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The Actuary The magazine of the Institute & Faculty of Actuaries

Real options in IT management

Heavily dependent on information technology, financial services firms globally spend over e235bn on IT, representing – for large banks – 15% to 22% of their overall non-interest expense. Unfortunately, their investments too often fail to generate anticipated returns – and worse, many firms do not even know which are paying dividends and which are losing money. In fact, benefits realisation data was available for only 31% of those interviewed in a recent study initialised by ING and executed by IBM. Compounding the problem, few firms actually reserve funds as a contingency for projects that exceed their budgets, though there is a compelling need to do so. The repercussions can be considerable, as evidenced by one study participant whose projects, on average, ran more than 60% over budget. With so much at stake, financial services CIOs need a more effective way to manage IT investments – and the clues may come from the firms’ asset managers down the hall.

For decades since Markowitz, Miller, and Sharpe first began publishing their complementary Nobel Prize-winning theories in the 1950s, financial services firms have applied portfolio management concepts to reduce risk and improve returns on invested assets. More recently, progressive firms have turned to those same basic concepts to significantly enhance the performance of their IT portfolios, particularly important with the spotlight Basel II has put on returns and efficiency. IT ‘portfolio management’ takes a holistic view of IT projects across the enterprise, evaluating proposals against the firm’s strategic objectives. More conservative investments compensate for riskier ones, thereby lowering the overall reserve requirement – for study participants, reserves could be reduced by up to 55% of total project budgets.

For more on this rather actuarial approach to managing IT investment, see www-1.ibm.com/industries/financialservices/doc/content/bin/fss_bae_IT_management.pdf