Insurance value creation in a new on demand world · 1 Insurance value creation in a new on demand...

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deeperAn IBM Institute for Business Value executive brief

Insurance value creation in a new on demand world

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brief is based on an in-depth study created by the IBM Institute for Business Value. This

research is a part of an ongoing commitment by IBM Business Consulting Services to provide

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Insurance value creation in a new on demand world IBM Business Consulting Services1

Insurance value creation in a new on demand worldImagine a world in which:

• An insurance company defines its risk appetite, adjusts the profile dynamically and communicates the changes to its agents and brokers as an ever changing target market definition while simultaneously adjusting reinsurance arrangements . . . AIG does this with Domestic Brokerage Group (DBG) capacity today1

• An insurer’s entire book of business is focused on and segmented by narrow customer segments, specific risk types and various channel strategies in order to maximize customer lifetime value and address competitive issues in seconds rather than years . . . Horace Mann does this with teachers today2

• An insurer’s risk preference is supplemented, on a realtime basis, by its knowledge of reinsurers’ risk preferences and a network of third-party product manufacturers and reinsurers with complementary risk profiles . . . Lloyds has been doing this for centuries3

• An insurer sells insurance as part of a bundled offering with an auto purchase, capturing a greater share of wallet with minimal effort . . . Tokio Marine and Fire, MitsuiSumitomo and Sompo all do this today4

• An insurer dynamically prices an auto premium based on actual risk exposure – time of day, location, speed and weather – on a realtime basis . . . AVIVA and Progressive do this today5

• An insurer pays on a per policy basis for infrastructure and application management services in order to run its core insurance administration environment to reduce costs and to match revenue with expenses . . . Canada Life does this today6

• An insurer transfers its subscale life book of business to another carrier possessing the appropriate scale and scope economies required to improve focus and cost structure . . . Fortis U.S. does this today with RBC Liberty Insurance Services7

• An insurer captures the majority of acquisition value while ceding unwanted risk and outsourcing a significant portion of operations, plus achieving double-digit shareholder returns . . . Direct Line does this for Royal Bank of Scotland share-holders today.8

These examples are real and similar capabilities can be implemented by other insurers. However, for the majority of insurers, implementation comes with significant risk, cost and time investments. Moving forward, those that are able to overcome these challenges will be positioned to dominate their marketplace.

Contents

1 Insurance value creation in a new on demand world

2 On demand vision

8 On demand and value creation

16 On demand migration paths

18 Getting started

20 Appendix

20 About the authors

20 About IBM Business Consulting Services

21 References


On demand capabilities help enable insurers to seize strategic and tactical advantages by reducing the risk, cost and time required to implement innovative strategies. This is closer to reality than you might think. While the scenarios described above have tested the limits of what is considered reasonable, many capabilities from these scenarios are quite real and available today. This paper will explore the vision that enables these scenarios to become reality, the sources of value creation and the migration paths that make this vision accessible.

On demand visionOn demand is a fundamentally new way for insurers to operate their businesses and variabilize the cost of large investments. On demand enhances execution of your current strategies and expands strategic options by making a broader range of business and operational strategies economically and technically possible. By creating an on demand operating environment, designed with open standards for ease of integration, insurers can implement new capabilities and the associated enabling technologies with significantly less effort.

InsCo dynamic product illustration

John Smith, an InsCo life insurance agent, sits with Bill and Mary Jones as they discuss their retirement

and protection needs, as well as the investment and insurance options available to them. Bill and Mary

are very happy with the mutual funds that serve as the couple’s primary investment vehicles, and both

Bill and Mary participate in employer-sponsored group term life plans.

John calls up his Dynamic Product Illustrator on his laptop and creates a virtual insurance product, layer

by layer. The risk layer is based on InsCo’s current risk appetite for Bill and Mary’s risk profile and product

elements available from third-party product manufacturers, including the provider of the Joneses’ group

term life plans. The investment layer is based on Bill and Mary’s preferred mutual funds, all of which

are included in the broad array of funds available through InsCo. Because the Joneses want to control

administrative expenses, John selects the lowest cost service level package. Finally, the Joneses are not

interested in purchasing conversion options, as they are only interested in variable products.

As they speak, John’s laptop has been downloading information from an InsCo data hub via a wireless

connection. In turn, the InsCo data hub consolidated information from sources across InsCo as well as the

third-party providers of term life coverage and investment vehicles, while matching the Joneses risk profile

against InsCo’s risk appetite and reinsurance limits. Moments later, John is able to show the Joneses a

side-by-side comparison of their "virtual" product and the InsCo product that John can offer them. The

Joneses then are equipped with the information required to make an informed decision on the spot.

