Oliver Peterkin explains how (re)insurers can improve value for money from R&D spending.

Despite spending over $150 million a year on catastrophe research and development, senior executives of insurers and reinsurers are increasingly questioning the return on this investment. Growing pressures on the (re)insurance sector are leading to more demands on in-house research teams, who are already under pressure to deliver better value for money. The question being raised by executives is how can we get more value from our R&D budget and can our research people meet the increased challenges of the next decade?

During the past 10 years, over 100 reinsurers, insurers and modelling companies have developed models of natural hazards, such as earthquake, hurricane and other perils. These models are now at the centre of decisions on strategic risk management, reinsurance purchasing and insurance securitisation. More than 1,200 people are directly employed on front-line R&D, with a further 5,000 involved as consultants and contractors. Cordis Consulting estimates that in 1998 modelling companies alone spent over $50 million on R&D, closely followed by the large brokers spending over $40 million. Between them, insurers and reinsurers, we estimate, spent less than $40 million.

The difference in spending between the intermediaries (brokers and modelling companies) compared to the risk carriers themselves, suggests a worrying trend - one of growing dependence of the underwriters on externally produced models. Suggesting to an investment bank that it should base its trading on someone else's market research and pricing models would be met with surprise, but this is just what seems to be happening in reinsurance and insurance companies.The growing dependency on commercial packages is shown by about half the total R&D expenditure going on externally purchased models with the remainder accounted for by in-house R&D teams. One of the issues faced by insurers buying external models is how much competitive advantage they are really getting. These models are now widely available and are seen by a number of users as getting them on the same playing field as everyone else, but not delivering unique competitive advantage. One key benefit, however, is that users do have the comfort of knowing they are managing risk and pricing on a common industry basis without incurring the risks of developing their own models.

Proprietary knowledge
As insurance markets around the world get more competitive and more transparent, so successful insurers are going to be the ones with their own proprietary knowledge about risk, letting them select the better risks and price at superior margins. The question is whether the best way to do this is through in-house development or by purchasing external, ready-made models.

Many reinsurers and a growing number of insurers, maintain their own R&D capability, developing in-house models of catastrophe risk around the world, as well as running other suppliers' models. However, senior executives are questioning this approach. Given the rapid increase in R&D budgets over the past five years, R&D departments are being asked to justify their costs, not just in terms of models developed but also in terms of how have they added to their group's competitive advantage.

Indeed, the challenges facing in-house teams are growing and constant changes to the business environment are posing a threat to accepted R&D strategies. In addition to increasing demands on their limited resources caused by market changes, technological advances will mean that a number of teams will struggle to keep up. Technology is advancing on a number of fronts, resulting in new business processes, such as integrated risk management and processing systems, as well as the increased competition posed by internet suppliers. New sources of data are becoming commercially available, often from military R&D programmes, such as remote sensing using satellites and airborne synthetic aperture radar. The object revolution in computing is producing a new generation of modelling tools, including object orientated geographic information systems and parallel processor computers.

In response to these growing pressures, advanced R&D management techniques from the high technology and manufacturing sectors are being imported into the world of insurance and reinsurance, providing an alternative to the traditional R&D strategies of in-house teams and commercial packages. Greater use is being made of sub-contracting with outside parties. Contract R&D, for a long time a standard technique for R&D teams in the computing and automotive sectors, is being used to gear up in-house resources so that they can obtain more flexible and expert resources to tackle specific problems. Project management techniques, such as time boxing are being used to get better value for money and to ensure the delivery of projects on time and to standard.As the challenges facing insurers and reinsurers continue to grow, so the demands placed on in-house R&D resources are escalating. In the face of the continuing squeeze on insurance and reinsurance margins, it is no longer an acceptable solution to expand staff numbers and their overheads to meet these demands. For many companies, contract R&D offers an exciting and effective way of increasing R&D capacity, obtaining improved value for money whilst maintaining full control over projects and costs.

Oliver Peterken is managing director of Cordis Consulting, a part of the Willis Corroon Group, which focuses on helping senior executives of risk carrying businesses enhance earnings and manage risk. Tel: +44 (0) 488 8923; fax: +44 (0) 481 7193; e-mail: peterkino@cordisconsulting.com