July 2011

Financial Services

Planning, budgeting, and forecasting: steering clear of the panacea approach

by James Richards, Don B. Rogers and Andrew Dubin

Generating more value from a new, holistic approach

The latest economic downturn exposed long-standing gaps in the planning, budgeting and forecasting (PB&F) practices of some insurance carriers. As the economy improves and stability returns, PB&F has risen on the transformation agendas of many finance executives. Intensifying regulatory oversight, the globalization of markets and increasing operational complexity are placing a new spotlight on PB&F capabilities. Specifically, insurers need to perform insightful analysis of future revenue and expenses, more efficiently produce meaningful budgets and accurately forecast capitalization requirements. To some extent, these processes have been afterthoughts within the finance function of insurance companies. For instance, while many core accounting processes have been transformed and automated through the use of enterprise software (e.g., general ledger, billing and accounts receivable modules), most plans, budgets and forecasts are still created from spreadsheets which require significant manual intervention to produce results. A business case for upgrading PB&F is largely based on automating and streamlining the tedious and time-consuming tasks of data collection, which frees up time for higher-value activities, such as analysis. However, to realize full value from investments in PB&F, insurers should recognize that a methodical, holistic approach is required. The temptation to leap right to technology implementation as a panacea for all that is wrong with the PB&F function must be resisted. Critical process, organizational factors and underlying data issues must also be addressed for PB&F transformation to be truly successful.

Internal challenges to effective PB&F

Many insurance executives complain that their PB&F processes are overly complex and time-consuming and are not applied consistently across the company. The results may not focus on accurate information or timely and important measures of performance and are typically out of date by the time the data is ready for consumption. Thus, they offer little predictive value, which limits carriers ability to respond confidently to changing market conditions and increases the possibility of poor strategic decision making. Given the challenging economic environment and complexity of operations at many insurers today, this level of accuracy and foresight is insufficient. Finance executives perceive these issues to be exclusive to their companies, but the reality is that these are industry-wide issues. A recent Ernst & Young study of insurance companies revealed that in considering the effectiveness of PB&F capabilities, only 5% of respondents viewed the process as very effective, while 27% of the respondents felt it was somewhat ineffective or not effective at all. Additionally, nearly two thirds of those respondents stated that they planned to enhance the process either quite a bit or substantially.1 Other external research confirms this point. A recent Economist Intelligence Unit global survey of 250 C-suite and board-level executives found PB&F to be the second-most important area of focus.2 Data challenges, organizational issues, inefficient processes and fragmented
1 Insurance Finance 2010 Studytaking a broader view, Ernst & Young, 2010. 2 The Economist Intelligence Unit, July 2008.

technology continue to be major obstacles to outstanding PB&F performance. Often insurance companies lack transparent management information, with each functional unit relying on its own set of numbers, processes and systems. Responsibility for performance data is illdefined, so there is little or no accountability for ensuring accurate inputs into plans, budgets and forecasts. This multiple versions of the truth scenario is particularly dangerous in the insurance industry, as the underlying data forms the basis for important decision-making capabilities. From underwriting, actuarial and investments, to billing and claims, to sales and incentive management, different functions need accurate, complete and current data to succeed. Those insurers able to share accurate information easily across functions give themselves a significant advantage in the marketplace (i.e., better decision-making, ease of regulatory compliance, reduced labor costs and faster time to market). In the context of PB&F, the organization must agree on core data definitions, a common business language, the key metrics to measure performance and standard processes for seeding budgets. This will facilitate driver-based logic in the planning process. Unfortunately, this is not the case today. Corporate-wide budgets often do not contain the same dimensions or level of detail as business unit reports (i.e., revenue and other fundamental metrics may be defined differently across lines of business) and this results in a lack of consensus on critical targets. These variances create a noticeable disconnect in overall performance management, undermining credibility in both forecasts and reported information. If

Planning, budgeting and forecasting: steering clear of the panacea approach

Organizations that consistently meet guidance and accurately forecast are rewarded by the capital markets.