At their next meeting, John will be able to offer the actual composite product, which will no longer be

just an illustration. When this happens, John will be able to process the client application, generate a

policy quote, confirm reinsurance coverage and bind the policy in realtime. This capability will drive a

range of business processes from automated data capture and policy issuance to updated InsCo’s risk

appetite and shared information with reinsurers.


The InsCo dynamic product illustration scenario highlights the potential for InsCo and other insurers to realize benefits across a number of dimensions. The product illustration tool will increase customer product knowledge and provide agents with the opportunity to address potential customer objections immediately. As a result, there is a high potential that the close rate will increase, the "regret" factor will dimin-ish and retention rates will increase. Other impacts can include:

• An increase in face values – Increasing understanding of the product and the underlying value proposition will translate into greater confidence in the product and higher face values

• Improved profitability – Allowing the insurer to define a risk profile, vary it dynami-cally, and provide alternative sources when the customer need falls outside the current profile, which will lead to improved profitability and reduce the need to write "accommodation" business

• Expense avoidance – Enabling technologies will be developed and provided by a third party and can be paid for on a usage basis rather than as a single, large capital investment.

The technologies required to enable this scenario are available today and are cur-rently being implemented by several leading insurers. It is the adoption of open standards and business architectures that facilitates integration across and beyond the enterprise. In this example, both InsCo and all of its business partners have adopted open standards built around defined business processes.

The economics of delivering such capabilities are also changing, making the realiza-tion of the on demand vision possible. The cost of a laptop configured appropriately with wireless enablement has dropped significantly in recent years. The options for application development and hosting also have expanded to include the option to pay on a usage basis and to avoid a large capital expenditure for InsCo.

Evolutionary, not revolutionaryThe future operating environment of the on demand vision builds on earlier efforts by insurers to break down organizational silos, to optimize select business and technology capabilities across the enterprise and ultimately to "componentize" capabilities. From a business perspective, insurers have long recognized the benefits of more closely integrating key areas of the value chain. Non-life (P&C) insurers are clearly focusing on more closely aligning the underwriting and claims processes to improve their ability to identify and price risks. Life carriers have historically invested heavily in the product development and distribution processes to increase product and service relevancy, speed-to-market and new business growth.


From a technical perspective, many insurers are facing rising maintenance costs and systems inflexibility in a market demanding low operating costs and high agility in introducing new products in constantly evolving market niches. Many of the existing core insurance systems that insurers operate are inadequate to meet these demands because of a longstanding patchwork of maintenance procedures and tightly coupled systems designs. Optimizing, modernizing, and opening up individual legacy applications for more general access and use is one step toward increasing system flexibility, reducing maintenance expenses and increasing responsiveness to business needs.

For both existing legacy applications and new replacement applications, extracting the business logic and data elements from a web of "spaghetti code" is always a critical and difficult part of the process. But it also provides an opportunity for modular redesign of core system functionalities. For example, instead of embedding and distributing business logic in applications themselves, a modernized core solution architecture will likely have a rules engine that houses the business rules, databases that store data and Web services that render the presentation layer. This decomposition of business/IT logic makes solution maintenance much easier, and is a large force behind the less expensive and more flexible "future proofing" that insurers have been pursuing over the last several years.

Once a capability is isolated as a bundle of business processes and enabling technologies, the evolutionary next step is to ask, "How should the enterprise source each capability element?” There are opportunities to source the business process, organizational and technology enablers from within a traditional silo, from across the enterprise or from third parties. The criteria for determining how to source capabil-ities will be driven by cost/benefit analyses unique to each application and insurer enterprise architecture. But in each opportunity, there are differing levels of value. If an insurer chooses to source a capability from across the enterprise, it should do so because measurable benefits to both the total business and line of business, rather than because of a business-independent technical strategy.

Instead of insourcing all capabilities, rules engines and applications could be maintained by a third-party that provides deep subject matter expertise and that shares a piece of the underlying risk. What if the insurer held a third party contrac-tually responsible for delivering best-in-class capabilities – including organizational, business process and enabling technologies – within a predetermined pricing structure linked to service level agreements? What if the presentation layer was rendered through an agency portal managed by another third party? These are all facets of componentization that enable virtualization, focus and access to best in class capabilities. This is what it means to have an on demand environment.


On demand is more than just jargonOn demand is real. It is more than just jargon or a new marketing slogan. At its core, it is a simple business concept: Configure your business model to provide customers what they need, when they need it, from any source, at the right cost and with faster speed to implementation.

On demand is more than being technology focused, although technology is a key enabler. On demand represents both a vision for the operating environment and the delivery strategies for realizing that vision.

On demand is more than the outsourcing of technology to reduce costs. It is a comprehensive sourcing model across the organization, business processes and technology to align expenses with revenues. It optimizes the mix of internal and external capability sourcing for both core and non-core functions by leveraging the use of external parties with competencies in areas of strategic importance.

