Does outsourcing make sense?

In one sense, outsourcing is a longstanding and crucial part of the insurance industry. Look no further than brokers: aren't they an example of an outsourced distribution mechanism?

But beyond that, the UK insurance industry demonstrates typical British reserve compared to the US when it comes to outsourcing. Indeed, UK business in general is lagging behind its US counterparts in embracing what some have described as the ultimate executive tool.

Royal & SunAlliance (R&SA) strategic supplier director Andrew Turner describes himself as "quite cautious" when it comes to outsourcing, saying that he is determined not to be "slavish" to it. "There are many pitfalls".

This attitude is reflected in research by independent analyst Datamonitor, entitled Claims management in UK general insurance. The report, published in January 2003, looked at the issues of outsourcing in the claims process and found that "most insurers are still asking themselves if outsourcing is the right option for them".

The report concludes that while there is no right or wrong answer for the industry as a whole, there was a clear split between the larger insurers and the smaller ones. The larger insurers tend to retain the service in-house, while the smaller ones choose to outsource. The reason for this, says Datamonitor, is that the larger companies feel that claims management is a core competency and that they have the capacity and skills to manage the work. The smaller insurers tend to focus on underwriting, and see claims as non-core; they use outsourcing to control costs and to maintain customer service.

But even smaller insurers like Groupama are not rushing into outsourcing. Corporate services director Paul Picknett says that the company's experience of outsourcing has been "mixed".

"At present we outsource only asset management [the placing of company capital into bonds]. We did outsource claims handling, but brought it back in-house for service reasons. The service provider was more interested in volume than keeping claims costs down. It was a learning experience."

Picknett says that the insurance industry still has a lot to learn from other sectors when it comes to outsourcing. He points to companies like Dell, which outsources extensively, creating "virtual" centres where all business processes are handled by third parties. "The insurance industry is not that smart yet," he comments.

Hesitant industry
Why is the industry hesitant about embracing outsourcing? Historical reasons, says Tony Barker, director of marketing, UK financial services, at IT service provider CSC. He says that the industry has been at the forefront of adopting and developing processes and systems, such as IT, and as such is used to doing the work itself.

There is also a feeling among some companies with large, established departments that they have the skills to do the job. Churchill, for instance, keeps most of its operations in-house for this reason. "We feel we can do the job better than an outsourcing company and we want to remain closer to our customers," says a spokeswoman.

The way insurance companies view their operations also plays a part. Outsourcing is seen as a way to allow companies to concentrate on their core operations, by using third parties to provide non-core services. Whether a company treats a particular function as core or not will affect its decision on whether to outsource it. Some argue that underwriting is the only core function of an insurance company, and that all others are ancillary; others take a broader view of what is core.

Picknett says: "Insurance companies need to be very concerned about what they consider to be core competencies. We used to outsource claims and found our claims costs rising - managing claims is a core competency."

Critical operations
Barker says that many operations are seen as critical and insurers are concerned at what might happen if they give them to a third party to run. "It's like saying, 'Here's a bag of money. I don't know you, but look after it'."

Nevertheless, outsourcing provides numerous benefits. Cost savings, the ability to focus on core competencies and access to the best skills and practices are the traditional reasons for outsourcing.

Certainly, the cost savings can be considerable. For instance, outsourcing call centres can achieve cost savings of up to 40%, says Adam Husbands, client development director at contact centre provider iSky.

"People don't look at the true cost of insourcing. There is more than just the cost of the people on the phone; on top of that there are the managerial overheads and the infrastructure costs." And Barker suggests that savings of 30% would not be unusual if IT were outsourced.

The flexibility that outsourcing offers a company is also a key driver, says Picknett. "Cost is an attraction, but it is about scalability and flexibility. It is about moving the organisation up and down.

"For instance we wrote Saga's motor book - a big book of business. Outsourcing enables us to scale down if we lose business and to increase operations without too much pain if we gain business."

But these are short-term tactical considerations. The new way of thinking is to see outsourcing as a strategic tool, says Shaun Purrington, director of receivables management at credit management company Gerling NCM.

"Companies are asking themselves whether outsourcing is a strategic issue or whether it is a tactical short-term problem, solving solution for reducing costs. It is currently seen as the former - businesses are wanting to free-up time to make strategic decisions," he says.