executives rely on inconsistent data to make business and investment decisions around products, distribution channels, customer segments and business units, the potential impact could be significant. Even for organizations committed to vetting and validating all the data in their PB&F processes and systems, there are significant challenges. Many organizations have siloed and incompatible systems and considerable resources must be expended in manually gathering the data pulling it from one system and then entering it into spreadsheets or contacting local staff accountants to provide the missing figures. Then there is the sheer volume of data that must be culled from multiple feeder systems, including premium, billing and claims systems. The data sets are huge, and some of them, such as those from policy administration systems, are highly complex, with many dimensions to be factored. Given these issues, its easy to see why the development of the PB&F process in the insurance industry lags the level of sophistication when compared to other sectors. Unifying standard data structures and sources and implementing integrated data transformation processes are essential to reliable, time-saving information production. They will also enable improvements to enhance areas like scenario modeling, sensitivity analyses and driver based forecasting and budgeting.

forced PB&F to move up the agenda for finance executives at insurance companies. Working around incompatible systems and manual processes is not a sustainable management course when historically healthy profit margins face new pressures. The stakes are too high to stick with risky, error-prone spreadsheets. As insurance business models grow more complex, the buried links and cross-referencing will only become riskier. Some of these spreadsheets have thousands of line items, and an error in any one of them could impact the high-level conclusions and actions.

areas. Nearly all insurers who undertake PB&F improvements will realize marked improvements in terms of increased worker productivity, the elimination of manual processes and reductions in the resources necessary to prepare budgets, forecasts and reports. Necessary investments are usually funded by savings in these areas. Perhaps the greatest economic benefit to insurers with effective PB&F is in market value: Wall Street rewards organizations that consistently meet guidance and deliver accurate forecasts. A recent study from the Economist Intelligence Unit showed that the stock price impact can last as long as three or four quarters. Further, firms with forecasting accuracy of +/- 5% enjoy an advantage of 10% in terms of stock price growth.3 Similarly, another study by Audit Analytics found that 50 days after earnings restatements, the average company can lag overall market performance by up to 5%.4

The value proposition

While the challenges are many and the need for action is urgent, it is important to note that there are many potential benefits from improved PB&F. The short list of strategic gains includes: Enhanced performance management capabilities Increased visibility into and across operations More objective and data-driven decision-making Greater executive focus on higher value tasks Increased responsiveness to external factors Lower regulatory risk

Methodology matters
In helping leading insurers realize the value proposition for PB&F, Ernst & Young has found that successful change programs and transformation initiatives start with a clear and methodical approach and thorough planning, with project execution guided by several leading practices. Steer clear of panacea thinking. With enticing benefits, there is some risk that insurers will view implementation of a planning tool as a one-stop cure-all for their
3 Forecasting with Confidence: Insights from leading finance functions, Economist Intelligence Unit and CFO Research, November 2007. 4 Financial Restatements and Market Reactions, Audit Analytics, October 2007.

External forces equate to opportunity

A number of market drivers more intense competition, increasing regulation and pressure from capital markets have also

Higher ROI from existing technology (e.g., ERP) Interestingly, the business case for investments in new systems will likely be built on more quantifiable benefits in other

PB&F ills. Software vendors often market their wares as just that. But by focusing exclusively on technology and rushing to implementation, adopters of this supposed solution may soon find themselves facing the same issues and problems they had before investing in these new tools. In extreme cases, they simply gain the ability to make poor decisions faster or break down unreliable information more granularly.

Implementations that produce little or no benefit can cause business stakeholders to lose faith in the finance function altogether. While the business case may appear very compelling, it is critical that PB&F leaders carefully evaluate all of the components to the PB&F process to clearly see the value of a PB&F tool. Establish governance and framework. The PB&F process should start with a well-defined

plan, linked to the organizations overall vision and strategy. This strategic plan should drive the budget process on an annual basis. Historically, many insurance companies manage PB&F completely within finance, only obtaining input from the business when needed. If each division has a different way of building their plan and budget, they will not be comparable or understood across the organization. Plans and budgets should have

