The insurance technology landscape has reached a maturity level wherein most P&C companies can tailor an appropriate transformation strategy for their size and scale. The transformation journey for insurance companies need not be as daunting and expensive as it used to be.
Business case for transformation
Before the financial crisis, P&C insurance companies saw little need to invest in technology because they were flush with cash and customers. In fact, while the Internet and dot-com were embraced by multiple industries back in the late ’90s and the early years of the past decade, the insurance industry waited on the sidelines. Now low on cash, pressured by shareholders and increased competition, insurance companies find their outdated technologies are dragging down their expense ratios. Many still use green screens — batch programs for policy administration, billing and claims systems — at the core of their business processes.
These legacy technologies are cumbersome, costly to maintain and lack the agility to react to market conditions. Smart companies realize that they need modern technology to increase revenues and cut costs. The major strategy for carriers to improve their combined ratios and to gain competitive advantage is to undertake technology transformation to modernize their legacy systems. Seven or eight years ago, the technical options for modernization were rather limited, but now most insurance companies, regardless of their size and scale, will find many options to modernize that suit their budgets.
Strategy 1: Custom-developed software
Often, as any industry starts to spend money on technology, the early birds realize that there is a lack of commercial off the shelf (COTS) packages tailored to that industry. Typically, early adopters are big companies with deep pockets, so they start building new applications from scratch, i.e., custom development. Tier 1 companies have complex processes, so simple packages do not meet their business needs. Moreover they have a convoluted web of hundreds of applications and packages that do not yield to simple solutions. Such custom development is done either in .net or J2EE technologies with a combination of SQL Server or Oracle databases.
Such transformation programs are difficult, lengthy and fraught with challenges. A number of the Tier 1 auto insurers in North America did begin the transformation journey in the previous decade, but only one was successful. The others abandoned their custom development effort after multiple failed attempts to go live. Typically the cost of such modernizations could range anywhere from $500 million to $2 billion.
These large-scale multimillion-dollar initiatives typically have four phases that can last many years. Phase 1 is building the core applications, a process that resembles “product development” and could take three to six years, depending on the scope of the functionality. Phase 2 involves “go-live” with first state, setting up customer support, organizational changes, and maturation and stabilization of product and implementation process. Phase 3 is “rollout” to multiple states and lines of businesses. Phase 4 is “decommissioning” of the old legacy applications to realize benefits by reducing the costs of maintaining dual systems.
Strategy 2: COTS-packaged software
As the technology spending in the insurance industry increased, it attracted commercial interest from venture capitalists. As is usually the pattern in any industry, many COTS packages were introduced for modernization of legacy systems. In some cases the custom-developed work at certain clients was standardized by vendors to be sold as a package to other companies.
Guidewire is the leader in COTS offerings. Its bestselling flagship claims product had gained popularity by the middle the past decade. Now Guidewire offers all three core offerings — policy, billing and claims systems. There are many other providers in the market: OneShield, FirstBest, StoneRiver, AgencySword, Vertafore, Exigen, Chameleon and many others. It is not uncommon for these COTS packages to offer end-to-end solutions of not only policy, billing and claims, but also complement it with front-end-facing distribution core and back-end analytics offerings. Distribution core enables interaction with insured customers and agents via channels like email, mobile, fax, social media, etc. Analytics offer business intelligence tools as well.
It was believed until a couple of years ago that COTS packages lacked the depth, breadth and flexibility needed by large insurance carriers. Recent decisions by several of the top 25 largest insurance companies to choose Guidewire is an encouraging sign of maturity of the products. This could set a trend where packaged implementations are favored over the longer custom-developed route.