On demand is more than process redesign for efficiency or effectiveness. It is a fundamentally different paradigm for running a business. If all business operations need to support on demand, then it becomes essential to have a capability delivery model that integrates internal and external processes.

On demand is more than utility-like computing, however, it enables payment for only the business and technology capabilities used on a variable basis. This "pay as you go" approach allows insurers to take advantage of strategies that formerly required prohibitively large initial investments.

On demand is more than expense savings achieved by optimizing costs and managerial degrees of freedom. It is a comprehensive approach that drives value across multiple dimensions, including improved cash flow, reduced capital base, reduced risk and increased options and flexibility.

On demand can elicit diverse reactions. Is it a vision? Is it business transformation? Is it outsourcing? Is it infrastructure? Is it a new technology? Is it a marketing campaign? Is it a financing and pricing option? To some degree, on demand is all of the above. To further illustrate this, consider an ancient fable in which three blind men were asked to touch different parts of an elephant and to describe what each thought the object was. Upon examining the tail, the first blind man reported the object as a rope. Touching the leg, the second blind man argued it was a tree. After handling the trunk, the third blind man claimed it was a snake. In reality, it was one object – an elephant.9 Much as each blind man’s perception was defined by his unique experience, each insurer will realize value from on demand in distinctive ways based on its individual implementation approach and business and technology strategies.


Insurance value chain examplesTo better understand on demand in the context of insurance, we will examine specific components of the insurance value chain.

Underwriting (for P&C and life insurance)In an on demand operating environment, insurers would be able to access best-in-class data management and analysis capabilities as an enterprise shared service or from an independent service provider. Insights into the existing book of business in the context of current market conditions and trends would dynamically feed an insurer’s risk tolerance profile. This profile would reflect changing target market definitions, underwriting guidelines, rate plans and reinsurance arrangements.

On demand underwriting capabilities would leverage predictive modeling, micro-segmentation and advanced decision-support capabilities. These capabilities could enable rate plan optimization, identification and execution of rate pursuit opportu-nities. Additionally, it would provide greater understanding of specific risk factors, identify the impact on profitability and update underwriting guidelines.

Policy administration and product management (for P&C and life insurance)In many cases, current policy administration systems depend on overnight and intra-day batch updates to synchronize policy and customer information in multiple databases. An on demand operating environment could enable realtime updates so the current view of the policy and the customer would be rapidly available to authorized employees and business partners as well as to the customer.

Additional on demand policy administration capabilities could include just-in-time “policy building” including coverages, credits, exclusions and terms and conditions. Other features may incorporate prompt policy renewals and changes with the inherent flexibility for product management and policy administration. These capabil-ities could be delivered in a utility model in order to reduce unit costs and enable transition to a variable cost structure. This may be especially relevant for closed life books of business with declining activity volumes.

In the area of product management, an insurer may provide rapid development of new, “game changing” products that leverage hardware, data, analysis and applica-tions from across and beyond the enterprise. An insurer may enable easy access to third-party products to meet specific market needs and leverage automated under-writing based on proprietary rules.


Separate account administration (for life insurance)Similarly, life insurers can virtualize various components of the asset management process. They can utilize third-party separate account administration for deposit and fund allocation changes. Open standards for fund management that offer a myriad of investment choices can be tailored to a customer’s needs. External call center services can respond to customer inquiries. And, financial information and investment research from business partners could be distributed to policyholders by third-party marketing agencies.

Claims management (for P&C insurance)On demand also has the potential to take claims management and processing to a higher, more cost-effective level. For example, by working with auto manufacturers to install collision detection devices in new cars, an insurer could be notified instantly in the event of an accident. Empowered with this first notice, an insurer may initiate contact with the insured, dispatch emergency responders to the accident site, notify body shops of the incoming workload, schedule a claims adjuster to be present when the damaged vehicle arrives at the body shop and deliver a replacement vehicle to the crash site. All this can be done before the insured has a chance to contact the carrier directly.

In an on demand environment, claims resource requirements can be allocated based on predictive modeling techniques, dynamically driven by internal and external data (e.g., PIF, local weather conditions). On demand capabilities can also offer variable cost structures to support the ebb and flow of resources required to handle changes in claim volumes and to provide a resilient infrastructure for virtually uninterrupted operations in the event of disasters.

Technology enablersTo a large extent, technology advances are the key enablers that are making it possible for firms to operate in an on demand fashion. As IT becomes more open, integrated, virtualized and autonomic, it provides new collaboration methods, enables more comprehensive business integration and allows for reconfiguration. Additionally, it allows firms to better manage the rising complexity of IT environments. Portals, business integration, autonomic infrastructure and grid computing help facilitate the on demand operating environment. When combined with the options for delivery, financing, partnering and collaboration, the on demand business model becomes an excellent and preferred option.