Case study: Getting to improved PB&F

When a large, domestic insurance company looked to improve its capabilities in determining revenue, expense and capital targets, it made a typical first move investing in an industry-leading software package. But it failed to realize the full value of its investment because it only partially implemented select functionality and was challenged in terms of its processes and organizational structures that existed at the time of the PB&F software implementation. Reliance on over-engineered spreadsheets and manual data entry Inefficient and time-consuming processes for data collection Lack of confidence in PB&F results Unclear or non-existent ownership and accountability for process inputs and outputs No clear linkage of PB&F processes to overall performance management Interestingly, while the company thought it had a problem limited to technology, the organizational and process issues uncovered by the project team, including Ernst & Young insurance specialists, proved to be more complex and challenging. For instance, the group responsible for budgeting was housed in IT, there was little or no coordination with other departments, and relevant information was not fed into planning and budgeting processes. As a result, executive leadership did not trust the numbers being produced and had no way of holding management accountable for managing to targets. Moving the budgeting process into finance and restructuring the organization resulted in the synchronization of different departments including finance, tax, accounting, underwriting and actuarial groups. This step proved to be as critical to implementing the technology in a way that resulted in overall project success for the entire organization.

Challenges
The companys PB&F challenges were related to: Lack of a clear and consistent vision for PB&F Non-standardized, manual processes throughout the organization, with many departments running their own plans and budgets

Driving to change
The project team set out to address immediate needs and develop a long-term vision for PB&F excellence linked directly to overall corporate goals. The initial steps included: Extensive discovery and analysis of existing processes and roles

Steering clear of the panacea approach for planning, budgeting and forecasting

broad input from across the organization in order to increase buy-in and acceptance at all levels. Further, good PB&F governance should allow executives to set budgets and plans that are achievable and credible, instead of those that are inaccurate and unrealistically exceed managements expectations. Look outside. Often insurance companies overlook the importance of external information in relation to planning processes.

Top PB&F performers utilize external market-based data to assist in the generation of targets for the budget. Additionally, objective third-party information should be used to develop external assumptions, cost allocations and drivers. Benchmarking data may also be useful. Leading-practice companies also articulate key assumptions regarding what must happen in order for budgets to be realized and use

scenario analysis to create multiple budgets. For example, it has become increasingly important for cash-flow projection models to cover a reasonable variety of stress scenarios that could negatively impact the company. As these new risks are considered and initiatives are approved, the identified drivers and outcomes are automatically updated in the budget and plan.

Detailed documentation of workflows (e.g., budgeting by line item), in parallel with the companys management reporting process Creation of guiding principles for PB&F processes and activities Development of full business and technical requirements for process design, data flows and reports Design of more robust, automated and standardized to-be planning and budgeting processes Outline of new organizational structure, with dedicated owners for each line item in the budget To drive towards the new vision, the project team developed a complete implementation plan, with clearly defined key priorities, milestones, activities and resources. They also implemented a strong governance model, as well as an accelerated plan for realizing benefits within the current planning cycle.

With Ernst & Youngs assistance, the companys finance leadership worked with the executive committee to create standardized plans and enhanced targets based on more accurate data and direct alignment to the overall strategy. Ownership of targets was assigned to ensure accountability, and key performance indicators and metrics were implemented to track progress. Meanwhile, the new budgeting and planning tools were configured to support the companys needs and to automate critical activities. Instead of relying on error-prone spreadsheets and manual inputting of source data into the budget tool, standardized templates streamlined the creation of projections for staffing, expenses and revenue. Standardized reports made it easier to validate budget inputs and analyze results.

Value created
After overhauling its PB&F processes, the company now has an efficient and repeatable process and higher-quality budgets. The company also has more accurate comparable information and better insight. Senior management now trusts the output to make critical decisions. Because less time is spent collecting data, more resources can be allocated to higher-value activities, such as analysis and decision support. Looking ahead, the company plans additional enhancements for subsequent budget cycles, which will deliver more improved processes, further functionality and positive change to the overall finance environment and finance system architecture. In other words, improving PB&F has been a lever to broader improvements within finance.