Strategy 3: Layer and leverage (hybrid approach)
Although legacy systems have limitations of taking too long to make changes, using green screens and being hamstrung by embedded business rules, they do offer advantages of processing power, speed and scale. A hybrid approach is to add more advanced technology to both the mainframe user interface and the extraction of business rules. The new user-friendly screens and extracted business rules become part of the presentation and servicing layers, respectively. The goal of such a strategy is to leverage the investments in legacy systems and maximize returns on newer middleware software based on J2EE or .NET technologies. This layer and leverage approach provides the best of both worlds: Layers bring the benefits of modern architecture while leveraging the processing power of the mainframe.
Typically such an approach is favored by Tier 2 or Tier 3 companies, which have applications using IBM, Oracle or Microsoft middleware and enterprise service buses. There are a number of middleware products such as PEGA, Insurity and IBM WebSphere that provide quick and easy development kits for building servicing and presentation layers. Insurance industry packs provide ready-made functionality for new business, quoting and other transactions.
Companies can pick and choose components to modernize their end-to-end policy life cycle. For example, one company chose PEGA for Claims First Notice of Loss and contact center modernization for better response to customers, while keeping core claims processing in the old systems.
Strategy 4: Outsourcing the back-office pains
Many companies realize they have neither the competency to build the core administration systems nor the manpower to scale up their IT organizations for maintenance. They would rather spend their resources on introducing great products in the market or capturing market share. Such companies can save on hardware, software and development costs by going the route of Business Process Outsourcing (BPO) or Software as a Service (SaaS) options.
As cloud technologies become commonplace and secure, companies are letting external providers host policy, billing and claims applications on the cloud. In some cases, a revenue-sharing arrangement can also be structured as a percentage of premium issued on hosted new applications. Advantages of the BPO or SaaS approach are significantly lower costs, seamless upgrades and availability guaranteed by the cloud operator.
There are many new companies in this space. For example, SYSTEMA has streamlined claims operations on the cloud. Ebix offers BPO solutions for many of the insurance functions of policy administration, billing and claims. Coventry uses a BPO model to process workers’ compensation claims.
Which strategy is the right one?
While there are four major strategies, not every strategy suits every carrier. In the chart on page 2, the size and number of crosses indicate the popularity of the strategies amongst different tiers of insurance carriers. However, a carrier can mix and match these strategies for different lines of business (LOBs).
A pattern has emerged that custom development is favored by large Tier 1 carriers. This is partly because they started their journey in the past decade, when none of the packages were mature enough for the breadth and complex functionality of the industry. These carriers also have a multitude of enterprise applications, which make integration difficult. Additionally they have a grandfathered book of business and unstructured policy data, which makes it difficult to migrate using packages.
At the other extreme are smaller Tier 4 or Tier 5 carriers in specialty lines of business, which have a few thousand policies. For them, the investment in hardware, software and ongoing maintenance of package or custom solutions is not worth it. Typically their underwriters use Excel spreadsheets to maintain the rates, simple systems to capture customer data, and ERP systems for back-end operations of invoicing.
The middle Tier 2 and Tier 3 are undertaking the now-popular route of package implementations. Many of these packages offer personal and commercial line versions. They also can support multiple LOBs. They often come with out-of-thebox adapters to integrate with popular ERP systems and third-party vendors like ChoicePoint, Banks, for policy and Audatex or Mitchell for claims integration.
Challenges: Transformation journey or bumpy ride
While there are many transformational strategic paths for discerning CIOs and business sponsors, the journey of transformation itself is full of challenges. The success rate for such large-scale programs is less than 30%, according to some published studies. It is not uncommon for companies to try two or three times before they successfully go live with a new system. Here are some of the challenges to expect in a large-scale transformation:
Never-ending scope: The IT and business staff, in their enthusiasm to build a new system, do not realize that scope becomes a moving target. The documentation for how the old legacy COBOL systems work is not adequate and the SMEs have the knowledge in their heads. So the requirements mapping becomes a wish list rather than business critical functions. The requirements phase typically gets delayed as SMEs have to dig up the old code or comments in code to understand the functionality.