Open standardsOpen standards allow insurers to adapt to technology changes rapidly and simplify systems integration. From a technology perspective, this may entail the use of common data formats based on XML, Web services and a service-oriented architecture. From a business perspective, use of industry standards will facilitate ease of integration.

Integrated technology environmentAn integrated technology environment facilitates transaction and process integration across the enterprise. Integration also allows realtime connectivity among partners, suppliers and clients and helps enable active data mining and decision support. Integration is facilitated by use of component-based development, enterprise application integration services, portal services, e-business applications and Web services.

Virtualized computing environmentVirtualized computing environments leverage distributed IT resources. These distributed resources are shared and managed as a single, virtual computing environment to increase the use of existing assets and lower IT costs. This may take the form of grid computing, storage area networks or portal technologies, off-shore application development or third-party application hosting services. In addition, virtual-ization creates opportunities to link usage to pricing and to variabilize expenses.

Autonomic computing technologiesAutonomic computing technologies enable systems to be monitored and managed remotely and feature self-configuration, self-healing, self-protecting and self-optimi-zation capabilities. These features address the increased complexity of the computing environment and also offer embedded privacy protection and security capabilities. Examples include capacity, availability, performance and scalability services.

On demand and value creationA compelling case for on demand The IBM Global Insurance Industry team researched and developed several industry specific analyses in order to identify the characteristics of successful insurers across numerous dimensions.

• The Intelligent Growth study, which covered the 80 largest insurers worldwide, showed that insurers which grew premiums profitably had annual total share-holder returns (TSR) of 29 percent on average from 1996 to 2000. This is almost double the 15.7 percent return for the S&P 500 during the same period.10


• The U.S. P&C Value Creators study, which analyzed the performance of the top 75 U.S. non-life insurers over the period 1987 to 2001, found that a select few generated $47 billion while the rest of the industry lost $79 billion over the 15-year period.11

• In a study of the 60 largest life insurance industry merger and acquisition (M&A) deals from 1996 to 2001, the Life Insurance M&A Value Analysis found that insurers that focused on core expansion had over 50 percent greater TSR than insurers that pursued other M&A strategies.12

The shared characteristics of the high performing insurers identified in these studies include a relentless focus on 1) creating a differentiating value proposition, 2) operational excellence, 3) financial controls and 4) alignment among the three.

While the insights gained from these studies are important, many insurers are challenged to act upon them in light of real-world constraints. These constraints include limited budgets, silo-based organizations, last generation legacy infra-structure, restrictive business processes and a scarcity of the best people required to support strategic initiatives. On demand will address these constraints by enabling the winning characteristics identified above.

IBM has a vision for the future and a way to help insurers realize that vision through an on demand operating environment for insurers. Business processes and their enabling technologies will be integrated throughout and beyond the enterprise. Business capabilities will be optimized across the enterprise by leveraging open standards to integrate systems and bring economies of scale and scope within reach. It is anticipated that the technology infrastructure, including hardware and business applications, will be expanded, updated and maintained on a continuous, on demand basis. This will then help eliminate the large step functions common in today’s environment. Innovative financial structures for strategic initiatives and capability development will further enable insurers to align their expense profile with revenue volatility.

Qualitative attributesOn demand enhances insurers’ ability to execute existing strategies and expands strategic options. Insurers will benefit from increased focus, variability, respon-siveness and resilience. We begin by discussing these qualitative attributes.


FocusedIn an on demand operating environment, an insurer will focus strategic and tactical intent on developing unique and inimitable competitive advantage. Non-differen-tiating efforts may be sourced from a third party or an enterprise shared services organization. For example, on demand enables an insurer to concentrate on core competencies and differentiating tasks and assets by using tightly integrated shared services. Use of strategic partners can assist in managing core tasks ranging from policy administration, claims processing, commission processing, billing and collections to non-core tasks such as human resources and financial operations.

This increased focus will help insurers to achieve operational excellence by concentrating on core capabilities in underwriting, policy administration and claims. Selective use of shared services and third parties to access economies of scale or specialty capabilities will help reduce maintenance costs and allow for more resources for strategic investment. This is on demand.

ResponsiveOpen standards and enterprise integration will help enable a new level of respon-siveness. Insurers will be able to respond with greater speed and agility to changes in strategic direction, competitor actions or market changes. Improved respon-siveness will also translate into operational excellence. For example, business processes will be rule-based, where the rules are maintained by a business user and can be rapidly changed. Moreover, enabling technologies will truly enable, rather than constrain, the business.

For example, consider the ability to:

• Identify new, unmet needs for coverage of exposures and rapidly develop new products to address these risks

• Understand competitors’ pricing actions for specific markets and products and make rapid changes proactively or reactively based on competitors’ moves

• Reduce or mitigate customer losses through proactive loss control and provide rapid response during and promptly after a loss incident

• Sense changes in the environment and respond dynamically, whether to unpre-dictable fluctuations in pricing, emerging customer segments or availability of new product providers

• Integrate new products, capabilities and acquisitions.


