Vendor Park II: The Rise of the “Compys” in Technology Market 

The P&C insurance industry is weathering the recession relatively well. As we observed last year, three important facts underpin the industry’s health. First, most of the premiums spent in P&C are nondiscretionary; while both households and business have trimmed coverage, with the exception of certain markets where special conditions pertain (e.g., mortgage insurance), the industry’s top line has held up far better than other segments, such as life insurance. Second, two thirds of the aggregate P&C investment portfolio is in high-grade industrial, municipal, and government bonds, which significantly mitigated capital losses. Third, as a result of recent catastrophe experience and reserve-strengthening, the industry entered the recession significantly less leveraged and remains capable of sustaining itself through an extended tough period.

A recent study by Moody’s Investors Services, a leading bond rating agency, concluded the investment portfolios of property/casualty insurers are expected to remain strong amid volatile market conditions: "A cautious investment approach has meant most P&C insurers have been able to operate through a very difficult investment environment without seriously compromising capital adequacy."

Add to these ameliorating factors a very mild 2009 hurricane season. As of press time, within a few weeks of the end of the 2009 hurricane season, no hurricane-related storm damage has pierced the $25 million limit that defines a catastrophe for industry-tracking purposes. Compare this with the fact last year the industry had to deal with the impact of five major hurricanes, including Ike, which made landfall on Galveston Island, Tex. It caused an estimated $12.5 billion in insured losses, which puts it third on the list of costliest U.S. storms.

The Insurance Services Office (ISO) recently reported second-quarter industry results that show net income for the first six months of the year dropped from $14.1 billion in the first half of 2008 to $5.8 billion for the first six months of 2009. The main driver of these results was a more than 50 percent drop in insurers’ investment gains that fell to $12.4 billion this year from $24.9 billion for the same period last year. Negative investment results were offset by the improvement in net underwriting losses from $5.6 billion for the first half of 2008 to $2.2 billion for the corresponding period in 2009.

Should the hurricane season play out without a major storm, these numbers, which are hardly good news but are not disastrous, should improve significantly for the second half of the year.

How did this weakened financial situation affect P&C automation initiatives? All indications are most carriers decided the imperative to replace or upgrade 20- to 30-year-old core insurance systems was more pressing than a bad financial cycle. Indeed, most carriers decided to weather the storm, stay the course, and continue to invest in key technologies. As far as I know, no major technology projects were cancelled, and few planned software acquisitions were postponed. Industry spending, which at the start of the year was pegged at about the same levels as 2008, held steady.

An August 2009 survey by industry analyst Novarica is illustrative: Novarica found two thirds of surveyed P&C carriers were planning to spend equal to or more than their original 2009 IT budget. Of the remaining respondents, 25 percent were planning to cut back "somewhat," while only nine percent were planning "dramatic cutbacks." The survey found the top drivers of IT planning were "operational effectiveness" and "growth strategies," which outpolled such negative drivers as "economic downturn," "investment losses," and "pressure to reduce IT expense." In the response to the question of top project priorities, carriers responded policy and claims administration replacements were top of the list followed by business intelligence, agent portal, and underwriter workstation initiatives.

This indicates carriers still are debating where they get the most "bang for their buck" in terms of software investment. Many carriers continue to grasp the nettle and pursue the "rip and replace" strategy, which results in a new and upgraded core systems environment. Other carriers, daunted by the risk and cost of this approach, have followed the "lipstick on the pig" approach and wrapped their legacy systems with front-end portals, rating and underwriting engines, workflow tools, and new output and storage solutions. An interesting problem for the latter group is what it does next. As one CIO of a very successful "lipstick" project recently commented, his organization is driving increased revenue through the new agents’ portal and is well positioned to implement rate changes, but a product change, entry into new states, or a business acquisition would be as lengthy, risky, and expensive as ever.

Also, the incremental risk associated with the legacy policy administration (and claims) system grows each year as support staff age and retire and as the vendor focuses elsewhere. Simply put, the "lipstick" carriers still have to deal with the "pig" at some point but now have a less compelling business case to justify what continues to be a complex and risky project. However, regardless of the approach chosen, CEOs and CIOs decided planning and preparing for future growth and market competition were more important than short-term expense reduction.

Data is not readily available that measures deal activity in our market, so the comments that follow are a blend of personal observation in addition to conversations with vendors, carriers, and analysts. Given the observations made above about the sustained level of IT activity in P&C carriers, it hardly is surprising the vendor market has remained strong. Carrier acquisitions of big-ticket items, such as core systems—policy, claims, and billing—and business development-related second-tier systems, such as agent portals, underwriting, and business intelligence, have remained at the same vibrant level as 2008. New vendors have continued to enter the market—some from international markets, others from related niches such as the self-insured space, while others simply are "new." Recent analyst reports from Celent and Novarica for policy administration vendors list more vendors than last year’s equivalent reports.

For their part, vendors continue to report sales at least equal to 2008 and, in some cases, have reported strong year-on-year growth. It would appear those vendors that develop and support the new generation of "highly configurable" core administration systems had a very strong year. These systems, which combine a significantly lower cost and risk profile with a higher likelihood of success and satisfaction, clearly have won hearts and minds in the property/casualty vertical and now are well established as the "new normal." As noted in prior-year articles, the legacy vendors have continued to work hard (scramble?) to compete in the new world, but it is likely we will look back in years to come and recognize the end of this decade as the point in time when a new generation of vendors took control of the P&C software vertical. Consider the following: One new-generation vendor grew about 40 percent last fiscal year, while one long-standing player recently announced it was no longer in the "rip and replace" business but rather now was focused on component replacement and reuse.

One significant development in the 2008 vendor market was the "appearance" of huge international software vendors in the P&C insurance vertical. These vendors are known for well-established horizontal applications such as financial systems but are not known as vendors of P&C core application systems (except possibly at the upper end of the carrier market). These vendors, attracted by a sustained and active market, declared their intent to enter and dominate our vertical market.

As I styled the observation last year, our vendor market had "gone Jurassic" with the arrival of these tyrannosaurs, whose stated aim was to dominate the small vertical market players ("the compsagnathos") we are used to dealing with. So, a year later the question arises as to how the war is going between the "tyrannosaurs" and the "compys"? Well, as of the fourth quarter, the game is heavily slanted to the little guys. "It ain’t over ’til it’s over," so let’s not prejudge the outcome, but the market has not exactly been flooded with press releases about big wins by the big guys. What I hear jibes with my own experience of having worked in the very large vendor community. The big guys don’t understand and are not interested to learn the nuances of a complex market. They generally have an "end-to-end solution" perspective that does not play well in the market. And there remains a significant concern among buyers that if the tyrannosaurs don’t win in the short term, they will stomp off to some other forest where they believe more immediate gains are to be made.

The property/casualty vendor market remains specialized and parochial. Insurance is a long-term business looking for long-term partners. It is open to new entrants and to innovation, as has been clearly demonstrated in recent years. But while the successful new vendors are different in important ways from the legacy vendors (they write much better software, for a start), they are the same in one very important way: They are niche market specialists that have won their spurs in this vertical market. In that sense, our market has not changed—we remain wary of strangers, especially big ones. So, here at the end of 2009, the more things change, the more they stay the same. I wonder what next year will bring.