Lack of project management offices (PMOs): Such programs have a big budget and span many years. They usually require companies to commit their best resources (pulling them away from production support). Workforce management becomes essential and a continuous part of the program. The typical in-house project management processes prove inadequate for managing such large-scale programs. The discipline and depth of a mature PMO is essential for success.
Budget overruns: Many companies underestimate the amount of effort, time and money required for such transformation programs. The budget burnrate is high during the first half of the program because the leadership is busy ramping up the staff, fine-tuning the processes and achieving steady state, while sponsors are patient. It is critical to keep an eye on the budget from the very beginning, or else risk the alienation of the sponsors. The time-tracking and financial controls must be part of the program management processes.
Organizational maturity: A journey of such magnitude is not for faint-of-heart organizations. If the company has not gone through this before, it requires a level of maturity that will challenge most companies. The leaders must instill discipline and constantly motivate their personnel. The software development processes have to be adjusted based on the chosen strategy, the size of the company and vendor preferences. While Agile is seen as suitable for small companies, it often fails for distributed global teams on big implementations. The people, process and tools need to quickly reach maturity level for the success of the venture.
A successful journey
The success of a transformation program depends on many factors: organizational readiness, sponsor’s continued support, maturity of project management and systems development life cycle processes. At the enterprise level, companies can minimize risks and maximize benefits through the following strategies.
Clear goals and key performance indicators: While many insurers are jumping on the transformation bandwagon, they often fail to lay out clear and communicable goals. It is important to set unique goals at the enterprise level. For example, business goals could be set to close the gap of combined ratio with key competitors or to sell 30% of policies online and through the new systems. Examples of IT goalscould be reducing cost ratio (IT as percentage of gross premiums) or IT unit ratio (IT cost per policy or per insured risk in the portfolio). Such goals allow you to build success criteria and develop metrics/KPIs for measuring the success.
Reducing the business risk: There are considerable business and technical risks when deploying the new system and migrating existing policies. Mismatched premiums and lost coverages could lead to unhappy customers or lawsuits. One smarter way to avoid the risk is to deploy the new system to new states or new products, which do not have existing customers. This slow ramp-up helps the system to become stable while building customer base on new systems and retaining existing customers on the old system. While this strategy may work for carriers who are expanding into new markets and states, it may not work for large carriers doing business in all states. These large carriers must clearly define their rollout strategy. They can choose to go-live in the state with the fewest policies; this will help to finish the “must-have scope” of technical development work. The second state could be another small state to stabilize the system and institutionalize the processes (software development factory) and complete remaining scope. The third state could be a complex state to shake out the various permutations and combinations of business processes. The fourth state could be a big-volume state. So with this rollout strategy after the fourth state, the program can reach its peak and for subsequent states the trip will be easier.
Relying on consulting companies: These large programs drain resources from all corners of the company. This could endanger existing legacy production systems’ support and business. Companies find that they are not equipped for the journey because of the immaturity of their people, processes and tools. The best way is to invite consulting companies for staff augmentation, or to run the entire program. The consulting firms will bring professionalism, best practices and accelerators to expedite the program.
Management reserves: The rule of thumb for 20% of total transformation program budget as management reserve will not last very long. More than 75% of adopters underestimate the cost of these programs, and the budget proves inadequate. It is advisable to setaside 30-40% of the budget as reserve, to avoid having to go back to sponsors again and again. Additionally, it’s important to manage sponsors’ expectations about budget overruns and missed milestones.
Organizational readiness: This long, arduous transformation journey will require motivation, drive and ambition from companies to be successful. Leaders play a key role in preparing the staff, sponsors and suppliers to face the challenges. Everyone can expect to encounter work-life balance complaints to meet the deadlines. Rewards and prizes go a long way to reduce burnout. Evenly spaced milestone celebrations and parties will re-energize the staff and motivate them further.
While there is no silver bullet for a successful journey, many companies have used legacy modernizations to transform themselves into industry leaders.
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