Economic conditions for 2012 do not look particularlypromising, challenging companies to find unique ways to generatesustainable growth and profitability. Continued high unemployment,near zero interest rates, limited growth in the economy, increasedconsumer diversity, extended low investment returns, intensifiedservice expectations, expanded competition, and a probability ofadditional natural disasters converge to create yet anotherchallenging year for the insurance industry in general.

Constrained by the combination of these profit-compressingvariables with little room to maneuver, earnings are likely toremain low throughout 2012. Despite the low profit projections,strategic plans and a longer-term horizon demand that leadershiptake action now to be positioned for growth and viability in thefuture.

The systemic challenge facing the industry hidden amid all thesecritically relevant and immediate economic, regulatory, andcompetitive distractions can no longer be found in simplisticproduct variations and reduced cycle times. Market diversity,increased options, advances in consumer awareness with easy accessto information, and ubiquitous and affordable technology haschanged the competitive landscape.

Brand is important but not determinate as consumers have watchedeven the greatest fall; pricing is relevant but within a wideracceptable variance as convenience, serviceability, socialresponsibility, and individualization of product design takeprecedence; distribution is complicated by generational andcultural differences bringing new demands for diverse method,as-needed access; and service has become the true competitivedifferentiator as consumer expectations of treatment, competence,responsiveness, and individual relevance have become thedeterminant of loyalty.

The convergence of changes combined with the diversity of newtools, technologies, and talent bring the industry to the tippingpoint at which the ultimate solution rests with true innovation.Refined status quo will be drastically insufficient to meet thedemands of the new market. Gradual transition will equally fail, asthe degree of patience for change is minimal at best.

Leadership within the industry must focus on innovativeintegration and leveraging of technology to significantly alter themechanics of how insurance is designed, communicated, distributed,and serviced. Unfortunately, barriers abound, in particular thechaotic tactical challenges that command the bulk of leadership'sbandwidth to address, leaving naught for the contemplation ofstrategic directions or innovation.

Despite these challenges, sufficient awarenessof the need and willingness to invest in moving to the next levelexists, even in these difficult times. In fact, from atechnological perspective—the foundation for near term innovativesolutions—four different year-end 2011 surveys by reputable firmsregarding IT investments in 2012 indicated a likely increase inexpenditure in the two to five percent range, with the top priorityfocusing on replacing policy administration, or core processing,systems.

More specifically, according to a well-known industry analyst,the level of activity directed at installing modern, flexiblesystems has never before been as high as it is currently running,validating recognition of the critically important competitiveadvantage that will be provided by those who successfully navigatethe complex renovation and replacement path.

THE FOCUS

Granted, with a nod to the skeptics, legacy system replacementhas been around for quite a while, and has been toutedintermittently as "the" focus of a given year. Yet the oldersystems persist, in various forms of enhanced, wrapped, blended, orhybrid form as the complete transition to a new platform has provenboth expensive and, in the eyes of many C-suite executives, ofquestionable ROI compared to other market growth strategies.

In fact, after engaging with a number of different companies inthe RFP / ROI process, it has become apparent that the initialselling point of legacy replacement—operational efficiency andreduced maintenance cost—is in truth inconsequential on a relativebasis compared to the creation of previously unforeseenrevenue-leveraging opportunities. The true benefits of legacysystem revitalization or replacement, clearly in combination withother synergetic technological investments, rest with:

• The capacity to nimbly adapt to customized productdesigns that are granular, modularized, and targeted;

• Extensive servicing options that easily integratewith social networks, portable devices, and 24/7 access;

• Analytically informed pricing, distribution,underwriting, servicing, claims payment, and retention strategies;and,

• Consolidated and incremented customer data providinga holistic view of economic value across lines and time.

At the core of each of these advantages is anunderstanding of the market and customer as opposed to the moretraditional focus on process improvement or efficiency. Brand name,product features, even pricing differences within a given margin,no longer provide the differentiation needed to successfully gainmarket share. Instead, competitiveness and differentiation arebased on finely-priced products, an effective pairing ofdistribution with target market, and an intimate knowledge of bothprospects and customers.

ANALYTICS INVESTMENT

This introduces the second critical area of investment for 2012and forward, one that has gained prevalent coverage in more recentyears and that is analytics. While the industry has traditionallybeen data intensive, the data has tended to exist within distinctand separate silos and has resisted translation into coherentinformation that was proactively actionable; for the most part, itwas a lagging indicator of performance that could be used to makeretrospective adjustments in pricing, product mix, target market,or channel compensation.

