Insurers can benefit from an audit of their outsourced claims arrangements, says Colin Heap

' As the use of outsourcing increases, there is a necessity for insurance companies to audit the performance of those acting on their behalf. This has intensified through the FSA's demand to have outsourcing audits completed independently.

After all, the cosy relationship which can exist between buyer and supplier may contribute to the decay of even the highest principles and standards.

Outsourcing companies win contracts on the basis of promises and conditions, which are well understood by all parties. But some struggle to communicate properly and, unless they are tightly managed, companies can let efficiencies slip and money can be lost.

Specialist auditors are now being instructed to review not only service providers' technical capabilities, but also the methods they adopt and the overriding culture, all of which may have a significant impact on insurers' earnings and profitability.

Typically, auditors discover if there is any control over third party payments, both in relation to indemnity spend and liability exposure.

Third party legal costs is a serious issue. In personal injury claims, claimant legal costs can exceed the amount of damages, so making sure these costs are controlled is vital. Auditors will attempt to quantify what saving can be made and how any savings can be measured and implemented.

There may also be issues involving services purchased by the outsource provider for the insurer. Some outsourcing companies have established relationships over many years with loss adjusters, solicitors, and others because there has been no regular competitive tendering. As a result, costs have risen, and so demand close auditing control.

Another area where mistakes are made is in reserves. When accidents happen, an instant reserve figure has to be arrived at. It is quite understandable that this figure is a hit or miss affair.

What is inexcusable is the failure to make necessary early inquiries to produce proper reserve detail. There appears to be a reluctance to pick up the telephone and speak to people who may have the information so essential to the reserving issue.

No claims outsourcing company is deliberately badly managed, but over time standards slip, expediency starts to rear its head and the workforce starts to find short cuts.

At a time when everyone is looking for cost cutting and increased margins, management telescopes are often put up to blind eyes. And if no one checks, who is the wiser?

Also, an audit of an outsourcing arrangement can show that the original formula has no professional or commercial merit and should be terminated.

We have found culture conflict where insurance companies with a hard-earned reputation of being fair-minded are employing companies who may be inclined to repudiate claims without legal foundation.

Traditionally, the claims auditor is seen as someone who comes on the battlefield long after the firing has stopped and bayonets the wounded. That is certainly not the new and preferred style.

The way forward is not only to highlight the problems, but also to highlight the positive and try to find a solution. That approach can only benefit the insurer, the outsourcer and hopefully the claimant.

An increased interest in claims costs and the management trend to retreat to core competency drives outsourcing.

It can also drive a cynical and corner-cutting culture, which unless checked and audited goes only one way.

Which is why more and more insurance companies even before the FSA made its demands were undertaking independent audits of their claims handling arrangements. IT

' Colin Heap is joint audit manager with Fitzgerald Consulting