Modernization: Here Is Where to Start

When we polled approximately 300 insurance executives about the biggest risks facing their companies, a third answered: “competition from companies that will significantly lower their operating costs by modernizing finance, risk and operations.” Based on our experience, we agree: The most direct way for insurers to gain a competitive strategic advantage by increasing efficiencies and reducing costs is to modernize in an integrated manner their finance, operations, actuarial and risk functions. Drivers of change There are several drivers of change that make modernization an imperative. Internally, CEOs are challenging finance, accounting, actuarial and risk functions to be more relevant to the business, as well as better communicate the value of the business to stakeholders. Externally, there are several major, related drivers of change: The cumulative implications of these changes will be deep and permanent and affect business strategy, investor education, underlying processes, systems, internal controls, valuation models and other fundamental aspects of the insurance business. While there is widespread acknowledgement that modernization is necessary, many companies are having difficulty determining just where to begin and how far modernization might go. Each driver will cause considerable change; collectively, they could be overwhelming. As a result, most companies are taking a wait-and-see approach before they fully commit resources, and the functions that are trying to be more aggressive are struggling to secure funding -- often because difficulties in defining their vision make it hard to demonstrate just what implementation could entail. Common change themes and operational synergies Whether they have started to modernize or not, perceptive insurers recognize that the drivers of change have common themes and will require them to:

• Revisit their strategies and lines of business;
• Redevelop and reprice products in light of different profitability and capital levels;
• Develop, understand, report and disclose new and more complex performance measures;
• Produce different and more complex financial and risk reports, with sufficient analysis explaining results both internally and externally; and
• Manage a business where performance measures are likely to be very different and more volatile than today’s.

The likely effects on people, process and technology significantly overlap and will drive the finance, operations, actuarial and risk (FOAR) functions to:

• Revisit and realign governance, roles and responsibilities to meet new requirements and functional responsibilities;
• Revamp key performance indicators and information to provide management meaningful understanding of what drives performance;
• Retrain stakeholders (board, shareholders, analysts, etc.) on revised reporting metrics and help them understand the link to performance;
• Develop a “single source of the truth” to allow comprehensive experience and performance analysis, and avoid reconciliation errors across the various metrics;
• Set consistent assumptions anchored in a common view of “best estimates” across generally accepted accounting principles (GAAP), price-to-book-value ratio (PBR), risk and capital metrics;
• Enhance enterprise architecture around data, systems and tools to improve governance and controls, reduce run-time and facilitate more complex calculations and results analysis;
• Shelve legacy actuarial systems and implement modern cashflow projection calculation engines that consistently produce required metrics, are well-controlled and flexible enough to meet emerging requirements; and
• Reassess organizational design, competencies and talent.

This will require multiple disciplines to work closely together that probably have not done so in the past. As a result, there will be cultural/behavioral and operational challenges to address. Accordingly, to obtain the greatest benefits, any plan and implementation should consider likely changes to people, processes and technology in the aggregate, not just individually. Conclusion: The benefits of a pragmatic approach Given common change themes and complex implementation implications, prescient insurers are not waiting for final dates and requirements but are developing pragmatic implementation plans that:

• Are forward-looking and consider relevant drivers of change;
• Evaluate people, process and technology changes and determine how long it will take to implement them;
• Consider which current projects need reevaluation and bring them in line with the broader change agenda; and
• Stage the implementation changes over several years. This will allow functional areas and management to embed new processes and familiarize themselves with managing the business under new metrics and reporting requirements.

And, while modernizing technology and processes is a significant expense, the benefits usually justify the costs:

• Insurers have been wanting to make many of the anticipated changes to FOAR functions for years.
• Improvements cost less than adding staff and using existing infrastructure.
• Streamlined process and more modern technology result in greater speed and efficiency and reduce operational risk and costs.
• A comprehensive, well-thought-out, pragmatic and staged plan to modernize FOAR functions and prepare for new requirements can lead to a competitive advantage through revamped products, reduced expenses and increased efficiencies.

In the coming months, we will address how modernization affects insurers’ various operational functions.