In order to achieve the necessary foundation for integrating thewealth of silo data within a carrier with the calculating abilitiesof predictive analytics is to be able to holistically look at allof the available data on a given customer, channel, location,demographic, and psychographic in order to construct the idealcombination of appeal and profitability. A number of approaches canbe used, including:

• Integrating all of the relevant variables regardingcustomer information into the policy administration system, similarto creating a complex CRM built around the transactionalsystem;

• Develop an external BI layer that rests across thevarious silos of data, including the separate creation of a"behavioral database" that consists of externally purchased dataand caller/non-transactional data collected;

• Building disparate models for the various scenariosthat take extracts from the different data silos and assemble thoseextracts into a coherent view of the target situation to determineoptimal offering; or,

• Create a hub-and-spoke model with a data warehousein the center with spokes of informational exchange connectingoutward to each of the operational and informational systemsincluding the policy admin system.

HOLISTIC VIEW

Whichever method is selected, the end goal has to be to take aholistic look at the data across systems, not only at apoint-in-time basis, but also over periods of time within thecontext of what is occurring to best inform the model. The keytakeaway is that analytics will only provide complete value whendata is no longer segmented into discrete silos within a company;it must be viewed as a complete dataset, which will requirecultural, technological, and intellectual changes from the currentmindsets.

The traditional functional views of data have a great deal ofmomentum, and will take change management effort to divert into thenew direction of consolidated modeling. Despite the growingprevalence and apparent acceptance of the importance of dataanalytics, recent senior executive level research indicated severalbarriers to success, including:

• Nearly two-thirds of today's senior executivedecisions are still made based on experience, collaborativeconsensus, group dynamics, or intuition, with only one-thirdstating they use analytics;

• Limited investments in analytical tools ortechniques are likely over the next two years according to thosesurveyed, as historical trends, benchmarks, and traditional unitmeasures and ratios remain prevalent;

• Agency management and actuarial (pricing) remainless likely to use analytics than underwriting or finance, withclaims in the middle of the pack; yet they all representsignificant profit-improving opportunities;

• Those organizations using analytics tend to havefragmented unities within individual departments, several separatesystems versus a single integrated one, and/or rely upon finance orIT to do their analytics for them; and,

• Of most concern were two of the top reasons thatsurveyed companies were not further leveraging analytics, the factthat the benefits were not viewed as outweighing the cost and ageneral lack of the executive sponsorship needed to ensure anintegrated solution is pursued.

MORE RIGOR NEEDED

After surmounting these obstacles, expertise will have to beestablished and formal roles assigned at the enterprise level inorder to maintain consistent data use definitions (how manydifferent ways can "premium" be interpreted within a company),ensure effective data management across the silos, sustainpersistent consistency of data etymology via formalized governanceover new applications and developed systems, and monitor the tools,techniques, and practices used by various departments in modelingactionable strategies from the analysis of the now-common data.

The additional rigor is needed not only to offset the newfoundcomplexity, but to allow for the fact that today's analytics are nolonger retrospective, but are forward-looking (a/k/a, predictive)as companies seek to learn, integrate, and act at a granular levelof customer attributes and expectations regarding product features,method of sale, service delivery, and lifetime touch points. Hereis where one finds the source of innovation, as companies take thevast amount of discrete data items, consolidate them withexternally acquired behavioral and lifestyle information, andgenerate individualized solutions presented in the preferred mannerat the appropriate time from initial prospect through customerlifecycle.

It is no longer a matter of an offering of predetermined optionsby a trusted advisor in response to a call, lead or referral, ithas become a well-defined approach via a singularly specific method(advisor, Internet, telephone, mail, email, online chat, Webcam,podcast) to present a custom-designed solution. The method, timing,and features are the result of extensive multivariate orGeneralized Linear Model (GLM) analysis working with tremendousamounts of variables operating within the context of existingcompany channels, product components, risk appetite, growthstrategies, and profitability goals, all constructed for thespecific offering.

This is where the true innovative use of analytics comes intoplay—the bridging of the vast amount of operational andtransactional information that exists within policy processing andcore systems, first eliminating the silos and then supplementingthe data with externally acquired relevant information. Property& casualty lines have been expanding their use of GLMs as asource of pricing for a number of years, combining age, gender,driving record, credit score, ZIP code, and other variables into asingle rate. The key complexity of GLMs resolved by predictiveanalytics involves coming up with the answer to two keyquestions:

• What rating variables to include as relevant andmaterial in calculating the rates; and,

• What relative weight to give each of the variablesincluded.

