Around the world, CEOs at insurance companies are slowly coming to the conclusion that they need smoothly running IT departments if their companies are to remain competitive. As a result, IT projects and budgets are getting some respect and are becoming less likely to fall victim to arbitrary cuts, according to analysts in North America, Europe and the Asia-Pacific region.The newfound respect is coming at a time when IT departments face intense regulatory pressure in Europe-and tamer but still formidable rules in the United States, China and Japan, according to reports from Boston-based Celent LLC. Pressure also arises from the need to service customers and distributors in real-time transactions and with rapid information flow, Celent says. Those functions can strain internal legacy systems, prompting insurers in mature markets, such as the United States, Europe and Japan, to update communications systems and core data environments.
The world's insurers are coping with another modern challenge in the form of service-oriented architecture (SOA). SOA is a critical framework for the legacy change, according to Cambridge, Mass.-based Forrester Research Inc. Forrester found in a survey of North American insurance companies that 74% are either using or pursuing SOA, while 14 out of 17 insurers using SOA plan to increase usage over the next 24 months. Forrester says insurance firms have been patching together existing client/server and mainframe systems to "make do" and are now recognizing they need to replace their core systems.
Health insurer Blue Cross Blue Shield of Michigan, for example, devised a U.S. $200 million to $400 million multi-year investment plan to modernize its systems infrastructure and increase capabilities, says Joe Hohner, vice president and CIO of BCBSM, which is headquartered in Detroit.
Making the most of their legacy systems is a common focus among insurers throughout Europe, too. "We call this the 800-pound gorilla challenge," says Celent senior analyst Catherine Stagg-Macey, who works with European insurers. "How do you become an agile and flexible organization when you are weighed down by disparate, complex and outdated legacy systems? Approaches differ widely; from re-platforming to newer technologies, wrapping and extending or replacing core systems."
European insurers will pay considerable attention to IT purchases and will make sure to address core systems, predicts Stagg-Macey. "A number of the largest insurers are undergoing a rationalization exercise—reducing the number of core systems from more than 20 to two or three," she says.
The legacy issue poses less of a problem in China because Chinese insurers-old and new-are starting almost from scratch when it comes to building IT infrastructure, according to Celent reports. In China, the insurers focus on building infrastructure to handle growing capacity, while maintaining flexibility to handle a rapidly evolving business and regulatory scene.
Compliance affects IT spending globally, too. Although the "heavy lifting" on Sarbanes-Oxley is mostly done, U.S. insurers continue to invest in compliance-related projects, especially IT security, but also communication monitoring and retention, anti-money laundering and other areas, according to Celent.
A compliance issue especially important to European insurers is Solvency II, according to Stagg-Macey. That set of rules is being introduced as a European Commission directive in 2008—although the date keeps slipping back, says Stagg-Macey. "At the very heart [of the regulation] is capital adequacy - making sure you have sufficient capital set aside, depending on the risk you are taking on," she says.
IT needs to focus on management information-having a multifunctional view of data, incorporating valuations, payments, reserves and loss data, according to Stagg-Macey. "We are already seeing money being spent on data warehouses, business intelligence and MIS systems," she says, "and this is largely being driven by compliance reasons."
Insurers also need to look at the broader picture, as does Greg Schueman, vice president and CIO of Thousand Oaks, Calif.-based Employers Direct Insurance Co. When determining spending, he takes into account Employers Direct's business strategy, as well as the company's plans. "Taking a look at the sequencing of key initiatives over the next five years is important," he says, "as well as keeping in mind the overall capital expenditure level planned for our five-year forecast."
BCBSM also weighs a number of factors when allocating spending. "Proposed major IT projects require a business case, which contains five items," says Hohner. Those five items are administrative cost savings, market share retention and growth, long-term strategic fit, regulatory requirements, and customer- specific requirements.
LIFE/HEALTH VS. PROPERTY/CASUALTY
In North America, Europe and the Asia-Pacific region, life/health carriers spend more IT money than their counterparts that sell property/casualty. But, North America stands out with its similar numbers for both types of businesses. Celent predicts North American life/health insurers will spend U.S. $18.8 billion on IT in 2008, while its property/casualty insurers will spend U.S. $17.4 billion.
A much bigger difference arises between life/health and property/casualty IT spending in Europe and Asia-Pacific. European life/health insurers will spend U.S. $25.3 billion on IT in 2008, while its property/casualty will spend U.S. $10.8 billion.
In China, the life insurance sector makes up most of its insurance industry. Health and accident insurance make up 11% of the total market, according to Celent. And its projected IT spending supports these numbers-life spending U.S. $3.1 billion in 2008 and non-life spending U.S. $2 billion.
Celent estimates that, on average, the Chinese industry spends 3.5% of premium on IT and predicts that will grow to 5% by 2009, as more foreign firms enter the market and as operations expand further, requiring more investment in more complex infrastructure.
MAINTENANCE VS. NEW INVESTMENTS
Globally, maintenance beats new investments in the battle for IT spending. However, Europe's allotment is getting closer to equal as time goes by. In 2008, estimates put Europe's 2008 maintenance spending at U.S. $19.1 billion and new investments at U.S. $17.0 billion.
