Product Complexity and Interfaces
Policy administration involves complex products and systems, and complicated interfaces between these systems. Products can range from simple term policies to sophisticated variable universal life policies. Systems interfaces include linkages between underwriting, policy maintenance, commission, reinsurance, call center operations, cash management, claims adjudication, billings and collections, reserving, and accounting.
Outside providers typically have the systems and processes to support the most complex products and can provide seamless interfaces back to the life company's in-house systems, supported by real-time, daily, weekly, or monthly connections.
Fortis believes Liberty is successfully managing the complexities of its products, according to Donivan. Interfacing between systems is not an issue, he says, because there is a seamless interface back to the insurer's own accounting, reserving, and investment systems through extracts between Liberty's systems and those at the insurer.
However, multiple products and interfaces, together with the long life of policies, result in another major complication: system conversions. The applications supporting policy administration must support a range of products whose life cycle can exceed 50 years. Often, the systems applications are home grown or are modified versions of commercial applications. Given the life span of insurance products, it is inevitable that they will need to go through several systems conversions throughout their life cyclean expensive and risk-prone process.
Adding to the complexity is the acquisition of companies or blocks of business that can result in a life insurer's maintaining multiple systems applications. Insurers often elect to maintain multiple applications rather than incur the costs of conversions. However, multiple applications mean multiple support processes, such as reprogramming each application for a change in tax law. Outsourcing removes these issues, and outside vendors claim that they often can complete conversions more quickly and at less cost than the company would incur in doing a conversion itself.
Substantial Cost Savings
There is some skepticism in the industry about an outsourcer's ability to provide services at a cost lower than the life company itself can achieve. However, Manulife's John Mather reports that the savings his company realized from its outsourcing deal with IBM exceeded what the company anticipated when it first began examining outsourcing opportunities. He estimates the seven-year deal will result in a 30% savings on the $1 billion Cdn it would have cost Manulife to continue to manage ICT itself.
Sun Life of Canada reported a $50 million savings from outsourcing policy administration in one business unit. Abbey Life and Fortis also cited cost savings resulting from their policy administration outsourcing arrangements.
According to Bruce Powell, senior vice president of Liberty, its customers have realized an average of 25% to 30% savings in annual policy administration expenses, and a one-time system conversion typically costs between 30% and 50% of the initial annual cost. The savings result from economies of scale, process innovations, and the provider's ability to spread its investment in new technologiesfor example, new universal life systems applications, imaging, work-flow and call-center operationsacross many companies, reducing the costs to each one.
Another benefit of outsourcing, says Donivan, is that previously hidden costs are now visible and are better managed. For example, when Fortis maintained its own policy administration information systems, program changes were not clearly defined, resulting in inefficiencies and rework. Now that Fortis receives explicit bills from its outsourcing provider for programming time, it has learned to better define exactly what is needed and why before involving the provider in systems development.
A number of other less obvious factors, in our experience, can have a financial impact on the success of an outsourcing transaction:-- The opportunity to reflect expense savings in product pricing. -- The changing regulatory capital requirements that result from disposing of capital assets such as systems, facilities, and call centers. -- The transfer of employee future benefit liabilities from the balance sheet of the life insurer to the provider. -- The potential commodity tax impact of converting internal salary and other expenses to external service fees. -- The conversion of internal fixed costs into variable external costs based on transaction volumes. -- The ability to smooth cash flows by avoiding the periodic capital expenditures related to maintenancd of in-house processes and systems. -- In some countries, such as Canada, there may be an actuarial liability impact. -- The insurer's willingness to take capital stock from the provider in lieu of cash. Typically, when a provider takes on a business process, it will acquire, and pay for, the assets underlying that process, such as call centers, technology, and facilities. In some cases, the provider prefers to issue its own stock as consideration instead of paying cash to tie the customer to its success.
Making It Work
Our study found that, despite the good will that usually marks negotiations with a provider, the final wording in many contracts focuses only on cost cutting and includes numerous nonperformance penalties. This is not the right framework for fostering cooperation and joint problem solving.
Life insurers that have implemented or managed a major outsourcing arrangement agree that having the right attitude is a critical success factor. This issue starts with the leader of the business unit that is being outsourced, says Manulife's Mather. If that leader views outsourcing as amounting to selling off the business and a threat to his or her position, it is unlikely that an outsourcing arrangement can be worked out.
To Donivan of Fortis, maintaining an ongoing relationship after the deal is implemented is equally important. "To succeed, you have to approach the relationship with the provider as a partner, not a vendor," he says. "You need daily communications, you have to train your own people in the outsourcer's methods, and you must stay involved with the process." That means having an in-house structure to manage the relationship at a governance, relationship, and process level.
One of the key quality and audit control techniques employed by Fortis is to maintain one of its own auditors full-time on its provider's site to conduct daily audit procedures on applications, claims, call handling, and the management of suspense accounts. It also uses its corporate auditors to conduct more formal semiannual reviews of processes such as underwriting and claims adjudication.
Service-level agreements are important and should address both quantitative and qualitative performance measures, says Donivan. Quantitative measures include speed to process a policy, error rates, and waiting time at call centers. Qualitative measures, such as customer satisfaction surveys, look at the intangibles that cannot be captured by traditional measurement systems.
While some argue that the consolidation and uncertainty prevalent in the industry today will delay outsourcing decisions, we believe the opposite will occur. The trend toward outsourcing of IT and business processes in the life industry will accelerate, because a well-structured, well-executed outsourcing arrangement can increase company value and facilitate future integrations with other life insurers. The promise of future cost savings is driving much of the consolidation now occurring in the industry. And based on the experience of the companies that have tried it, cost savings is exactly what outsourcing delivers.
Doug McPhie, (416) 943-3800, [email protected], is a partner in Ernst & Young's Toronto office.