Fine tuning the variables down to the materially impactfulsubset and then determining the appropriate relativity of eachvariable requires processing an extensive amount of data throughiterations of models that are validated against real world resultsbefore adopting.

BEYOND P&C

Looking beyond P&C business, at a recent life insuranceproduct development conference, the discussion centered on the useof predictive analytics for pricing purposes. Here, the variableset would be expanded beyond the typical age, sex, risk class,face, and duration to incorporate additional variables like maritalstatus, geographic location, occupation, income, type of car, typeof housing, and even number of children.

In both instances—p&c and life—there was discussion abouthow additional generally-available sources of information could beused to supplement the models in the future, further enhancing thegranularity of the pricing, by including magazine subscriptions(weight loss versus runners world); foods purchased (its logged byyour "frequent buyer" card); time in front of television; creditcard purchasing patterns; and a variety of other already publiclyavailable information that could be integrated into the GLMs forpricing purposes.

Needless to say, both explaining and perhaps even justifying theinclusion of many of these variables may prove a challenge. Still,they exist, and they could be used to model out casualty risk ormorbidity. In fact, as it turns out, there are examples offeredwhere this information is already being used in the healthcarefield for similar determination of group ratings, treatmentprograms, and other individualized solutions to specific needs.

LIFETIME ECONOMIC VALUE

The value of analytics extends beyond the pricing, distribution,and acquisition of a customer, and serves a purpose prior to eventhe fraud detection opportunities at point of claim. A fullyintegrated analytics program looks at customers on an ongoing basisin order to determine levels of service provided, potentiallycall/answer rates and field access, or even support options. Thegoal is to balance the needs of the customer with the profitabilityin terms of Lifecycle Economic Value (LEV).

LEV measures a given customer's total contribution to thecompany's bottom line from the perspective of across product lines,across points in time, and through the expected future interactionsand premiums. In determining this LEV, or lifetime profitability,customers that may look like small contributors from one line areseen for their total economic value when looked at across theenterprise and family-line connections, which in turn could drivedifferent rating actions, retention efforts, and pricingconsiderations.

A substandard policy on a low-risk line might be adjusted, forexample, if the LEV of a customer is seen to be high whenconsidering all other business and associated business. Absent theability to have a holistic view, decisions are made thatsub-optimize the full value of that hard-earned relationship. Giventhe upside potential of revenue over expense reduction, the extracare to fully understand the implications of each customer willprove well worth the effort over time.

NO WINDFALLS

The economy is not going to provide a windfall break to theindustry; survivability and profitability rests with leadership tofind near-term solutions. Given the rapid rate of change indiversity, globalization, technological advances, and competitivelandscape, time is of the essence for those wishing to achievecompetitive advantage. Neither analysis paralysis, a patient "waitit out" perspective, nor a continued focus on expense reduction atthe staff level—that front line of talent that represents your mostcritical customer touch points—will provide the necessary solutionto sustainable growth and profit. Sustainable profitability willcome directly from:

• Investing in your front line staff, ensuring thatthey are empowered to provide world class differentiatingservice;

• Investing in a policy administrative system that isnimble, adaptable, cost effective, and customer friendly;

• Investing in a consolidated collection of businessdata across all systems that is externally supplemented;

• Investing in a comprehensive, granular understandingof your market, distribution partners, and customers; and,

• Driving decisions and strategies from awell-governed dynamic pool of reliable facts, projections, andmodels.

For the strategic enterprise, the long-sought alliance betweeninformation, technology, business, and the intellectual capital ofthe work force has arrived. As Victor Hugo once said, "There isonly one thing stronger than all the armies of the world: and thatis an idea whose time has come."

The convergence of economic challenge, technologicaladvancements, insurance market dynamics, and consumer expectationsbrings with it a tremendous opportunity for those willing to riseto the occasion. Similar to buying houses in a down market (perhapsa controversial example), the best time to invest and excel isnow.

Steven Callahan is a senior consultant and practice directorfor the Robert E. Nolan Company, a management consulting firmspecializing in the insurance, healthcare, and banking industries.For over 38 years, Nolan has helped companies achieve measureableimprovements in service, quality, productivity, and costs throughprocess innovation and effective use of technology. Steven can bereached for further comment via e-mail [email protected].