For several years now, life insurers have been struggling to manage profitability as they face a combination of increasing costs (due to a variety of factors that include inflation, policyholder longevity leading to longer healthcare and annuity payout streams, and the cost of maintaining legacy systems), the need to comply with an increasing regulatory burden, and earning low or negative returns on investments. Although interest rates have increased at an unprecedented rate over the past year due to efforts by central banks to curb inflation, insurers are locked into low-yielding investments, and it will take several years for their investment yields to improve.
Insurers are also struggling with high, mostly fixed costs and the complexities of maintaining legacy systems, which makes current variable cost-based alternatives more attractive. Insurers want to shift from fixed to variable, “pay-as-you-go” operating costs. Core modernization (processes and technology) is a top priority for every insurer.
To accelerate speed-to-market, grow the business with new innovative products and services, gain new and deeper risk insights, and improve customer experience, most companies are also emphasizing digital transformation.
Life insurance companies that have been in business for a long time typically have a significant part of their “book of business” that consists of insurance policies that were issued several years ago, with products they no longer sell. However, they must continue to administer these policies—including premium collections, customer service and benefit payments—until the policies “run-off” the books due to the death of the policyholder or policyholder actions that lead to the termination of the policy.
As the number of “closed-book” policies decreases over time, the insurer has to absorb the fixed cost of their systems and IT infrastructure investment over fewer and fewer policies, resulting in ever-increasing administrative costs per policy. It also often means that the insurer must continue maintaining legacy operational and IT systems that are used for the management of the closed book.
How is the insurance industry addressing these challenges?
There are three recurring themes that we see most often:
1. Core modernization
Most major insurance companies have determined that their mid-to-long-term strategy is to migrate as much of their application portfolio as possible to the cloud. There are many considerations leading to this strategy—all equally applicable to other industries as well. The six key “game-changing” enablers of cloud are as follows:
Cost flexibility: The ability to shift cost from CapEx to OpEx and from fixed to variable pay-as-you-go models.
Business scalability: The ability to allocate and release resources based on demand and gain savings from economies of scale.
Market adaptability: The use of cloud speeds time to market for products and services and supports rapid prototyping and innovation.
Masked complexity: Cloud enables more sophisticated products to be added to the portfolio while facilitating a simpler user interface for customer interactions.
Content-driven variability: The user experience is customized based on the context of the user interaction and knowledge of user preferences, movements and behaviors.
Ecosystem connectivity: The use of cloud enables industry-specific platforms that connect to new value nets of partners, customers and other external players.
Depending on the size of the application portfolio (which, for the medium- to large-sized insurers, typically is between 1,000 and 5,000 applications) and the geographical dispersion of their business units, companies have created 5- to 10-year roadmaps for completing their “application modernization” and “mainframe modernization” initiatives.
Many Insurance companies that embarked on this journey two or three years ago have come to the realization that they require a hybrid multicloud approach, with some of the very old and complex policy administration, claims, underwriting and actuarial systems continuing to run on an IBM mainframe (possibly utilizing a “Mainframe as a Service” contract with an IT Service Provider). They may need to either do a “lift and shift” (e.g., operating under IBM Cloud for VMware Solutions) or actually modernize, refactor and containerize the other legacy systems and operate them in a cloud-native mode.
IBM’s hybrid multicloud approach—when combined with the best-in-class security and compliance control features enabled for IBM Industry Cloud Platforms workloads and our deep industry expertise in mission-critical processes—offers a compelling value proposition to large insurers in all geographies. We are assisting several prominent companies in every geography on their core modernization journey.
2. Digital transformation
Insurance companies are reducing cost and providing better customer experience by using automation, digitizing the business, and encouraging customers to use self-service channels. It used to be that insurance companies used a combination of automated workflow, a business rules engine and content management software. With the advent of artificial intelligence (AI), however, companies are now implementing cognitive process automation that enables self-service options for customers and agents self-service and assists in automating many other functions, such as the IT Help Desk and employee HR capabilities.
The introduction of ChatGPT capabilities has generated a lot of interest in generative AI foundation models (these are pre-trained on unlabeled datasets and leverage self-supervised learning with the help of Large Language Models using a neural network). Foundation models are becoming an essential ingredient of new AI-based workflows, and IBM Watson products have been using foundation models since 2020.
