these three operational strategies as getting bigger, leaner or smarter. “The financial crisis means that every insurer needs to rethink its choices,” said Light. “Insurers can choose to get bigger by generating more sales and growing in more markets. They can choose to get leaner by reducing expenses and increasing productivity. Or they can choose to get smarter by correctly pricing risks, making the right underwriting decisions, adjusting claims and matching their assets and liabilities. The choices that insurance companies are going to make among these options are going to change. Corporate goals and objectives may change with companies ratcheting down their return on equity. It may take a mix of strategies to reach new objectives. In past recessions we have seen eagerness in many cases to just cut staff. We will have to wait and see if that will happen this time around. We think the tactical focus within strategies is going to be changed. Insurers are going to have to look at what strategic or tactical levers are available to pull right now and which of them have a longer lead time.”
IT Strategy
A company’s IT strategy must be there to enable and support business strategies. Light said this aspect of an insurance company’s IT strategy has not changed. However, he said some companies may need to rethink some of their IT strategies given the current financial crisis. Every insurer has ongoing IT initiatives. Most insurers’ portfolios of planned or ongoing IT projects probably include point solutions, infrastructure, sourcing strategies or IT governance. “These IT initiatives can provide tactical and/or strategic benefits for an insurer,” Light said. “The current financial crisis makes it critical that insurers re-evaluate their current and future IT initiatives and review the kind of value each initiative can provide; keeping in mind that tactical benefits are available sooner but may address more limited issues; while strategic benefits take longer but can change how an insurer competes. Balancing tactical and strategic initiatives is essential to making sure short-term goals are met while at the same time supporting long-term business strategies.”
According to Celent’s recent report, “IT initiatives must adjust to the new economic environment.” Light described in detail which IT initiatives could provide strategic value, which could provide tactical value and which initiatives provided both. In general, tactical solutions usually take less than a year to make an impact, while strategic solutions take one to three years to make an impact.
Core Systems
First, Light looked at core systems initiatives, such as policy administration replacement, rationalization of multiple policy administration systems and claims. According to Light, because of the size and complexity of replacing an administration system, most of the value is going to be on a strategic level and will provide all three types of strategies Celent identified—getting bigger, leaner and smarter. “For policy administration system rationalization where there are multiple policy admin platforms that are being combined onto a smaller number, this is a multi-year process,” Light said. “So we think the value here is also primarily strategic. Core claim systems we think can deliver both tactically and strategically because companies can see leaner benefits within a year in addition to longer-term productivity improvement.”
Point Solutions
Celent also looked at the strategic value of Point Solutions such as product development, pricing and rating solutions, new business and distribution, business intelligence analytics and data mastery and billing solutions. “We think solutions that enable product development or product configuration are primarily strategic in value especially among variable life and annuity products,” Light said. “We also think product development initiatives can help improve innovation and customer responsiveness thus allowing companies to take share from competitors by having a better product available in the market more quickly using these tools.”
Pricing and rating solutions can provide both tactical and strategic benefits, according to Celent. These solutions can enable quick changes in pricing structures. “In the long term, fundamental changes in pricing strategy, such as developing a microsegment pricing approach for a new line of business can have major impacts but takes longer to achieve,” Light said.
New business and distribution initiatives can also provide both tactical and strategic benefits. “In the short term, these solutions can help grow top-line revenue through better partnership with producers,” Light explained. “These solutions can also address longer-term issues like more straight-through processing for certain lines. They can also help with becoming leaner by potential reduction of staff and they can help improve underwriting efficiency and results.”
Analytics, business intelligence and data mastery initiatives can also have both tactical and strategic benefits. “In the short term, tactically, these capabilities let companies become both smarter and leaner in an operational sense,” said Light. “Over the long term, these solutions can give insights for major adjustments in business and financial models leading to improved financial performance.”
Billing solutions tend to have more strategic long term benefits, according to Celent. “These solutions have benefits in terms of management information and dues, but we think they will take a longer time to realize,” said Light.