Increased focus and responsiveness has the potential to dramatically improve average insurers’ performance to best in class. The variance in performance between average and best in class insurers across a number of operational metrics can have significant results, based on IBM Global Insurance Industry research. For example, high lifetime value customers represented 50 percent of the total book for best in class insurers compared to 20 percent for average insurers. Household penetration, as measured by policies per household, exceeded 4 policies per household for the best-in-class insurers versus 1.4 policies per household for average insurers. Retention ratios were 98 percent for best-in-class insurers compared to 90 percent for average insurers.13

Imagine if an insurer could dedicate a critical mass of high skill and high will resources to address its operational objectives. For every $1 billion in net premium written (NPW), a single point improvement in customer profitability represents $10 million in reduced losses. For every point improvement in retention, an additional $10 million in premiums would be captured. Improvement in cross-sell would impact both premiums and retention. This is on demand.

VariableBy migrating toward an on demand vision, an insurer will have the opportunity to variabilize a significant portion of its operating expenses. This may include deploying resources rapidly, training of additional staff to match growth require-ments, leveraging third parties to host applications or supplying and maintaining the entire technology infrastructure.

Variabilizing an insurer’s operating environment could include:

• Shifting the cost structure from predominantly fixed cost to predominantly variable

• Establishing an infrastructure that efficiently enables rapid scaling of a new distribution channel or that accommodates decreasing volumes from a nonstrategic channel

• Establishing a modular infrastructure and the core systems that efficiently facilitate the runoff of specific books of business

• Establishing an infrastructure and partner value net that enables rapid scaling to address peak claim periods with particular applicability in catastrophe scenarios

• Being able to adapt with flexibility to changes in cost structures and business processes and to reduce risk and drive business performance at higher levels of productivity, cost control, capital efficiency and financial predictability.


From a technology perspective, a typical insurer only utilizes 15-30 percent of its server capacity. 14 Imagine if the insurer optimized its computing capacity by leveraging grid technologies. Imagine if the insurer only paid for what it used. This is on demand.

ResilientExecution of the on demand vision provides an insurer with the opportunity to improve resiliency. This may take the form of improved exposure monitoring, operational redundancy or deployment of self-monitoring, self-healing systems.

An insurance company that is resilient will also:

• Understand exposure to operational, market and credit risk in realtime

• Reduce capital requirements through risk management

• Provide for enhanced security, availability and performance during peak claim periods or spikes in new product sales

• Recover quickly from external disruptions to operations, including both man-made and natural disasters.

Imagine if the hundreds of millions of dollars spent globally on resilient infrastruc-tures could be redirected to develop differentiating insurance capabilities. Imagine if an individual insurer could do this while improving its level of resilience. Imagine if an insurer’s disaster recovery planning was embedded in its operational costs and did not require explicit planning or provisioning because it was embedded in its procurement contracts and service level agreements. This is on demand.

Quantifying the valueFinancial benefits from moving toward an on demand insurer are manifested in four key areas. An on demand insurer creates value through 1) improved capital efficiency in invested assets, 2) reduced cost of capital and risk, 3) increased cash flow, and 4) expanded real options.


Figure 1. Value creation framework.

Source: IBM Global Insurance Industry analysis, 2003.

Improved capital efficiency in invested assetsAn insurer depends on capital to underwrite new business, make investments, pay claims and benefits and offset capital expenditures. Investors expect an insurer to generate cash flows at least equal to the required rate of return on its capital. By transferring assets and reducing capital expenditures, an on demand insurer requires less capital and correspondingly less cash flow to profitably operate its business. This reduces an on demand insurer’s need for external financing and increases its flexibility to allocate existing capital to areas that generate positive cash flow.

The IBM Global Insurance Industry team performed an analysis to identify and examine the composition of the cost of capital for a select number of leading U.S. insurers. The analysis found that operational assets represent 1.95 percent of a life insurer’s capital and 5.07 percent of a P&C carrier’s capital. An on demand operating environment would enable an insurer to reduce its operational assets share of the balance sheet. With an average of $30 billion in capital, the average life insurer studied could eliminate $565 million in operational assets, reducing its required cash flow by $42 million annually (equal to $312 million in present value over 10 years).15 To reach the same level of profitability from sales, a life insurer would have to sell over 700,000 additional policies, each with $1,200 in annual premiums at 5 percent net margins.

Capital efficiency benefits for P&C insurers would be even larger as P&C carriers have a greater proportion of operational assets as a percent of total capital. For the average P&C carrier studied with a capital base of $15.7 billion, the capital efficiency improvements could reduce its required annual cash flow by $58 million annually (equal to $434 million present value over 10 years).16 This is on demand.