The supervised learning that is used to train AI requires a lot of human effort, is difficult, requires intensive labeling and takes months of effort. On the other hand, self-supervised learning is computer powered, requires little labeling and is quick, automated and efficient. IBM’s experience with foundation models indicates that there is between 10x and 100x decrease in labeling requirements and a 6x decrease in training time.
IBM has integrated foundation models with several Watson products, including software like IBM Watson Discovery, IBM Watson Explorer, IBM watsonx Assistant, IBM Text to Speech and IBM Watson Speech to Text. IBM foundation models are pre-trained on curated data. A user can train, validate, fine-tune/prompt-tune and deploy pre-trained foundation models incorporating domain data with ease to drive better conversational experiences and result in faster trusted responses. Watsonx is a new AI and data platform that includes watsonx.ai—a studio for new foundation models, generative AI and machine learning. The following chart shows the approximate number of model parameters used, by domain, to scale up the AI foundation models:
3. Addressing the “closed-book” challenge
New players like consolidators (including private equity firms), have entered the insurance market and shown that investments in closed-book insurance portfolios can still create value. In the top five European insurance markets, McKinsey analysis indicates investment yields in the 2018 to 2020 period varied by country, ranging from 2-5%. The ROE ranges also varied by country, from –5% to +13% .
Several insurers have created separate entities to manage their closed-book insurance portfolios. They focus on keeping their closed-book administrative costs under control and seek opportunities to cross-sell newer insurance products to closed-book customers. They often use third-party administrators (TPAs) to manage the closed book, with costs agreed on contractually in multi-year deals. IBM has multi-year TPA contracts with some large insurers for administering their closed-book life insurance business.
External closed-book consolidators acquire closed books and seek scale, operational efficiencies, and superior asset and investment management to drive profitability. Private equity has entered this market and set up consolidator subsidiaries. Some well-known consolidators are Phoenix, Athora, Catalina Re, Monument Re, Compre and Fortitude Re.
Some external closed-book consolidators have found it difficult to grow sufficiently through acquisitions of closed books alone, so they are also acquiring new open-book policies in order to scale their operations and generate better business margins.
Althoughtightly controlling costs is the primary driver and the market for administering closed-book life insurance portfolios is very competitive, there are very few companies with a modern, cloud-based insurance platform that offers the game-changing capabilities summarized above. IBM has deep experiencein architecting and deploying such an insurance platform solution on IBM Cloud.
How is IBM helping insurance companies prepare for the future?
IBM is one of the very few companies globally that can bring together the range of capabilities needed to completely transform the manner in which insurance is marketed, sold, underwritten, serviced and paid.
Companies need to get a good understanding of data (structured and unstructured), organize it, manage it in a secure manner (while complying with industry regulations) and enable instant access to the “right” data. This capability is fundamental to providing superior customer experience, attracting new customers, retaining existing customers and getting the deep insights which can lead to developing new innovative products (e.g., as required for a “Gig Economy”). It also helps improve underwriting decisions, reduce fraud and control costs. IBM’s Data Architectures and automation software operating on cloud are being implemented by leading insurers in all geographies.
Application and mainframe modernization
Many companies make application modernization decisions without having a holistic view of their application portfolio and the underlying technologies being used. They also do not have a well-defined target state and make decisions such as “we want to move claims to cloud” without a clear view of all the cloud services they may need to consume, potentially in a hybrid cloud target environment.
IBM’s approach to modernization begins with understanding the company’s business and technology environment/workloads and assessing modernization needs, driven by both business and technology priorities. We then align value propositions with problem statements. A well-defined target architecture (including the technology stack and the application services/microservices) is key to successful application and mainframe modernization efforts. This chart shows our approach to modernization.
IBM’s solution for administering closed-book portfolios
IBM has a well-architected, secure core insurance platform for life and group insurance operating on the cloud. This enables insurance companies using the insurance platform to reduce their operating costs as their book of business declines and policies “run off.” Companies that plan to issue new policies using this platform will benefit from the flexibility and business scalability that is offered by operating on a cloud-native solution. We leverage technology to promote automated processing for the majority of insurance transactions, we and use AI- and analytics-assisted decisioning by underwriters, claims adjusters and medical professionals for the more complex transactions.