Calling to the outside: for the first time, insurers' spending on external technology solutions is expected to outpace internal IT spending.

Insurers are deciding they don't have to do it all themselves. Some information technology projects require highly specialized skills, some can be executed more efficiently somewhere else, and sometimes outside advice can mean the difference between failure and success.

A recent study by independent market analyst Datamonitor said that for the first time, insurers' spending on external technology solutions is expected to outpace internal IT spending. Increased need for defined skills sets for various IT projects, more widespread adoption of Web-based architecture and continued growth of IT outsourcing are a few of the developments fueling that expected rise.

U.S. non-life insurance companies will have the greatest hand in external spending when it comes to IT. Data-monitor predicts that through 2009, investment in external solutions by these insurers will grow by 7.2%, compared with 2% for internal IT spending. Life companies, on the other hand, will have slightly smaller growth, 6.5%, compared with 1.4% for internal spending.

Not only are insurers expected to spend more on external solutions such as hardware and packaged software, but many say they'll look more to outside professional services providers and consultants to develop, implement and manage complex technology projects. The hope is that these external solutions will help insurers gain an advantage in a highly competitive market.

The Move to the Outside

Over the past five years, there's been a gradual decrease in internal IT spending among all tiers of insurance, said Ed Blomquist, financial-services technology analyst at Datamonitor and author of the "U.S. Insurance Technology Strategies" study. "Insurers are increasingly looking for vendor solutions as opposed to developing solutions or products internally as they once had," Blomquist said. And while insurers will continue to handle a high degree of customization of systems and applications internally, they're increasingly looking to vendors to deliver more in terms of expertise, he added.

Datamonitor anticipates insurers' spending on outside professional services will grow 5.5% between 2005 and 2009. "Some carriers don't want to think of themselves as software developers, for instance, so many are beginning to find partners who are software developers to create external solutions," said Craig Weber, senior analyst for Celent LLC.

Ongoing re-engineering projects that increasingly require sophisticated mapping and definition capabilities and service support are driving the expected rise in external IT spending. In addition, re-engineered core systems, implementation of regulatory controls and insurers' need for specialized skills, such as Sarbanes-Oxley compliance and migration of legacy systems, are prompting more insurers to partner with vendors.

In selecting vendors, Blomquist said, insurers are generally looking to those who specialize in the insurance industry. In addition, they're seeking vendor partners who are developing their own implementation frameworks, particularly for service-oriented architecture, he added.

Better enterprise architectures, such as SOA, are becoming a growing part of insurers' external IT budgets. "Most insurers talk about developing service-oriented architecture and are looking at this in terms of long-term planning starting in a line of business, along with developing an architecture at that business level and developing those areas and integrating into a group architecture," said Blomquist. But it won't happen overnight, he said. "There are still boards out there that don't even understand the definition of SOA, so it's incumbent on IT departments and business alignment to make this happen."

Outsourcing

Datamonitor expects an 8% to 10% annual growth in IT outsourcing over the next four years. "It's a matter of vendors proving they can handle more complex outsourcing frameworks," Blomquist said. In addition, the industry has largely accepted infrastructure outsourcing. Companies' consolidation of both data centers and information services in general over the past five years shows savings are being generated from outsourcing. "Now, insurers are looking to improve flexibility management options and have become more comfortable with outsourcers handling more development aspects of the business," he said.

Part of Ohio National Financial Services' $16 million annual technology spending is devoted to outsourcing. R. Allen Bowen, senior vice president of information services for the company, said outsourcing is a way to keep the company's core of 100 insurance technology professionals small. "We're looking outside for outsourcing opportunities in an opportunistic and entrepreneurial way, such as for specific skills or capabilities we need for very specific purposes. Because individuals with these specific skills generally are quite expensive and are unique, we couldn't afford to keep them on staff all the time."

Insurers across the various insurance tiers are expected to see a spike in dollars devoted to outsourcing, but life insurers will likely have the largest spending rise. Datamonitor anticipates that life writers' $1.7 million in outsourcing spending in 2005 will grow to nearly $2.1 million in 2007, while non-life companies' spending will rise from $2 million in 2005 to nearly $2.4 million in 2007. The smaller growth is linked to the relative non-life growth in overall IT budgets after 2006 rather than interest in a particular application, Blomquist said.

Areas of Investment

Bill Jenkins, chief information officer of Harrisburg, Pa.-based Penn National Insurance, believes improved sophistication of solutions and the onset of an IT skills shortage are also fueling the expected rise in external IT spending.

