With apologies to Sebastian Junger, 2007 has been a "perfect storm" for software vendors. Several conditions have come together to create this major buying wave. These conditions include:

o Carriers generally have made money over the past few years and thus have more money to spend on IT in addition to making other investments.

o The business pressures to deploy on the Internet, offer better service, support product innovation, and create actionable business intelligence have become overwhelming.

o The Y2k hangover (remember Y2k?) finally is a distant memory. Y2k affected IT investment in two major ways: first, by draining the IT budget in order to make all the then-current assets Y2k compatible. This should have been a relatively short-lived effect but for the fact many carriers effectively were forced to spend money from future budget years in order to complete their Y2k compliance projects on time. Second, the focus and scrutiny that was placed on the entire legacy code base made insurers realize replacing core systems is a complex task and also the legacy systems represent a huge and valuable asset base.

o A series of vendor failures and implementation horror stories from the earliest years of the century also are a thing of the past.

o New vendors with superior software have proven to be real, not Memorex.

o A new generation of executives, arriving from outside the industry, have demanded better systems, information, and technology support.

To follow up one of the points raised above, there is a new breed of software vendor in our market space, and we should be glad about it. These new kids on the block differ from the legacy vendors in our market space in some important ways.

These newer companies are led by technologists who first and foremost believe in the power of technology to solve and automate complex problems. This is a reversal of the "traditional" vendor model, where domain expertise came first and the software came second. Simply put, technologists build better software than insurance people.

The new generation of software developers is just flat out better than its predecessor. It's not only that the languages, development tools, and engineering disciplines are better, which certainly is true. Nor that developers are better trained than they were previously, which also is true. My point is that recently the insurance vertical has started to attract a higher caliber of developer than it ever has before.

The new generation of software these vendors are writing is better architected and built than prior systems and holds significant potential finally to deliver flexibility and responsiveness to an industry that is hobbled by the constant and ever-changing need to respond to market and regulatory pressures.

The new vendors are building tools and templates that form the basis of rapidly implemented, client-tailored application solutions. The new generation of applications is built from rule sets and configuration toolkits that are used to define client-specified insurance products and processes with minimal, if any, programmer involvement.

Another defining mark of the new generation of vendors is it employs agile methodologies for both its own development efforts and also for client implementations. The traditional "waterfall" approach has been replaced with rapid, iterative development techniques that not only reduce project risk but lend themselves readily to the type of software being deployed. Short-duration build cycles that produce nontrivial, verifiable results are only possible if the software being used supports rapid development because of its flexibility and power.

Some of the most successful vendors in our market in 2007 have been "legacy" players. How can this be? Well, different carriers are looking for different solutions and frame their problems differently. I have advised clients for years that when it comes to vendors they have to choose between technology and functionality because they will not get both. While this is less true than a few years ago, it still is true.

The legacy vendors still have some compelling advantages compared with the newbies, including:

o Deep domain expertise.

o Mature business functionality that was won over the course of numerous client implementations.

o Value-added services, such as rate, rule, and forms maintenance.

o Established outsourcing options.

However, the gap is closing rapidly, and market sentiment is changing. Increasingly, carriers are concluding flexible, open, service-oriented architectures and strong functionality are not mutually exclusive. When such a change in sentiment occurs, the market can shift rapidly. Consider what has happened in the claims administration arena in the last few years. In terms of new sales, that market now is dominated by a vendor that was not even on the radar screen five years ago. The same phenomena almost certainly will occur in policy administration, but it will be less rapid because the stakes are higher and the implementations take longer. The midterm to longer-term problem for the legacy vendors is their core assets are P&C applications that are very large and very complicated, running to millions of lines of code, much of which is badly architected, poorly written, and largely undocumented. However, the good news for the carrier base is twofold. First is the evolution of these new vendors and their superior software and execution capabilities. Second is the fact the legacy vendors generally have raised their game in order to compete.

I get the sense carriers are getting better at selecting and implementing core insurance systems. As much as anything, I base this on a lack of data–that is, a lack of disaster stories circulating in the industry. I know of one carrier that, in the rush to do too many things at once, made an inappropriate PAS selection. However, in that instance, a failed proof of concept saved the day and avoided a costly implementation debacle. I think this story is instructive. Carriers are getting better at recognizing and mitigating the risks inherent in major software acquisition and implementation projects. More carriers use proof of concept, pay for performance, and other incremental commitment mitigators to control the greatest financial and operational risks.

A trend that has been cemented in 2007 is the shift away from the "all or nothing" upfront commitment that used to be the standard model for software deals in our market. Until quite recently, it used to be the basic structure of a software deal was: For the carrier, all the financial risk was front-end loaded and all of the benefit was back-end loaded. This meant, of course, any carrier finding itself in an implementation that was heading nowhere already was so deep in the hole financially the idea of killing the project seemed unthinkable. All this did in most cases was further enrich the vendor and deplete the carrier by unnaturally extending the revenue stream associated with an already doomed project. This has changed for the better. Most vendors now will volunteer a pay-for-performance contract that obviates the worst financial excesses. It's not clear whether this has come about because the carriers got smarter or because the vendors got fairer or, as I suspect, a combination of the two.

All the signs are 2008 largely will be a continuation of the generally positive trends seen in 2007 for both vendors and carriers. The underwriting cycle looks to have turned again into a softer market, which in time will bring IT budgets under (even) greater scrutiny. Whether this will directly and negatively impact IT spend is an open question. Certainly the vendors are not reporting any weakening of interest by the carriers, and the carriers are not reporting significant budget cuts. One change that appears permanent and will ameliorate the effects of the industry's profit cycle is the fact it now is an article of faith among carriers that there are few significant business improvements possible without technology and also that technology really is a potential differentiator.

The year ahead promises to be another interesting one. I look forward to sharing it with you. Happy New Year.