Infrastructure Initiatives
The third category of IT initiatives that Light discussed during the recent Webinar were infrastructure initiatives, which include business rules and business process management solutions, content/document management, integration and SOA, risk management and data centers. Business rules and business process management solutions can make substantial changes especially for companies with inflexible legacy systems. These solutions can help companies achieve greater control, consistency and decision quality over what is happening, but because these benefits can take longer to be realized, Celent categories these as strategic initiatives.
According to Light, content management and document management can have both strategic and tactical benefits. “In the near term, content and document management can be deployed to get companies much leaner and more efficient. The longer-term benefits are primarily from a compliance point of view.
Service oriented architecture and integration methods tend to provide more strategic benefits. “These strategies will lead to companies becoming leaner and more agile,” Light said. “Most companies have started their SOA build-outs and realize that seeing the benefits is a multiyear process.”
Risk management initiatives can have both strategic and tactical benefits. “This might be seen as kind of the heart of the issue, especially over on the investment banking side and to an increasing degree on the insurance side,” Light said. “Risk management initiatives can help yield smarter capabilities which are important before a crisis and absolutely critical now. The benefits of risk management initiatives range from meeting regulatory requirements to survival.”
Data centers and networks tend to yield more tactical benefits, according to Light. He said these initiatives can help deliver “get leaner” benefits; integrated voice/data/video benefits and also have potential “get smarter” benefits in the short term.
Sourcing initiatives consist of two categories, Information Technology Outsourcing (ITO) and Business Process Outsourcing (BPO). “We see ITO as primarily tactical especially in the traditional areas of maintenance and support,” Light said. “Business Process Outsourcing on the other hand is more strategic. It can have an impact both on the fixed cost and the variable cost structure of a company. This is a big step that requires more time to understand and to find the right partner to do this with.”
IT Spending
How will the financial crisis affect IT spending in 2009? Celent believes that there will be a downward pressure on IT budgets for 2009 and maybe even 2010. “Before the severe current stage of the crisis and the crisis spreading to the insurance industry, we had projected that IT spending in 2009 in general would be modestly higher than 2008,” Light said. “Now, we are predicting spending being stable or down two to three percent. We realize that most insurance companies are on an annual calendar budget year and most of the plans are already in place. Right now, from what we have seen companies are not panicking and reducing budget plans. However, budget plans and allocations can change in a matter of days or weeks if senior management sees the overall situation deteriorating in a serious way.”
Advice for IT Vendors
Celent also had advice for insurance IT vendors. Light said that although this may not be the best of times for IT vendors, it is really not the worst of times either. “The need for the types of value that IT solutions provide in terms of enabling the strategies of insurance companies has not changed,” he said. “In fact, the limitations and difficulties that the older legacy systems present may be felt more acutely as companies are forced to make more rapid adjustments to new environments.”
According to Light, Celent does believe that the way insurance companies buy IT is going to change. “We believe the purchase process for IT will slow down in some cases,” he said. “We also believe that some insurers will employ modified priorities in financial criteria in terms of choosing which vendors they want to partner with. Vendors need to recalibrate and recraft their offerings and messaging to meet these needs. This is a good time for vendors to revisit their own strategies and product roadmaps. A smart insurance company that is looking at vendors for a major initiative will ask questions about the roadmap and want to see a roadmap that reflects that current set of realities.”
Weathering the Storm
So what should insurance companies do to remain strong through this financial crisis? Celent recommends that the insurance company first decide how it will deal with the challenges presented by the financial crisis. “Insurance companies should take a view on what this crisis is going to mean for their particular enterprise,” Light said. “Then, they need to rethink their strategy in terms of that view for 2009. Rethink your tactical and strategic IT projects and initiatives. Looking within IT ask how the current application portfolio can help in terms of flexibility. Where do you have flexibility and the ability to change decisions, processes and product offerings? Make sure that you take full advantage of those capabilities, especially if you are a company that has upgraded your systems in recent years. Look at the IT initiatives pipeline to see if priorities should change.”
Light also advised companies to rethink the approval criteria for new initiatives. “Think about how or what projects might make it easier to take business from current competitors,” he said. “Analyze the tactical and strategic value of these projects. Look at the projects that might enable near-term expense reductions. If an insurance company does not have a risk management system and tools in place this might be an excellent time to start looking at that area. If you do have those systems in place, make sure they are robust enough to handle the changes that are likely to occur in the current environment.”