Strategic operation
There are a number of ways in which outsourcing can operate at a strategic level. First, it can reduce exposure to operating risks that might prevent a business from operating, for example a dependency on limited skill set. It can release capital - assets such as equipment and people - that must otherwise be retained in the balance sheet.

Second, it can assist managing industry issues such as FSA compliance. "The outsourcing company takes responsibility for compliance, taking the burden off the customer who merely has to ensure that the service company is capable of complying," says Barker.

And Purrington suggests a third way - to use outsourcing as a tool for business transformation. This assists the business to develop and adapt to future needs, and is a developing trend, he says.

"One example would be where a company is looking to launch a new business venture, but doesn't have the infrastructure," says Purrington.

Outsourcing can help to achieve transformational change, such as when outsourc-ing IT. It avoids the internal resistance to change that can arise in an organisation. People may want to protect their own interests and may not see the bigger picture. Outsourcing companies are not bound by the same emotions.

Business processes
A further trend is to outsource entire business processes, such as human resources or accounts. Figures from analyst Nelson-Hall estimate that in 2002, the UK business process outsourcing (BPO) market was worth £15bn, growing at about 45% over the previous year.

The attraction of BPO is that it amplifies the benefits that outsourcing only part of a process provides.

Dye says: "If you outsource part of a process, you never get the efficiencies that can be achieved from outsourcing the entire function."

The increased benefits gained from outsourcing a process mean that companies wishing to make strategic gains from outsourcing should look to BPO. It allows businesses to concentrate more fully on core processes and provides increased flexibility. It also enables a company to change and grow more quickly and can provide a quick way to build a market position.

An example of the strategic use of BPO is provided by Swiss Re. It has been acquiring direct insurance companies and closed books of business in the US, and has chosen to outsource all non-insurance processes to CSC.

"The company decided it was more effective and efficient to outsource business processing and IT to a third-party," says Barker.

Where are these developments leading? The US is at the forefront of this new way of thinking. Companies such as Nike, Microsoft, Dell and Tommy Hilfiger have outsourced vast swathes of their businesses. "These companies are looking at BPO in more radical ways. The whole business dynamic is changing," says Purrington.

"Companies are looking at what they really do well and are outsourcing everything else. Nike has outsourced everything except brand, and sales and acquisition. And Tommy Hilfiger has decided that its assets lie purely in its brand."

The natural conclusion to this way of thinking is the "virtual" company: a company that outsources all business functions save strategy.

But while BPO is developing rapidly in the US, it is still embryonic in the UK insurance industry. PRI finance director Michael Walton says: "The industry is not very sophisticated when it comes to BPO. This is down to uncertainty, the fear of losing control. They want evidence that this won't happen."

But he says that this fear is misconceived. "Provided clear parameters are set, with appropriate reporting, auditing and benchmarking, then control will not be lost."

But Srinjay Sengupta, head of Europe at IT service provider Infosys, warns that control can be lost if a company outsources too much, such as IT strategy, governance and architecture. "Many companies have outsourced, then 'insourced' because they have done exactly this," he says.

Datamonitor financial services technology analyst Anders Maehre says that BPO providers themselves are partly to blame for this poor level of acceptance by the insurance industry.

"The providers have failed to communicate successfully the benefits of BPO. They will say that they have an excellent platform and that they have the capability to take on staff and cut costs," he says.

Clearer explanations
"But instead of being encouraged by this, the financial services industry is actually sceptical. The way the message is communicated lacks credibility. Many financial services companies think that what the providers say cannot be done, or that they can do it better in-house," Maehre explains, saying that the providers are trying too hard to differentiate their offerings and are failing to explain their core services.

Should the insurance industry outsource more? Barker argues that all context activities should be outsourced.

"These are the non-core processes that fulfil a company's commitments to its stakeholders, support its business, and maintain any standards that everyone in the industry must achieve.

"They do not create value because they do not create an advantage, nor sustain any proven advantage." Barker cites examples such as asset management, HR and even claims.

"Core processes, on the other hand," he says, "are those that contribute directly to producing an organisation's competitive advantage and improve its ability to sustain this advantage over time."

Barker says that identifying which insurance industry activities should be considered core and which are context has sparked much heated debate over the past few years with no real consensus yet emerging. But he argues that as much as 80% of current processes could be outsourced.

He also argues that increased outsourcing would make the insurance industry more profitable. He says that core activities provide the greatest return on capital and as such a business should focus on these and cease non-core functions. "If it doesn't do this, it will open itself up to new and different competition from companies who are more agile and able to do things better," he warns.