Invested capital X cost of capital =

Value created

Required annual cash flow

Option value

Value destroyed

Actual cash flow

Minimum required cash flow


Reduced cost of capital and riskA company’s cost of capital is widely understood to be the weighted average cost of debt and equity financing. Cost of capital can also be understood to be the risk-free rate of return plus a risk premium based on a company’s business profile. In the case of insurers, this includes insurance underwriting and supporting functions such as IT and operations. Industry proxies for IT and operations reflect a higher cost of capital than an insurer’s composite business, reflecting the market’s perception of risk. As a result, reducing IT and operations as a component of an insurer’s business and related risk profile would reduce an insurer’s overall cost of capital.

The industry cost of capital for life insurers is 7.47 percent and 7.30 percent for P&C carriers, while the cost of capital for IT and related services companies is materially higher at 12.18 percent.17 By virtualizing IT and various operations, which together consume most of the operational assets, a life insurer could lower its cost of capital by 9 basis points to 7.38 percent. While a P&C insurer could lower its cost of capital by 26 basis points to 7.04 percent.18 In addition to the capital efficiency benefits identified, insurers could reduce their annual cash flow requirements by $27 million and $39 million (equal to $197 million and $293 million in present value respectively over 10 years) from lowering their cost of capital.19

Additionally, a typical insurer experiences earnings volatility driven in part by variations in the expense ratio. On demand enables insurers to align their expenses with their revenues, reducing earnings volatility and the resultant cost of capital. U.S. life insurers have an average beta of 0.89, and U.S. P&C insurers have an average beta of 0.85.20 IT and related services firms have much higher betas – 2.08 and 1.92 respectively.21 These higher proxy betas represent higher earnings volatility for IT and operations. On demand can help insurers separate the more volatile IT and operations components from their composite underwriting and operations activities. Because the IT component is a smaller portion for insurers, the resulting "pure underwriting" beta would reduce the overall company beta, reflecting more stable earnings delivery for insurers. This is on demand.

Increased cash flowCash flow is directly impacted by increased revenue and decreased expenses. An on demand operating environment is designed to enable an insurer to focus and devote more resources to strategic initiatives which help improve core capabilities, potentially increase revenue and reduce expenses.


For example, an on demand insurer could focus on enhancing customer insight by leveraging world-class, third-party data management and analysis capabilities to improve profitability. P&C carriers could leverage the resultant customer insight to identify, target and retain high lifetime value customer segments while identifying remediation opportunities for less profitable segments. The average loss ratio for the U.S. P&C industry in 2001 was 75.3, while the best-in-class carriers were 16 points lower at 59.3.22 IBM Global Insurance Industry research on P&C value creators indicates that a 1-point investment in Loss Adjustment Expense (LAE) results in a 3-point reduction in losses incurred for select carriers, a net 2-point reduction in the combined ratio. With average NPW of $11.8 billion, the U.S. P&C carriers studied would on average increase their annual cash flow by $235 million (equal to $1.8 billion in present value over 10 years) from a 2-point reduction in the combined ratio. Similarly, U.S. life carriers could leverage customer insight to reduce lapse rates. The U.S. life average for lapse rate in 2001 was 8.3 percent while the best in class averaged 4.2 percent. For the U.S. life carriers studied with average NPW of $13.8 billion, a 1 percent reduction in lapse rate translates into an increase in annual cash flow of $26 million (equal to $189 million in present value over 10 years).23 This is on demand.

Expanded real option valueFinally, on demand insurers have expanded options from developing a business that is virtualized, integrated, autonomic and based on open standards. Embedded in technology and operational decisions are six key options to increase the prospects for future cash flow.

• Growth options – Investment in multi-access, multiproduct capabilities provides the platform for future products and services, access to new/emerging markets, broader acquisition targets and strengthened core capabilities

• Time-to-build options – Staged development and release of capabilities enables ongoing reevaluation and redirection

•· Option to alter scale – New and enhanced capabilities can be readily added or upwardly/downwardly scaled in the context of changing strategic or tactical imperatives

• Option to abandon – Development or implementation can be abandoned at gran-ular stages throughout the development and implementation lifecycles

• Option to switch capability sourcing – Third-party solutions, relationships and ven-dors can be leveraged or reselected at key points throughout development

• Multiple interactions – The interaction of various options supports synergistic mul-tiples in value potential.


When appropriately identified and executed for value creation, each option can generate additional cash flow beyond the original investment. For example, embedded in call centers are growth options that many insurers overlook. If billing inquiries are a major pain point, an insurer may develop a $15 million graphical user interface (GUI) front end integrated to the billing system to help service representa-tives respond effectively to billing questions. Increasing the original investment by 33 percent to $20 million for a portal with Web-enabled applications and an enterprise integration layer can lead to multiples in return when leveraged as the market rewards access to multiple services and products. This is on demand.

