PA perspectiveon insurance

Extract article from

First edition 2009

Scenario modelling:developing products in uncertain times

Kenneth Hansen

When markets are uncertain, scenario modelling can be a powerful way to guide product development. This article looks at some factors critical to its success, and how scenario modelling was used at Storebrand, Scandinavia’s largest life insurance company.

BY: KeNNeTH HaNSeN, STOreBraND lIfe INSuraNCe aND alexaNDer HuuN IN NOrWay

Scenario modelling: developing products in uncertain times

This article will stick to the accepted definitions and

theories of scenario modelling, but will examine how

they can be more effectively used in the real world.

Scenarios must be a practical toolToo often, scenario modelling disappoints business

leaders. Scenarios require significant effort to develop,

and many find the results too generic or abstract – and

therefore doubt their value as a practical tool to make

better decisions.

Developing new products is challenging, and there is no

guarantee of success. Yet new products are essential

– to respond to regulation, changing markets and

competition, or simply to grow.

The financial crisis will make launching new products

more difficult. Although many companies will lessen their

activity, most will continue to develop new products in

some form. Using scenario modelling can vastly reduce

the risk of misjudging the market.

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The product development team after the first ‘TV debate (Photo: Storebrand)

In addition, the sheer magnitude of issues involved

in developing products can be overwhelming, without

the complication of considering several diverse

future scenarios.

Scenarios must be specific and relevant to the product

and its developers. It is essential that they are means

used to guide companies towards making more

profitable products, and not ends in themselves.

Developing credible scenariosTo develop quality scenarios, with a broad frame of

reference, a company should not solely rely on the

executive committee. Instead, a cross-functional

team of experts should consult and collaborate with

management. Diverse expertise will also ensure the

scenarios are credible in the eyes of the wider workforce

later in the process.

However, a common pitfall is involving too many

people in the early stages. The result is often the same:

scenarios so far removed from real-life situations they

are not precise enough to help decision-making.

At Storebrand, the iterative process between the

cross-functional expert group and the management

review team robustly defined the scope of the scenario

exercise, vastly improving the quality and usefulness of

the final scenarios. Picking a small expert group meant

all efforts could be concentrated on the scenarios, and

minimal time was spent co-ordinating proceedings.

By the time they were ready for a wider audience,

the scenarios had been rigorously challenged and

improved by the dialogue between the two teams. Upon

presentation, the scenarios were immediately adopted

and sparked fruitful debate.

‘Ask the audience’: communicating the scenarios The objective of scenario modelling is to be useful

during all phases of product development – from the

development process itself, through to marketing and

sales. This requires a strong common understanding

of the scenarios among people from many different

functional areas.

Scenario modelling

Scenario modelling is a framework for analysing

the main uncertainties about the future to help a

company make key decisions. Typically, it results in

four distinctly different descriptions of the future.

Strategies, product-design options and other critical

decisions can then be tested against the different

scenarios to evaluate their robustness.

Scenario modelling is distinctly different from

making prognoses, as the aim is to identify extreme

but probable futures. The analysis is primarily

qualitative but can to some extent be quantified.

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The key challenge is to convey the details of several

diverging scenarios. Textbooks recommend documenting

them as one-page stories, yet these still demand a great

deal from readers if they truly want to understand the

ramifications of each. Even more creative solutions,

such as producing fictional future newspapers, do

not address the mental challenge of comparing and

contrasting different scenarios. Our experience is that

the use of theatre and interactive plays can be powerful

aids to communication.

At Storebrand, a studio-based ‘TV debate’ became a

powerful communication vehicle. It comprised a host,

a studio audience and four expert panellists played

by carefully rehearsed Storebrand executives. Each

panellist became the advocate of a specific scenario

and, guided by the host during the 25-minute ‘show’, the

four of them passionately debated how different issues

would affect each possible future. Then they ‘asked

the audience’ their opinions: each audience member

voted with a special handset and the results appeared

immediately on screen – just like on TV.

The first debate helped an audience of 65 product-

development specialists question product-development

options against the scenarios. Subsequently, the TV

debate format was used in strategy discussions within

the Life division and at a meeting for 50 top executives

from across the company. As a result, a large number of

people developed an intuitive feel for the scenarios, and

could measure up the available options against them.

Power in numbers Product development often involves choosing IT

systems, deciding sales and delivery strategies and

calculating costs, market volumes and long-term

profitability. For these reasons, quantifying scenarios

greatly improves their usefulness.

Practitioners often resist quantifying scenarios – perhaps

to avoid equating scenarios with prognoses. In a scenario

modelling exercise, no one scenario should be seen as

more probable than the others. However, once you put

the numbers in, the temptation for some stakeholders is

immediately to calculate the average. For this reason,

it may be a good idea to seek advice beforehand, to

reduce the pressure to ‘average out’ the scenarios.

At Storebrand, quantifying some key indicators made the

scenarios much more tangible and useful. A fundamental

internal debate over a future system platform was

significantly advanced once customer volumes were

taken into account.

The corporate profitability model also benefited hugely,

as modellers ‘stress tested’ it under each scenario (see

Figure 1). This gave the top management new – and

sometimes surprising – information about possible

outcomes. The so-called ‘worst-case’ scenario did not

appear so bad when seen in the model.

Measuring market developmentIf a company decides on an option that will not thrive

under some scenarios, then monitoring how the market

develops is crucial. One solution is to employ a market

intelligence unit; gauging opinion through internal

surveys is another.

Storebrand decided to poll 50 of its leaders monthly

for their views of the market’s future direction.

Then, it reported the results in a newsletter, which

gave early warning of changing priorities and enhancing

the wider understanding of the scenarios. Leaders

200

180

160

140

120

100

802007 2008 2009 2010 2011 2012

Pro

fitab

ility

ind

ex

Scenario 1

Scenario 2

Scenario 3

Scenario 4

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completed the polls online, measuring each scenario

against the month’s news and research papers. Many

found this process fruitful, helping them to engage with

current events.

Storebrand’s chosen product design would have been

highly unsuccessful if one of the four scenarios were

to become reality. This scenario, initially thought so

unlikely it was almost removed, soon revealed itself to

be a real possibility. Thanks to the initial scenario work,

top management were able to immediately engage in

deciding what to do.

The results for StorebrandScenario modelling has helped Storebrand view the

recent extensive regulatory changes as an opportunity

rather than a threat. It has been key to its success in

becoming more competitive.

In 2006 Storebrand seized the largest market share

of the new Mandatory Occupational Pensions (MOP).

Then, in 2008, it increased its market share by 6%

compared with its closest rival with its new Defined

Benefit (DB) products (Q3 figures). In the MOP project,

the scenarios were built into the financial model,

giving information on vital decisions about pricing and

profitability. In the DB project, scenarios were employed

to help decide strategic and tactical issues, ranging

from product design, system development and process

changes to financial modelling.

figure �: The corporate financial model was stress tested against the quantified scenarios

PA perspectiveon insurance

12

Stepping up to Solvency II:

embracing the benefits in

the face of ambiguity

16

Wellness:

how can insurers get fit?

First edition 2009

“ As yet there is little evidence of a clash of cycles, but a perfect storm could be brewing, with a real tension between the need to lift rates and the need to reduce discretionary spend.”

David Batchelor EMEA Chief Executive Officer

Marsh

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Managing pension costs:

Nordic companies take the

lead in efficiency

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Opportunity amid the turmoil:

Marsh’s David Batchelor

comments on the opportunities

in a challenging market

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