In Europe, the growth of new investments is expected to be the same as for maintenance, i.e., 5.7% CAG from 2006 to 2008, according to Celent.
In North America, 63% of the average firm's IT budget goes to IT maintenance. Nevertheless, Celent says the industry is moving toward a 60-40 average split in maintenance vs. new projects.
Employers Direct's Schueman finds that his company's maintenance vs. new projects allocation is split evenly. But he expects that will change in 2008 to a 40-60 split in favor of new projects. In fact, Employers Direct has been investing in new systems, specifically Web portal technology and self-service reporting.
BCBSM is also predicting it will spend more on new investments than on maintenance. "We are working to reduce our cost of system operations and increase our investments in new applications and major enhancement," says Hohner. "For systems that are to be sunset over the next two to three years, we are seeking to even further reduce maintenance costs."
Of total IT spending, Celent estimates that Asia-Pacific insurers spent U.S. $6.8 billion on new technology in 2006, which is a 6.9% increase compared with 2005. IT spending is driven by investment in infrastructure for rationalization in mature markets such as Japan, and to build out new infrastructure in developing markets such as China. Maintenance spending is expanding, according to Celent, as core systems and other new infrastructures come online in developing markets. IT maintenance spending is expected to grow more than 10% in the coming two years, and new investment initiatives will grow at a slower pace than maintenance.
LABOR AND SERVICES
Labor and services spending doesn't vary much between the United States and Europe. The exception is China. Labor cost is low there compared with the rest of the world, so Chinese insurers don't need to spend much on external services. According to Celent reports, Chinese insurers allocated 10% of IT budgets to staff in 2005.
On the high end of IT labor costs are North America and Europe. Because labor costs less in Eastern Europe, some Western European companies taking advantage of "near-shoring" by sending work to neighboring countries. U.S. insurers devoted 50% of their IT budgets to staff in 2005 and European insurers allotted 43% of their IT budgets to staff in 2006. Chinese insurers are expected to allot 10% of their IT budgets to staff in 2009, according to Celent.
The United States will also take advantage of outsourcing, says Marc Cecere, vice president of Forrester's financial services team. "Service varies with the size of the organization," he says. "The large organizations [20,000-plus people] are increasing their spending on services, whereas the mid-tier is flat, so they won't be changing as much."
Larger insurers are also investing in business transformation services, notes Cecere. He says he fielded a call from a large insurer seeking advice on the type of consultants they should hire for business transformation. The carrier already had talked with all of the usual services firms and found they could suggest only incremental changes for the insurer.
HARDWARE AND SOFTWARE
Another dramatic difference among countries is spending on hardware and software. Because Chinese insurers aren't spending a lot on labor, they're allocating much of their budget to hardware, according to Celent. In fact, Chinese carriers may be spending an average of 40% of their IT budget on hardware in 2009.
The United States is seeing the opposite trend in hardware spending, according to Forrester's Cecere. "Insurers are cutting back on infrastructure," he says. "More of them are going to enterprise-negotiated agreements, so they're cutting back on the basics of the desktops and hardware, etc., primarily because we're in a digestion period of technology and because they're getting better deals than they did before."
With U.S. hardware spending decreasing, software spending is expected to rise. Cecere sees a big increase in U.S. IT spending for package deals. An example of software spending comes from Employers Direct. Much of its IT spending goes toward data warehouses, self-service reporting, Web portals, new internal Web applications and upgrades, and enhancements to its core insurance systems, says Schueman.
WHAT THE FUTURE HOLDS
Most large European insurers, Celent's Stagg-Macey points out, are looking at how to support the business across Europe on unified systems. "This raises questions on how to tackle multiple languages, multiple currencies, and local differences in business practice and national regulation," she says.
Depending on market conditions, Stagg-Macey believes IT spending in Europe will increase slightly in the coming years and sees it happening already. "Many of the larger insurers," she says, "are undertaking large rationalization projects [U.K.-based Norwich Union and Germany-based Allianz] that are about driving out the inefficiencies inherent in complex heterogeneous IT environments. But to get the cost savings, you have to spend money up front," she says.
Celent expects total North American insurers' IT spending to reach U.S. $31.2 billion at the end of 2006. Overall, Celent and Forrester research show an increase, but at a slow pace.
IT spending by Asia-Pacific insurance firms is increasing more rapidly than IT spending in the United States, with China and Japan contributing heavily to that growth. Celent estimates that insurance IT spending in China is U.S. $2 billion, and predicts that figure will increase to more than U.S. $5 billion by 2009. The China insurance IT market is currently approximately 7% of the size of the U.S. market but will grow to nearly 15% by 2009, Celent predicts.
Editor's Note: Insurance Networking News used the following Celent reports in the preparation of this article: "Insurance in China: Market and IT Overview," "IT Spending Trends: A Global Financial Services Review," "European Insurance IT Spending In General Insurance," "US L/H Insurance IT Spending, 2005-2010."
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