On demand migration pathsMany insurers are on their way toward implementing an on demand operating environment today. In seeking to modernize or replace legacy systems, these insurers are moving toward a componentized operating model. Once a business process, with the enabling technologies and organization, has been isolated into its component parts, insurers have the option to examine discrete capabilities along process, organization and technology dimensions to drive value creation. In doing so, they create the opportunity to leverage third-party services or capabilities and fully optimize capabilities. By focusing on high value add, differentiating capabilities and aligning the economic model with the business and operating strategies, componentizing and virtualizing business capabilities creates real business value. Key technology enablers support this value creation potential.

There are multiple migration paths toward an on demand environment. Figure 2 illustrates these migration paths.

Vertically integratedInternal core and non-core capabilities

Insu

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peci

fi c d

econ

stru

ctio

n

Industry wide virtualization

3. Sub-Optimal Value Creators

1. Early Value Capturers

2. Passive Value Creators

Preliminary virtualizationSelective third-party leverage

Industry networksSeamless, value driven internal and external sourcing

Enterprise optimizedCross-enterprise

value chain optimization

Process optimized Value chain level

process optimization

Silo optimizedLOB process optimization


Figure 2. On demand migration paths.


The insurer-specific deconstruction axis shown in Figure 2 represents the optimi-zation of an individual insurance company over time. As a company migrates from silo optimized toward enterprise optimized, the number of business and IT silos decreases; this occurs as the scope of process optimization broadens. The first phase focuses on improving process efficiencies within the existing environment. Within each major line of business, each functional area, such as underwriting, claims or distribution is redesigned for optimal efficiency. Silos still exist, but are more efficient. Note that in today’s operating environment, this will generally include some degree of componentization.

Eventually, an insurer will move from a silo-based model to a process-optimized model. Process-optimized companies create shared capabilities in non-core functions, including procurement, finance or human resources, and deploy these across silos. Frequently, this will involve centralizing and standardizing the procedures, people and enabling technologies across multiple lines of business and organizational boundaries.

In the final stage, a company achieves enterprise optimization. In this stage, the company begins to address optimization of core capabilities including underwriting, policy administration or claims. Capabilities across the enterprise are standardized where appropriate, streamlined so duplication is reduced and optimized so economies of scale may be realized.

The industrywide virtualization axis in Figure 2 tracks the development of industry solutions and networks. While our legacy environments have been largely vertically integrated, insurers have taken advantage of third-party administrators, claims adjustors and other solution providers on a selective basis. Arguably, agents, brokers and MGAs all represent some degree of industry virtualization, although historically integration has required significant efforts, resulting in semipermanent business arrangements. An on demand operating environment is designed to dramatically reduce the effort required for business partners to create and serve process and technology integration.

As industry networks and external capability providers become more sophisti-cated, more abundant and more mature, their solutions and services will become increasingly attractive to individual carriers. As individual insurers and the industry environment evolve, we can expect that more of the capabilities will move outside of the main enterprise and will be supplied in an on demand fashion. For insurers, the real question is whether to take advantage of the opportunities as they evolve or wait patiently for some future date.


Insurers who decide to leverage on demand and the resulting benefits that will accrue need to make decisions as to when and how they will migrate toward the on demand vision. Each of the three migration paths will generate benefits, and each has its own opportunities and issues, as illustrated in Figure 3.

Figure 3. Each migration path has its own benefits and issues.


As shown in Figures 2 and 3, the optimal path for transformation is taken by early value capturers. Early value capturers will initially benefit from enterprise optimization, followed by the additional benefits associated with industry virtualization.

Getting startedSo, how do insurers move toward implementing an on demand strategy and migrating toward an on demand operating environment?

Insurers should begin by defining an on demand vision for their business and operating environment. Several questions should be addressed. How can on demand capabilities enhance the execution of existing business, operating, and IT strategies? How can on demand enable new business strategies previously not executable? How can on demand change the economics of implementing a good idea?

1. Early value capturers

2. Passive value creators

3. Suboptimal value creators

• Improve time value of money for revenue and expense advantages

• Develop fi rst mover learning advantages

• Direct offerings and standards

• Maintain market share and state of the market performance

• Leverage proven partners and offerings

• Lower risk and increase option value

• Lowest implementation risk

Migration path Opportunities for value Issues

• Learning by doing• Partner with proven, stable vendors• Strong risk management

• Continuously monitor market for value opportunities

• Develop operating model that is ready to apply state of market offerings

• Limited ability to shape offerings

• Defer beyond the point of leverage• No ability to shape offerings• Potential for lock out


At the same time, insurers should identify both "quick hits" and longer-term initiatives which will deliver value, create competitive advantage, and migrate the operating environment toward the newly defined on demand vision. The quick hits should at a minimum include low risk, non-core activities that are high potential candidates for on demand delivery. Longer term initiatives should address high potential core capabilities which can be delivered better, faster or more economically in an on demand operating environment.

