The Right Combination - Rethinking Business Operating Models In Insurance

About this research

This report summarises the findings of a year-long study into the future of business operating models (BOMs) in insurance. A business model is a blueprint of how functions, divisions and organisations co-operate to capture shareholder value.1 The research primarily addresses the business model challenges of major global insurance companies operating in both life or non-life sectors across multiple markets; although the findings are relevant for all insurers. The report is based on several research methodologies including:

Face-to-face interviews with senior insurance executives; An online questionnaire completed in August 2009 by approximately 20 equity analysts in Europe and North America; Analysis of published year-end results (as at May 2009) of 24 international life and non-life insurance companies from Europe, North America and Asia; Focus groups of in-house Deloitte insurance practitioners. Our thanks are due to those senior insurance executives who enabled us to make an in-depth analysis of their business operating models.

Foreword

Over the past two years, many financial services institutions have been working towards one goal – survival. Like many others, insurers have come under great pressure during the financial crisis. Compared to their banking counterparts, most insurers have come through in good shape.2 But 'business as usual' is unlikely in the foreseeable future.

Deloitte's research shows that insurance-industry analysts no longer give top priority to revenue growth as the key driver of shareholder value. Balance-sheet strength and robust risk management are, they say, the most significant drivers of performance.

In the medium-longer term, we consider operational efficiency will become crucial to maintaining profitability, as insurers' prospects for revenue growth are hampered by increasingly saturated and commoditised core markets. Although certain retirement segments and emerging markets offer a bright hope for revenue growth, it will be some time before they are significant enough to shift the current focus away from balance sheets, risk management and operational efficiency.

We argue that insurers' existing business operating models are not designed to achieve these new priorities. The predominantly multi-divisional and decentralised models used by insurance companies have resulted in increased organisational complexity, duplicated infrastructure and localised, difficult-to-scale operations. In addition, the functions that have a direct impact on controlling balance sheets and risk have had a diminished role under the prevailing models. And, as sources of new revenues and customers have continued to shift from west to east, and from north to south, insurers have struggled to put in place business operating models that can translate synergies across both mature and emerging markets.

Insurers should address these fundamental issues now. Building models that foster standardised, enterprise-wide (globally) integrated operations is vital to compete in a market differentiating through operational efficiency. However, local business units in certain markets must also be allowed to be flexible in order to respond to dynamic market conditions. We suggest ways to achieve a balance between these apparently conflicting goals in this highly regulated sector.

Executive summary

Shifting demand causes business model challenges

While banks were, in the main, more severely affected, the financial crisis knocked investors' confidence in insurance, and triggered a radical change in priorities for the industry. Previously focused on revenue growth and return on equity, insurance analysts have placed balance-sheet strength, robust risk management and operational efficiency at the top of their agendas. Such changes in investor demands are likely to remain in place until 2012. At the same time, a changing regulatory landscape is also expected to shift the goal posts for insurers. For example, Solvency II is due to be implemented in the European Union by 2012. Additionally, insurance is in a period of global transition, as major insurers shift strategies to straddle both mature and emerging markets, requiring improved global coordination.

While demands on insurers have shifted substantially, their business operating models have not. Current models have evolved to respond to opportunities for revenue growth across multiple domestic and international markets. These same models are now creating barriers to more efficient operations, effective balance-sheet and risk management and global cooperation. In short, insurance business operating models (BOMs) are often no longer fit for purpose.

Principles for new business operating models

We set out principles for a new business operating model that will bring improvements to the management of balance-sheets & risk and operational efficiency.

1. Globally integrated (or enterprise-wide) operations: Existing models are set up for growth opportunities in local markets, and insurers are working towards creating regional-scale synergies to achieve improved controls and operational efficiencies. They must be more ambitious – driving through fundamental change to go for integrated operations on a global or enterprise-wide scale. The starting point for each insurer is different. But typically insurers should build stronger divisional and group/corporate functions to facilitate such integration.

2. Dual operating model: Moving to a globally integrated (enterprise-wide) solution may not be appropriate for all parts of the business as many insurers are in a period of transition, straddling mature and emerging markets. A dual operating model is needed based on two speeds: accommodating improved control and enterprise-wide scale where possible, while allowing a localised tailored approach for more entrepreneurial parts of the business (or those subject to unique regulatory environments). Being selective is key. Insurers should make a distinction between those operations that should be integrated (standardised and simplified to operate from a globally integrated model) and those operations which need to operate from a more autonomous basis to retain flexibility and responsiveness (e.g. difficult-to-scale or highly tailored processes).

3. The right combination: The dual model is not only applicable for the emerging/mature markets dichotomy. In defining the right mix of businesses to be integrated or operated more autonomously, insurers may choose to distinguish their core business in other terms. Manufacturing versus distribution, commodity versus higher-value business, back-office versus frontoffice, life versus non-life, or indeed protection versus savings and investment management can all be used as a basis on which operations can be selected for integration across the enterprise.

4. Strategic approach to building models: Initiatives aimed at fixing current business models are often thought up and implemented on a piecemeal basis. This can result in initiatives that fail to gain traction, leading only to incremental improvements or ones that may do more harm than good. Therefore a more strategic approach is required.

   Practical steps towards a more strategic approach

   Insurers seeking to transform their business models in order to respond to the new demands placed on them should take a more joined up approach to change. Each organisation has its own unique business operating model and starting point to the transformation agenda. However there are common tools and steps to a solution:

   Often initiatives to change business strategy or organisational structure are not strategically analysed or driven in tandem. Insurers should assess the current business operating model strategy and structure so that the two are better aligned. Some insurers have struggled to convince shareholders that their balance sheets are sound and that new business is not being written at the expense of disciplined underwriting. Balance-sheet efficiency and risk management should be established as a top priority, and relevant functional specialist teams strengthened. Business operating models have become more complex and opaque as the boundaries between insurance companies, intermediaries and distributors become increasingly blurred. Open architecture is also forcing strategic decisions around manufacturing or distribution as a core capability. Defining core activities (and non-core) is key to focussing resources on achieving operational excellence in the essential parts of the business. Non core activities may be outsourced, offshored or delivered through strategic partnership. Many business units are accustomed to autonomy, building their own solutions and product-sets tailored to their local markets or jurisdictions. Consequently insurance BOMs have typically become highly complex. For improved operational efficiency and more consistent governance and controls, insurers should simplify and standardise processes, laying the foundations for improved co-operation and scalable operations. Complex business operating models, led by autonomous divisions, have caused duplication and inefficiency. Simplified and standardised processes (see above) should be scaled up on an enterprisewide basis where appropriate. Insurance companies can aim for enterprise-wide (globally) integrated operations on a selective basis. Operational efficiency is crucial to competitive advantage in commoditised markets. However entrepreneurial units in either high growth products or niche and emerging markets can be crushed by a stifling business operating model. Within limits, insurers' models should allow specialised, autonomous operations in certain parts of the business. Some insurers were challenged by the financial crisis partly because they failed to convince shareholders of their financial viability. This was in part caused by a lack of enterprise-wide transparency and difficulty in communicating business...