Part 1 - Why the insurance industry must accelerate modernization efforts
This is the first in a series of blogs that examines how ‘internet savvy’ challengers are entering the insurance market and what this can mean to an industry that has traditionally been perceived as ‘stodgy’, ‘risk averse’ and ‘slow to change’. The blog goes on to discuss the legacy technology challenges that are hampering the industry today, and how different modernization strategies and/or radically new operating models are needed to compete in the future.
It is better to be a Hare than a Tortoise – Traditional Insurers vs New Entrants
In Aesop's famous fable about a race between a tortoise and an ‘uppity’ hare, the tortoise is ambivalent towards the Hare’s boasts of speed and generally being more hip and cool. After a blazing start, the over confident Hare decides to take a nap in the middle of the race. Meanwhile, the tortoise plods on by and is the first to cross the finish line. The moral of the story is that slow and steady wins the race. However, this story was written before the internet age.
Today, slow and steady is not an effective strategy against competitors that know how to effectively leverage technologies that never sleep or slow down. Much of this technology is based around the modern internet platform which is revolutionizing how humans communicate and conduct business. It has become a disruptive force that is forcing traditional industries to rethink their business strategies and invest in modern technologies that enable them to more effectively engage and compete in this new digital marketplace. It has already touched almost every aspect of our lives, almost every industry, and in some cases created completely new industry sectors of its own.
By leveraging the speed and efficiency of the internet platform, new entrants are able to challenge and disrupt long established business models and industries. During the late 1990’s and early 2000’s, new e-commerce entrants to the retail sector such as Amazon and ebay were starting to challenge and compete with the long established ‘brick and mortar’ high street retailers. The speed at which these early internet pioneers grew and claimed market share was astonishing. Retail was one of the first areas to experience how game-changing the internet channel could be. Those that were too slow to react or ignored the threat, quickly found themselves out of business.
In the US, the Borders bookstore chain became one of the early and most visible casualties of the internet age. They were the nation’s second largest bookstore chain, but were too slow to recognize and too late to respond to the threat of the online e-tailer Amazon.com. Amazon has continued to expand, and as of 2015, they surpassed Walmart as the most valuable retailer in the United States by market capitalization. Amazon is a great example of a company that is leveraging its web expertise to expand into other business realms such as travel services, cloud infrastructure services, consumer electronics, games software, video services, web services, and most recently financial and home services.
Other examples of internet companies that are leveraging their web presence to move into new business domains include Google and Facebook, who had originally relied just on the advertisement revenue model. Also, Apple is a good example of a company that very quickly leveraged the internet to enter into new business areas such as smartphones, digital music services and more recently the digital payments sector.
These internet pioneers all share a few traits in common. They understood the power of the internet and how to exploit it. They were not hampered by legacy technology and were able to utilize the latest technologies including powerful, low cost distributed computing environments such as Hadoop clusters. These technologies enabled them to better understand their customers, to improve their user’s experience and cross-sell other services and products to them. Incidentally, it was Google that developed Hadoop in an effort to analyze the mountains of new data that was being created and updated every day on the internet. Hadoop was released as open-source and made available to everyone. It has become the enabling technology behind the ‘Big Data’ storage and analytics revolution of today.
It is these kind of companies that represent the biggest threat to more traditional enterprises that have been slow to modernize, and have relied for too long on pre-internet business models. The new entrants are companies that forged themselves on the internet; that truly know their customers; that are masters of the digital channel; that operate on modern technology platforms that enable them to be extremely efficient and agile. These are companies that are not afraid to venture into new markets and challenge established companies and industries with new value propositions, innovative product and service offerings and outstanding customer service. With ruthless efficiency and speed, they have become dominant players in retail and media. So, what other industries are next?
The insurance industry has traditionally been perceived as ‘slow and steady’. Their basic business model has little changed since the 18th Century. For the longest time, this industry rarely made a profit from its core business activities, instead relying on impressive investment returns from the financial markets. The focus had been on selling as many policies as possible and collecting as much premium as possible for investment in the money markets. The returns had been so good, that few carriers enforced strict underwriting discipline and operational excellence. Technology investments focused on quickly processing the business, instead of creating a centralized, and integrated technology platform that could be easily maintained and updated in the future. Many carriers grew by acquisition, and each acquisition would result in ever more legacy platforms to support.
The good times ended when the stock market crashed in 2000. The attacks on the World Trade Center (WTC) on September 11, 2001, further depressed the market, and by 2002, the Nasdaq had fallen 78 percent from its high in 2001. This was followed by multiple rate decreases by the Federal Reserve to stimulate growth. Just when things started to improve by 2005-2007, the collapse of the sub-prime mortgage market in 2008 sent the 10-year Treasury yield to a 50 year low and prompted the Federal Reserve to aggressively maintain a low interest rate environment that has persisted through to today.
For the insurance industry, the low interest rate environment depressed insurers’ investment earnings and devalued their assets. It had been a ‘wake up’ call to the insurance industry and prompted a wide-scale return to disciplined underwriting and sound business management practices. Investment income from the financial markets could no longer be relied upon to ‘make up’ for poor underwriting results.
As the insurance industry struggled to return to profitability from 2001 onward, IT spend was initially focused on technology initiatives that directly supported underwriting profitability, operational efficiency (cost reduction) and profitable growth. Those projects that could provide tangible short-term return on investment (ROI), were the ones that received funding. In some cases, this only served to complicate the IT environment even more as many new, non-standardized systems were introduced on the basis of their short term business impact.
Large scale core system transformation and legacy modernization initiatives were deferred until the industry recovered, and it is only in the last 6-7 years that the industry has started to make significant investments in this area. Much of these efforts are focused on replacing the legacy core system platform first and then implementing their digital strategy and advanced analytics plans.
Thus, the industry has only just recently started to address the single biggest impediment to their future: their legacy platforms. But is it too little too late? The transformation roadmap for many insurers begins with the core system replacement and only after that is completed is the majority of the future state analytics and digital capabilities being considered. It will be a very long-time before traditional insurers will truly realize their future state transformation vision. Until then, they remain at risk from newer, more nimble and ‘internet savvy’ competitors.
What can the tortoise do if the Hare keeps on accelerating instead of stopping for a rest?
The next blog in this series will investigate some of the newer entrants to the insurance market and how some of the traditional insurers are innovating to stay ahead of the technology curve.