Clearly many challenges exist as insurers develop and implement their specific on demand visions on their way to becoming more focused, responsive, variable and resilient. The key to transforming the enterprise as a whole is to develop a long-term vision, appropriately scope the required transformation, and develop a realistic, phased migration plan. The question is not whether on demand will transform the insurance industry but which carriers will embrace the concept and create unsurpassed value for their constituencies.


AppendixVarious on demand optimization strategies by value chain component.

Figure A-1. On demand optimization strategies across the value chain (illustrative).

About the authorsJames Rosen is the Global Non-Life Insurance Segment Manager for IBM. James can be reached at [email protected].

Tom Park is the Global Life Insurance Segment Manager for IBM. Tom can be reached at [email protected].

About IBM Business Consulting ServicesWith consultants and professional staff in more than 160 countries globally, IBM Business Consulting Services is the world’s largest consulting services organization. IBM Business Consulting Services provides clients with business process and industry expertise, a deep understanding of technology solutions that address specific industry issues, and the ability to design, build and run those solutions in a way that delivers bottom-line business value.

MarketingProduct

operationsPolicyholder acquisition Underwriting

Claims management

Policy administration

Asset management

• Third-party data management and insight utilities

• Customer insight capabilities feed dynamic target defi nition

• Product alliance utilities

• Customer level

• Lead development and management utilities

• Direct marketing and biding capabilities

• Dynamic management of underwriting guidelines, rate maintenance and compliance utilities

• Real-time updates to shared policy and customer master files

• Just-in-time policy building

• Closed book management

• Third-party separate account administration

• Telematics and analytics for loss control and notification of loss

• Loss adjustments and supply chain management utilities

• Negotiation and settlement utilities

Channel management

Customer relationship management

Enterprise resource management

• Internet distribution and servicing utilities

• Agent Web page development and hosting

• Distribution alliance utilities

• Customer insight data aggregation and insight development

• Dynamic customer lifetime value calculation and leverage

• Human resources• Finance and treasury• Non-claims procurement• Investment management



References1 American Insurance Group (AIG) Annual Report and 10K, 2002.

2 Horace Mann Annual Report, 2002; A.M. Best’s Insurance Report - Horace Mann, 2002 Edition.

3 "The London market in the throes of change", Swiss Re’s SIGMA, March 2002.

4 "Nissan Motor dealers to carry only Millea/Sompo insurance products", AFX Europe, June 1, 2003; "Suzuki Motor cutting No. of auto insurance firms to 3", Kyodo, March 27, 2003; "A.M. Best Affirms Rating of the Tokio Marine and Fire Insurance Company", A.M. Best, June 16, 2003.

5 "Norwich Union to test 'pay as you drive' insurance", Financial Times, March 12, 2003; "Norwich Union has launched a revolutionary insurance policy for the motor industry", Datamonitor, March 14, 2003.

6 "Canada Life signs with IBM for pay-by-the-policy software," Datamonitor, March 27, 2003.

7 "Fortis Family Extends Outsourcing Agreement with Liberty Insurance Services Corporation", RBC Liberty Insurance Newsroom Website, October 1, 2002.

8 Royal Bank of Scotland Annual Report 2002; Salomon Smith Barney Royal Bank of Scotland Analyst Report, March 19, 2003.

9 Brackstein, Karen, Blind Men and the Elephant (retold), Scholastic Press, 1992.

10 "Intelligent Growth Study", IBM Global Insurance Industry Research, 2002.

11 "U.S. P&C Value Creators", IBM Global Insurance Industry Research, 2002.

12 Life Insurance M&A Value Analysis, IBM Insurance Industry Research Series, 2002.

13 A.M. Best data, 2002; IBM Global Insurance team analyses, 2003.

14 "Simplifying the Corporate IT Infrastructure", IBM Scorpion White Paper, 2000.

15 Benefits partially offset by incremental services fees due to third-party service providers.

16 Ibid.

17 Value Line database of 7,440 firms, 2003; Stern NYU "Cost of Capital by Sector", 2003; IBM Insurance Industry team analysis, 2003.

18 Ibid.

19 IBM Insurance Industry team analysis, 2003.

20 Value Line database of 7,440 firms, 2003; Stern NYU "Cost of Capital by Sector".

21 Ibid.

22 A.M. Best data, 2002; IBM Global Insurance team analysis, 2003.

23 Ibid.

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Insurance value creation in a new on demand world · 1 Insurance value creation in a new on demand...

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