The trend towards outsourcing to low-cost countries is here to stay, say Philip Allery and Jonathan Willetts. But there are some issues to watch out for

Distance workingThe phenomenon of outsourcing to low cost environments is a hot topic, but it is not new.

Throughout corporate history, the desire to improve profitability by using low cost environments is well documented.

What is new is the growing demand for back-office or business processing outsourcing (BPO) services from countries like India. This demand has been facilitated by the revolution in the availability and cost of technology required to run these operations.

Evidence of the use of this technology is clearly demonstrated by the numbers of call centres which have been set up in India servicing both US and European customers.

Issues to watch
Outsourcing by the insurance sector has a number of additional legal issues that need addressing.

1. Data protection
The Data Protection Act applies to processing of personal data of individuals.

  • Does the data subject consent to the processing in this way?

    Since the outsourcer only processes the data as the alter ego of the data controller it can usually be implied that the data subject would consent to this;

  • Does the data subject know where and how his data is being processed? It will be necessary to inform him that third party processors are being used. Suitable statements in contracts with customers will need to be prepared;
  • Is the country where the processing of the data is taking place `adequate'? Data may not be processed outside the EEA (and other approved places) unless the data controller makes an adequacy assessment. This is done in conjunction with an assessment of the outsourcer's financial strength, security provisions etc; and
  • Insurers handle a considerable amount of `sensitive' data particularly relating to health and convictions. The processing of sensitive data requires `explicit' consent. The nature of the processing will govern the extent to which any explicit consent will be required.

    2. Regulation
    The Financial Services Authority (FSA) already has rules for many sectors functions and which need its prior approval.

    The FSA is creating a similar regime for the insurance sector. These requirements will have to be factored into the documentation and the project timetable.

    3. Governing law
    English law/courts should be provided for agreements with UK companies wishing to outsource. In the event that enforcement of a judgment is required, most countries in the outsourcing arena have reciprocal enforcement arrangements with the UK.

    If arbitration is used, most outsourcing countries are parties to the New York convention on enforcement of arbitration awards. Many UK companies will seek parent company guarantees if there is an appropriate company in the UK or EU.

    4. Tax
    Direct tax issues in terms of a UK company having an overseas tax presence do not usually arise. However, reverse charge VAT is an issue for companies in the financial services sector that already have low VAT recovery. If the services are structured correctly, this can be minimised and possibly eliminated.

    5. Employment
    TUPE is not usually an issue, but union consultation must be taken into account.

    Although there will often be redundancies, a frequent byproduct of outsourcing overseas is that people can have a greater role in the management of the outsourced operation or become free to pursue other opportunities within the organisation.

    Here to stay
    The outsourcing of insurance non-core activities is here to stay. Outsourcing to overseas low cost environments to reduce unit costs while maintaining quality is proving successful, but requires careful consideration, planning, implementation and management.

    Often the most important question that management needs to ask itself is does it really want to do it?

    The success of such initiatives is often down to the appetite of management to take advantage of the opportunities that are available.

    Philip Allery is a solicitor with Putsman.wlc. For further information call 0121 237 3000

    Jonathan Willetts is a chartered accountant and the founder of the Magellan Group.

    For further information call 0065 96359212.

    A potted history of BPO
    BPO is the transfer of any part of the current support or back-office functions of a company to a subsidiary, joint venture or third party. The theory is that there are significant benefits to be gained by outsourcing these non-core activities to an organisation that regards them as their core competencies.

    These benefits include cost and the release of both capital and management time.

    Why move BPO to a low cost country?
    The key driver is cost. Salary differentials in some of the locations mentioned above can be as much as 60% to 70 % lower.

    These differentials can be even greater when you consider the cost of a qualified actuary or accountant.

    However, cost is not the only consideration and there are examples where significant quality and efficiency benefits have been derived from sourcing the work from these countries.

    Could insurance companies consider moving BPO to low cost countries?
    If you take those processes that require critical intellectual capital and so provide competitive advantage, why not?

    In fact many US and European insurers such as AXA, GE Capital, Royal & SunAlliance and Willis are already outsourcing part of what they regard as being non-core activities to India, China, Mexico and the Philippines. The processes that have been outsourced include:

  • Call centres
  • Accounts payable
  • Financial accounting
  • Credit card management
  • Reinsurance administration
  • Management information
  • Claims management
  • Data administration and maintenance
  • Credit control
  • One-off reconciliation projects

    What have their experiences been?
    Generally their experiences have been favourable. The benefits they expected to receive in relation to cost were realised quickly, though the quality and efficiency gains took longer to come through.

    These are often difficult to quantify as often there is no information on how well the process was performed before it was outsourced.

    If these are the experiences of these companies why is BPO not more widely used?

    It almost seems to good to be true. There is a tool out there that can reduce unit cost while maintaining or even improving quality and efficiency. So if it is so easy why is it not more widely applied?

    Although undoubtedly these benefits can be achieved there are certain legal, regulatory, cultural and operational issues that need to be overcome.

    Cultural differences
    Undoubtedly a cultural barrier exists for many companies that have trouble letting go of direct operational control of part of back-office functions such as accounting. Added to this is the thought of allowing this to go overseas and to a country that has a considerable time difference.

    A pilot is a good starting point for addressing this issue as it allows management to evaluate the concept and also establishes a framework for any further outsourcing.

    Modes of operation
    One of the advantages of BPO is the ability to obtain a 24-hour service from the outsourcer. This may require some readjustment both in terms of work practices and systems availability in the home office. These can often take time to implement.

    There will also be periods in the early stages when the operation does not go as planned. This transition period should be carefully planned.

    In addition, post-implementation management potentially requires very different skills from those needed to run an internal service. This should also be factored into the plan.