Certainly some sections of the insurance community are bucking the trend and starting to think this way. Start-ups like Axis and PRI have outsourced a wide range of business functions as a way to build a market presence quickly, tapping into established skills and infrastructure.

Adjusting controls
PRI has also taken a hard look at what it considers to be its core competencies and has outsourced most functions, including marketing, claims processing, HR and investment management. "We are interested in underwriting and not in back-office processes. We want to concentrate on this area," says Walton.

These companies demonstrate how easy it is, using outsourcing, to enter a market and compete with established companies. Good news for brokers and policyholders, but insurers should be concerned.

Of course there are dangers in outsourcing to these levels. "You need to have the right partner and level of control," say Purrington.

"There is a danger of losing sight of the customer. It is easier to have a virtual company in consumer goods markets. In intangible goods, like financial services, service is so much more important."

Outsourcing offers many benefits and outside the insurance industry many companies are using it very successfully as a way to develop and achieve strategic goals.

These ideas are slowly filtering down to the insurance industry, with a number of companies leading the way.

Is it time for the rest of the industry to take note?

Ten reasons to outsource
1 Reduce and control operating costs

2 Improve company focus

3 Gain access to world-class capabilities

4 Free internal resources for other areas

5 Resources are not available internally

6 Improve efficiency of non-core functions

7 Address the problem of a function that is difficult to manage, or is out of control

8 Make capital funds available

9 Share risk

10 Receive cash through sale of assets to service provider.

[Source: The Outsourcing Institute]

Why are insurers reluctant to outsource IT?
The insurance industry has been slow to outsource IT. It was an early adapter of computing and has been used to doing everything itself. Also, the IT departments in many financial services organisations are very big, which means there has been some resistance to change.

"There is also a fear factor," says Tony Barker, CSC director of marketing, UK financial services. "IT is a critical operation in financial services. And they may also believe they can do it better. It depends on how well they are organised."

Another factor is that some of the older outsourcing deals may not have gone as well as companies had hoped, says Datamonitor financial services analyst Anders Maehre.

But despite these fears, the IT out-sourcing market is developing well in financial services. The infrastructure outsourcing market - relating to networks and date centres - is maturing and represents 56% of the total financial services outsourcing market, says Maehre.

The application outsourcing market - incluing companies like Sirius that provide and maintain software - is also developing rapidly.

"Given current economic conditions the cost benefits of outsourcing IT have become a very attractive proposition," says Maehre.

He predicts a compound annual growth rate of 7.5% for infrastructure outsourcing and 7.8% for application outsourcing - a large growth, given that overall technology spend is estimated to rise by only 2%.

Cost has been a major driver in company decisions to outsource, but Maehre says that business strategy should be a more important consideration, particularly given the interest in business process outsourcing (BPO).

Maehre says that if businesses wish to obtain the full benefits of BPO they will have to make substantial investment in IT systems and infrastructure.

"The IT aspect of BPO is going to be very important. If a company doesn't want to change its systems, it will achieve only limited gains. If it wants to make a groundbreaking shift it will need to change IT platforms."

IT outsourcing is also important outside BPO. One example, says Ron Drake, managing director at service provider eFunds, is as a way to solve the problem of multiple 'views' of a customer - where a company has client details on a number of different systems. An example would be in bancassurance, where the bank may have banking details and separate insurance details.

Obtaining a single view requires a lot of changes in business processes, and many insurers have old legacy systems, says Drake. Outsourcing companies can help replace and integrate the systems.

Sections of the insurance industry are leading the way in these areas. Software development company Riskclick chief technology officer Anthony Siggers says: "Some of the stuff that the insurance industry is doing is very innovative, for example collaboration, the sharing of processes across organisations, such as Project Blue Mountain and Xchanging."

The success of these projects will be very important in shaping how the insurance industry views outsourcing.

"The relative success of an individual deal has a big impact on the market," says Maehre.

"If projects are successful we will see increased take up and a change in attitude."

How to outsource successfully
A recent report by analyst Gartner Dataquest estimates that 50% of strategic outsourcing deals fail in the first 18 months. A worrying figure, since a failed deal can have serious consequences, not least for the client company who can find their customer service seriously affected.

So what can be done to ensure success?

Srinjay Sengupta, head of Europe at IT service provider Infosys, says that contracts fail because the objectives are not clearly defined. "A company needs to ask why it is outsourcing - what are its goals and its strategy? Outsourcing is not a quick fix.

