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Thumbs Up on Outsourcing

Ernst & Young's Doug McPhie discusses how life insurers are finding that outsourcing can increase shareholder value by cutting costs and boosting efficiency.

By Doug McPhie

A properly structured and managed outsourcing arrangement has a positive impact on shareholder value, according to a recent Ernst & Young study, while an improperly structured arrangement can have the opposite effect. This finding is corroborated by the conclusions reached in a Morgan Chambers study of 100 FTSE companies in the UK which showed that the announcement of a mega-outsourcing deal resulted in a 5% sustained increase in share value over companies that did not use outsourcing. Another study by U.S. analyst Stern Stewart produced similar results.

However, despite the demonstrated linkage between outsourcing and shareholder value, Life insurance companies historically have lagged banks and other sectors of the financial services industry in the extent to which they engage in outsourcing. Another UK study indicated that the banking industry accounted for 35% of the total value of outsourcing contracts for business processes in the UK, while the life industry represented only 5% of the total.

Picking Up Speed

Now that may be about to change. Over the past year, the trend toward outsourcing in the life industry has been growing, with major deals occurring in North America, Europe, and Asia. Since the beginning of this year, Manulife Financial, Canada's largest life insurer, has announced the outsourcing of its North American IT infrastructure management to IBM, and Sun Life of Canada has agreed to have Marlborough Stirling handle the policy administration of its 800,000-policy UK business. Last year, Abbey Life announced a similar deal with Unisys for its 1.5 million life policies.

John Mather, chief information officer of Manulife, cites four main reasons why the insurer has entered into its partnership with IBM: to provide IT depth and flexibility for future mergers and acquisitions, to provide resource flexibility that will allow the insurer respond to the peaks and valleys of IT demand resulting from the rapid development of new products, to create a top-flight IT back office, and to drive cost savings.

Outsourcing is often viewed as falling into two categories. The first category, information, communications and technology (ICT) outsourcing, encompasses IT operations, development, infrastructure, and networks. The second, business process outsourcing, can include back-office operations for group, individual, finance, investments, human resources, and other operating areas. Providers such as Cap Gemini, CGI, EDS, and IBM all offer solutions in both of these areas for many industries, while other companies specialize solely in the life industry.

Historically, North American life insurers have used outsourcing only for minor business processes, or for new processes that lack an existing administrative infrastructure. However, as the recent announcement by Manulife and other companies suggests, the trend is shifting. And while IT is often the first place where life companies outsource, the bigger opportunity may lie in the area of business-process outsourcing. The incremental gains that come from internal management of business processes may be neither big enough nor achievable quickly enough to produce the kind of dramatic process improvements that senior management is looking for today.

Core Versus Noncore Processes

The Ernst & Young study found that financial services firms increasingly view outsourcing as an integral part of their strategy to save money and boost the bottom line. As a result, they are now willing to outsource activities once regarded as sacrosanct. Is policy administration one of those activities?

Most of the life companies we have spoken with say they have not given serious consideration to outsourcing some or all of their policy administration processes. They question whether outsourcing policy administration can reduce costs. They also maintain that insurance products, systems, and interfaces are too complex for outsourcing providers to manage effectively, and that policy administration should not be entrusted to a third party because it is a core business process. How valid are these concerns?

In the life insurance industry, we believe that product design, marketing and distribution, policyholder service, underwriting, and risk management are the key areas where life companies compete through differentiation. While many life companies attempt to differentiate themselves through outstanding policy administration, the marketplace recognizes only a few. Policy administration does touch the customer, but for many companies the goal is to deliver service at the lowest cost while meeting a minimum base line of quality. This makes policy administration a prime candidate for outsourcing.

Liberty Insurance Services, a U.S.-based third-party administrator owned by Royal Bank, currently provides policy administration outsourcing services, from underwriting to claims adjudication, for more than four million policies issued by a number of life insurers. Among those companies is Fortis Family Life, which decided to outsource the administration of its more than one million policies some years ago.

Doug Donivan, senior vice president, notes that Fortis uses Liberty for most of its policy administration activities, from initial application to claims payment. Other processes, including the product development, distribution, actuarial, and corporate reporting, are still handled in-house. Essentially, the policy administration process has been changed from being a back-office operation at Fortis to being a front-office operation at Liberty.

Policy administration in its broadest sense covers all stages of a policy life cycle after the policy design, marketing and sale processes (see exhibit).

Routine internal transactions are obvious candidates for outsourcing. More sensitive are those with a customer interface, such as the call center. Can a provider's call center deliver the depth of knowledge needed to handle for what can be a large portfolio of highly sophisticated products, and can the provider be given the right empowerment to resolve customer problems appropriately?

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