By John P. Varricchio
Understanding when and where to seek new sources
As the soft insurance market and credit crisis continue to pressure margins and return on equity, insurance companies are looking to accelerate operational improvement initiatives. One such initiative is alternative sourcing. Many financial services organizations, including insurance companies, have already achieved benefits from outsourcing and offshoring traditional back-office functions, such as elements of IT and call centers. In a new wave of alternative sourcing, insurance companies are evaluating sourcing options for more complex tasks, such as actuarial support, billing and collection and claims adjudication.However, one lesson companies across industries have learned is that unexpected pitfalls can ultimately outweigh the benefits by disrupting internal operations, triggering unanticipated additional expenses, and eroding customer satisfaction and brand strength. As companies contemplate expanding or revising alternative sourcing, they need to understand and account for the associated risks. It is also crucial that they not only map out the initial implementation, but also plan for the management and maintenance of the program after a function is outsourced.
Strategic context of alternative sourcing
Alternative sourcing is still sometimes looked at as a tactical measure to reduce costs, but companies come to realize that alternative sourcing is best approached in the strategic context of pursuing longer-term strategic objectives.
Deciding to focus on specific market segments, or customer service, or operational excellence, or product innovation must influence sourcing strategy as much as acquisition and internal growth strategies. This is particularly the case with the potential sourcing of higher-value, less commodity-type processes that are integral to achieving a specific strategic objective but can carry additional risk. Longer-term strategic considerations must be aligned with the attractive shorter-term cost benefits.
Roadmap to success
Successful alternative sourcing requires a comprehensive lifecycle approach that links business strategy with candidate processes, functions, service provider selection and contract development. Companies with the best alternative sourcing experiences are those that take a disciplined approach throughout planning and execution and then follow through with consistent measurement of results. This exactitude must be applied to navigating the numerous choices surrounding alternative sourcing, including strategic alignment, operating models, vendors, locations and measurements.
A four-part roadmap can help companies execute a successful alternative sourcing strategy:
Concept: Insurance carriers embrace alternative sourcing for a variety of reasons, including cost reduction. Regardless of the specific driver, it is difficult to select a sourcing option without having clarity on the current baseline cost and service levels of the process or activity and the potential impacts of moving it to an alternative location. A business case is needed that lays out current costs and service levels. Activity based costing is usually helpful in determining the baseline cost structures for insurance processes, back-office functions and operational areas. This analysis also provides insight into the RFP vendor selection process and eventual service-level agreements (SLAs) and contract arrangements. Often overlooked is the cost of the new governance structure and associated future costs for the insurer to support the new sourcing model.
Plan: Prior even to selecting a vendor, a company must develop a front-to-end plan for how it will handle the outsourcing. This includes thinking through an organizational and outsourcing model(s) and approaches for the governance and management of the relationship, designing controls and performance metrics, and assessing technology and infrastructure needs. Particularly for managing sourcing activities within a business unit, it is important to establish roles and responsibilities at both the unit and corporate levels.
Transition: It is imperative to establish a seamless transition process as early as possible that first identifies the most likely top risks and then addresses the longer-term program management and risk management responsibilities. Vendors' experiences with other clients, practical guidance they offer for scoping the transition work, and transition support should be important considerations in selection. In the planning and transition phase, vendor personnel should spend time at the company meeting staff and learning about the culture.
Monitor: Internal controls and regulatory compliance checks are critical, but so are performance metrics and structured communications. Performance targets stipulated in the SLA must be built into the dashboards the company and its vendor use to monitor SLA compliance. Focusing on quality and continuous improvement is just as critical as tracking the direct and indirect risks that sourcing arrangements entail. While a company can move work to other locations, the ultimate responsibility for quality and risk remains within the organization. Eyes wide open
While the potential benefits are compelling, it is crucial for insurers to understand the risks of alternative sourcing so they can successfully reap the rewards. Companies must ensure their sourcing strategy utilizes a comprehensive lifecycle approach that allows insurers to align and support their strategic goals.
John P. Varricchio is a Principal in the insurance sector of Ernst & Young LLP's Financial Services Office. He is based in New York City and can be reached at +1 212 773 7645While the potential benefits are compelling, it is crucial for insurers to understand the risks of alternative sourcing so they can successfully reap the rewards. Companies must ensure their sourcing strategy utilizes a comprehensive lifecycle approach that allows insurers to align and support their strategic goals.