"Choosing the right partner is also important. Cheaper is not always better. The contract also needs to be flexible to accommodate change and there must be an exit strategy if things go wrong."

CSC director of marketing, UK financial services, Tony Barker says: "Provided everyone understands what is to be achieved it will work. It won't work when expectations differ from what is actually delivered. It is easy to promise things, but both sides must perform.

"The hallmarks of a successful contract are an open partnership, flexibility on both sides, and a clear understanding of what it is that both parties want to achieve. There must also be clear criteria that can be measured."

Philip Allery, associate at law firm Putsman.wlc, says that many contracts fail because companies rush into them too quickly.

"These are long-term agreements which take time and money to set up. You need to take time to get the detail right. If you go about it too quickly things go wrong."

He also warns against a client company divesting itself of all responsibility for an outsourced function. "There is a perception that you can do this, but it won't work if you do," he says.

Allery suggests four key points to a successful outsourcing contract:

1. Plan the process - have a realistic timescale, plan for some overruns, have a project plan and a project manager

2. The schedule - outsourcing contracts have two parts: the main terms and conditions; and the schedule

The schedule is a key part of the contract. It describes the service - exactly what is to be expected - and the service levels. The schedule must be detailed enough to make sure things don't go wrong. There must be someone responsible for producing the schedule and it must also be completed prior to signing, as problems can arise after signature if people's expectations differ

3. Liability issues - both sides need to be realistic about liability if things go wrong. For a supplier it is unrealistic to try to get away with low levels of liability in a long-term high value contract. A supplier cannot expect to have a liability of x if the contract is worth many times that. From a customer's point of view, no supplier is going to agree to unlimited indemnity for every possible contingency. Try to get liability issues out of the way early in the negotiations, otherwise it can cloud everything else

4. Over a long-term agreement, change will happen, in terms of service requirements, size of the client company and so on. There needs to be a mechanism to support this.

When claims are outsourced
Claims is the area where the industry's traditional views of outsourcing are being most heavily challenged. Traditionally seen as a core function, insurers are now considering outsourcing the entire process.

Capita Insurance Services managing director Bill Dye says: "The claims process used to be very dear to insurers' hearts, but total outsourcing enables them to achieve greater benefits than merely outsourcing part of the process."

Dye says this may be particularly attractive to smaller insurers, as they may not have the size and capabilities to provide an effective claims service. But he adds that he knows of some larger insurers who are also considering it.

MMA has outsourced both household and commercial lines claims to loss adjuster Cunningham Lindsey. The loss adjuster provides a branded service to MMA policyholders.

"We are not a large operation," says MMA claims manager Bob Still. "We decided to outsource to someone who could provide large economies of scale and experience."

Still is not concerned about loss of control. "I can understand the fear. The important thing is to manage the relationship. If you build up trust, loss of control should not be an issue."

Cunningham Lindsey director of home services Mark Henderson says the arrangement provides a number of benefits. "It is clearer to the customer, as there is a single point of contact throughout the life of the claim. It is cost-effective and it removes duplication of records."

But not all insurers see it this way. Allianz Cornhill for instance outsources only the initial notification stage of the claim process. Claims manager Lesley Proctor says: "We chose to outsource this part because of the different skill set and IT infrastructure requirements. The remainder we kept in-house as we felt we could do it better."

Proctor acknowledges that cost savings can be achieved through outsourcing, but says these often come from savings on infrastructure and personnel, and may be at the expense of rising claims costs.

This was a problem that Groupama found when it outsourced its claims function. The insurer found that the service provider was more interested in volume than keeping claims costs down.

The service providers' response to these issues is that provided the controls are in place and the contract is managed, well there should be no problem. But insurers will be keeping a close eye on these projects. The industry is going to take a lot of persuasion to let go of one of its sacred cows.

When it goes wrong

The project was originally expected to cost £146m, but the final cost was expected to be more than double at £390m. Fujitsu risked bankruptcy and a new supplier had to be brought in.

Critics said there was a failure to understand the costs and scale of the project and that the LCD had mistakenly believed it could abdicate all responsibility for the project.

The project was beset by technical problems, leaving a backlog of over 12,000 applications and the prospect of schools having to delay the start of term. Capita said it failed to forecast the number of applications made by post, rather than phone. It was forced to send paperwork to India.

The government threatened legal action against Capita.