Reconfigure the organization. When it comes to optimizing the organization for PB&F, the goal should be to ensure the right type of work is being managed in the right locations at the right time with the right resources. Appropriate spans of control should also be in place to ensure that information is consolidated from the best sources and sufficient coordination of budgeting processes occurs. Clear lines of accountability for certain types of data or decision-making should be established. Typically, in a well-defined PB&F model, data collection is largely automated. But whatever cannot be automated should be managed centrally, with clearly identified owners within the lines of business and functions who provide raw data as necessary. However, analysis should be conducted close to the business by finance professionals who understand the business and can translate goals, variances and operational conditions into reliable plans, budgets and forecasts. By interfacing with the PB&F team housed in finance, these analysts can provide an important bridge from centralized corporate functions out to the front lines of the business. Dont forget the culture or the people. Beyond optimizing the organizational chart, insurers reworking their PB&F approach should embrace change management practices, because it is likely that organizational walls will be broken down and more information shared. Leadership should start at the top, with senior-level sponsors spelling out the case for change why it is necessary and how the company will benefit. If PB&F is to be a cross-functional pursuit, appropriate representatives should be identified from across the business (and corporate functions) and their roles clarified. This can mitigate the risk of internal politics becoming a barrier to change. It is important

to note that in a traditionally slow-moving and highly risk-averse sector like insurance, cultural evolution can be a significant challenge. But the results are very much worth the effort. Implement rolling-forecast capability.It is important for insurers to view planning as a continuous, iterative process to guide business decision-making, not as a oncea-year administrative exercise. Once a fundamental PB&F capability is put into place, implementation of rolling forecasts should be considered in order to improve the quality and accuracy of the PB&F function. A rolling forecast is the process of updating the forecast at regular intervals and advancing it to the next forecasting period, typically 18 months. Without a rolling forecast, the plan is unchangeable until the next planning cycle, which for most firms is annual. Many leading insurers use rolling forecasts as a way to be more nimble in anticipating and dealing with these challenges and to improve decisionmaking. Leading insurers adopt rolling forecasts to provide a consistent, ongoing view of the business rather than a static picture with an arbitrary annual cut-off. The purpose of the forecast is to provide an accurate view of the future, moving away from a stretch exercise or hedged goals. Forecasting accuracy improves as the accuracy of inputs and driver correlations improve throughout the cycle. In order to make rolling forecasts successful, leading-practice forecasts reflect the same drivers, dimensions, processes and systems as the rest of planning, making the exercise sustainable. A rolling forecast should be quick and utilize only the key changes in important drivers and dimensions; it should not repeat annual plan detail and duration. The discipline of annual goals can be maintained by picking one instance of the rolling forecast as the

annual budget. The intent of the rolling forecast should be to improve insight and decision-making, and not to create an administrative exercise.

Bottom-line value
After years of lagging positions in terms of process automation and technology adoption, the insurance industry has made major strides forward in the last several years. In finance and accounting, the combination of enterprise technology and off-shoring has led to impressive gains in overall efficiency and significant reductions in overhead. That track record confirms that a traditionally risk-averse industry is capable of enacting change on a broad scale. Within PB&F, the opportunity lies in the implementation of targeted improvements of fairly limited scope to this high-value area. The rewards from capital markets are a major incentive to move PB&F up the agenda, but the internal benefits of increased efficiency and lower risk should not be overlooked. Again, improving PB&F does not mean insurers must embrace leading-edge dashboard technologies or develop real-time visibility. However, there is considerable opportunity for improvement in even the basic outputs of plans, budgets and forecasts, and in important analytical capabilities in scenario modeling. Insurers can capture a great deal of the potential value just by coming up to par with their counterparts in other subsectors of financial services in these fundamental functions. More importantly, mastering the process, organizational and technology components of PB&F can lay the groundwork for long-term leadership in finance and provide valuable insights to drive positive economic results.

Planning, budgeting and forecasting: steering clear of the panacea approach

Contacts
James Richards Financial Services +1 212 773 0750 james.richards@ey.com

Don B. Rogers Financial Services +1 212 773 1530 don.rogers@ey.com

Andrew Dubin Financial Services +1 212 773 2477 andrew.dubin@ey.com

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