Several recent reports point to a national IT skills shortage. In one report, the Computing Research Association, a college trade group, said the number of newly declared computer science and computer engineering majors in the United States and Canada in 2004 fell 23% from the prior year. "As a result, companies are having to turn to outside help for the assistance they need," Jenkins said.

Insurers also are expected to put more of their future IT dollars into systems integration. Slightly more than 7% growth in systems integration is expected by 2009, according to the Datamonitor study. "Data integration, enterprise architecture projects and compliance dovetail in the form of overlapping solutions in the next several years," said Blomquist.

Off the Shelf

Part of the move to outside resources involves increasing purchases of packaged products. Life insurers, in particular, are expected to see a steady rise in spending in this area, with nearly $1.6 million in expected spending in 2007, according to Datamonitor. Such spending by non-life insurers, on the other hand, will remain flat at about $1.2 million.

For insurers like RLI Corp., packaged products provide an advantage in areas that are noncompetitive. "We take a separated approach of what we really want to build vs. what we want to buy," said Chief Information Officer Piyush Singh. He said the company chose a best-of-breed approach to purchase packages for things that are not a core competency, while focusing in-house development on strategic competitive solutions that integrate the processes into a front end that appears seamless to the user. The company recently purchased several such packages, including a rating system and forms solution. While Singh said the company is spending more on packaged products, the return on investment is paying off in a big way.

Packaged products also offer a relationship with vendors that provides companies access to vendors' talent, intellectual capital and their user community, said Ohio National's Bowen. "We're in a heavily regulated business and are barraged with regulatory scrutiny and legal activities, so one of the greatest benefits of a solution is that when things happen in that world, we're able to work with a vendor and its user community to spread the cost of whatever that might be over the community." The company's share of that change, he added, is relatively small compared with what it would be if the company had to do it on its own. When a business opportunity arises and the company is looking at how it's going to provide automation for it, he said, Ohio National first looks to packaged solutions as the answer.

Ups and Downs 

Not only are external solutions providing some insurers a competitive advantage and faster speed to market, they're also adding dollars to insurers' pockets.

"For every $1 we're putting into our maintenance program, we're getting back $40 in return," said Ohio National's Bowen. "Companies are spending twice as much as we're spending; for us, the answer is leverage."

But insurers say there are some challenges when it comes to external solutions. "For one, there's always an expense factor involved," said Penn National Insurance's Jenkins. Ongoing maintenance and licensing fees need to be expensed by companies throughout the year. "And if for some reason a vendor becomes unstable in some fashion, you may be [caught] without the necessary skills and knowledge to complete the task yourself," he said.

Companies also need to be prepared to weather any bumps in the vendor partnership along the way. "It's a relationship much like a marriage; there may be times when it's not always completely smooth," said Bowen. "Players change, and every relationship with a company boils down to a couple of people. And if people change, you then have to rebuild those relationships," he said.

In addition, some insurers' external IT spending will not outpace that of internal spending. Singh of RLI Corp., for instance, said the majority of the company's IT dollars goes to internal solutions. "We definitely believe our staff is there to provide us the leading edge competitive advantage using IT as a strategic tool set, and that's really where we deploy our staff."

But those companies that rely heavily on external solutions have to realize that often they're giving up a lot of control, Jenkins said. And some companies are not willing to do that.

"The thing that prevents use of external solutions and providers is that some carriers, in many product segments, think of themselves as unique. And who better to understand and solve their unique problems than their own IT staff," said Celent's Weber. "The carriers that break out of that mindset are willing to consider external solutions, but some carriers never really manage to do that."

A change in perception, however, may open the door to a rise in external IT solutions. "The evolution is really about getting people used to ideas and thinking about their businesses differently," said Weber. While he said he doesn't foresee a "watershed moment" when it comes to external solutions, he does expect to see continued steady growth as people get used to thinking differently about how they outsource their IT.

Key Points

* U.S. non-life insurance companies' external IT spending is expected to grow by 7.2%, compared with 2% for internal IT spending, by 2009. Life companies will have slightly smaller growth, 6.5%, compared with 1.4% for internal spending.

* Insurers' IT outsourcing is expected to grow 8% to 10% annually over the next four years.

* Part of the move to outside resources involves increasing purchases of packaged products.

Learn More

Ohio National Life Insurance Co. A.M. Best Company # 06852 Distribution: Career agents, personal producing general agents, institutional sales system

Penn National Insurance A.M. Best Company # 00766 Distribution: Independent agents

RLI Corp. A.M. Best Company # 04210 (RLI Insurance Co.) Distribution: Branch offices, wholesale brokers, independent agents

For ratings and other financial strength information about these companies, visit www.ambest.com