"...We have reduced warranty expense by over 1% by outsourcing. That one percent amounted to $200,000 last year."

"It was far more efficient to outsource the work to the experts that specialize in loss adjusting and claims administration."

Industry watchers predict double-digit outsourcing increases for 2006 and say that over the past year, a certain shift toward outsourcing has become much more prevalent among insurers. A large Canadian financial services organization recently signed a deal to outsource the policy administration of its 800,000-policy U.K. business.

Outsourcing core business functions is known as Business Process Outsourcing (BPO). Today, insurers are finding that BPO can lead to bigger returns on investment and reductions in operating costs, improved customer service, expanded reach in the marketplace, and increased efficiency. BPO can also create an atmosphere where insurers can focus on other issues such as underwriting.

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In the post September 11th world, it seems that there are simply too many complex claims functions for companies to juggle, particularly when they need to concentrate on costs and efficiency. The cost of claims has skyrocketed in the last two years, and claim volume has also become an issue in the industry.



A Trend for the Property & Casualty Insurance Industry

In the P&C industry, where gauging risk and providing as much financial security as possible to their customers is their very job, the idea of outsourcing claims functions has always seemed too risky. They would rather keep that business process closer to home. However, that is c h a n g i n g . The industry spends approximately $23 billion in human capital annually with more than 150,000 claims professionals and more than 300,000 supporting personnel. These individuals process about 750 claims per professional per year or 120 million new claims every year.

Considering the cost of claims administration and the stark reality that claims processing functions have become the key differenciator in sustaining competitive advantage for insurance companies, it’s only logical that insurers would look for ways to reduce costs and increase customer service.

A U.S. study conducted by Stern Steward shows that outsourcing of almost any kind, can provide that competitive advantage. According to the study, the mere announcement of a mega-outsourcing deal can result in a 5 percent sustained increase in share value over companies that do not outsource. Additionally, a 2002 study conducted by Ernst & Young reveals that properly structured outsourcing arrangements positively impact shareholder value.

However, despite the increases in the use of outsourcing and positive data related to outsourcing, the P&C industry represents 5 percent of all companies that outsource. Facing the post September 11 climate, the industry could incur substantial losses if it continues to overlook the outsourcing of claims administration.

“When business is good, there is less incentive to look at various business processes and re-evaluate what is working at an optimal level and what isn’t,” writes Chris Pryer in an article for Outsourcing.com.

In such an environment, he says tradition thrives. But when the winds change in the business climate and greater scrutiny of business processes is mandated, non-traditional solutions, like outsourcing, take on a different light.6 The aftermath of September 11th is just one of many huge challenges facing insurers. Insurers are also struggling with asbestos, mold, runaway lawsuits (including class actions), and large jury awards. Cash reserves are dwindling. _____________________________________________________________________

“Insurance companies pay out much more in claims than they take in premiums,” explains Carolyn Gorman, vice president of the Insurance Information Institute. “They make up the difference through their investment gains.” This, according to Gorman, is good for policy- holders because it leads to low premiums; however, when investments stop performing well, premiums are raised (known as a hard market) to make up the difference.

During a hard market, partcularly the one that faces the industry now, insurance companies clearly need to concentrate on their core competencies: writing new business, underwriting policies, new product line introduction or elimination, and, most importantly, improving cost control. Outsourcing claims administration to experienced TPAs gives them the freedom to refocus.

Member Insurance Agency, based in McHenry, Illinois, provides insurance services for the hardware and building material industry. In 2000, the company tested the waters of outsourcing and saw that BPO allowed the company to refocus on core competencies. “If you look at the industry, I think there’s a realization that just because you’re good at underwriting and you’re good at selling, it doesn’t mean you’re good at doing the paperwork,” says Wayne Fell, CEO of Member. “It used to be that you went to one place and they do everything from tuning up your car to servicing your transmission to changing your oil. ____________________________________________________________________________

Today, you go to one guy to change your oil, another guy for the transmission. It’s specialization.” Since outsourcing his company’s customer service department, Fell reports that he now spends 10 percent of his time worrying about current customers and the other 90 percent focusing on the company’s main core competency - obtaining new customers. Before outsourcing, the opposite was true.

Fell recognizes the industry’s reluctance to outsource, and warns that companies determined to do things the old way could suffer in the end. “If you talk to a lot of people in the major insurance companies, they’re going to tell you that nobody can do this [customer service and claims administration] better than we can – we’re never going to outsource these operations. And that’s the traditional thinking and that’s why insurance is always 10 to 20 years behind every other industry segment.”

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Insurers stand to save at least $30 billion through aggressive focus on claims cost, according to a 2002 study performed by consulting firm A.T. Kearne y.10 The study emphasizes transforming the claims process and says new claims processing strategies could generate cost efficiencies from 12 to 25 percent. “Extrapolating savings of 12 percent to the overall industry claims cost would shave 10 points off the U.S. P&C sector’s projected combined ratio of 120 in 2001,” says Stefan Spohr, a principal analyst with A.T. Kearney.

A July 2002 issue of Claims magazine reports that the Kearney study strongly suggests that “one way to dramatically affect profitability is by taking advantage of new technologies to transform the claims function.” Costs associated with reviewing and settling claims typically account for approximately 65 percent of an insurance company’s total revenue. In the claims area, opportunities for significant cost reduction include improving process efficiencies, restructuring supply chain operations, and leveraging technology and third-party resources to achieve economies of scale.

_______________________________________________________________________ There is a long list of variables that contribute to TPAs finding substantial savings for clients. In the area of life policies, for instance, the TPA approach has streamlined the claims administration process and turned it into a much more efficient and customersatisfaction oriented service. P&C providers, especially, should take note of the results TPAs have provided in the life industry.

Though the nature of the policies of the two markets differ greatly, the same best practices methods implemented by TPAs can lead to the same level of success for both industries. The underlying fact is that both industries need to achieve the same results.

“Policy administration involves complex products and systems, and complicated interfaces between these systems,” writes Doug McPhie for Insurance Technology magazine as he outlines the claims service requirements of the life industr y. “Products,” he says “can range from simple term policies to sophisticated

Insurance companies clearly need to concentrate on their core competencies: writing new business, underwriting policies, new product line potential or elimination, and, most i m p o r t a n t l y, lowering cost. 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.” These needs practically mirror what faces P&C providers.

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Outside vendors, McPhie goes on to say, typically are equipped 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.1Outside vendors can offer the vendors for P&C companies.

Fortis, a life insurance company, believes its TPA is successfully managing the intricacies of the company’s product line because there is a seamless interface back to the insurer’s own accounting, reserving, and investment systems through extracts between the TPA’s systems and those at the insurer.

However, McPhie points out that multiple products and interfaces, combined with the long life of policies cause another major complication – system conversions, a common problem among P&C providers as well. “The applications supporting policy administration must support a range of products whose life cycle can exceed 50 years,” writes McPhie. “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 cycle – an 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 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 often can complete conversions more quickly and at less cost than the company would incur in doing a conversion itself.

If you talk to a lot of people in the major insurance companies, they r e going to tell you that nobody can do this better than we can – were never going to outsource these operations. And that s the traditional thinking, and t h at s why insurance is always 10 to 20 years behind every other industry s e g m e n t . ________________________________________________________________________

Assessing the Hidden Costs

By outsourcing business processes, companies can get a firm assessment of the cost of running their operations, cites Information Week magazine. The article says that in many cases, clients are looking to save at least 15 percent of the cost to do the work themselves.

One TPA handling claims administration for insurance industry clients reported that its clients have seen an average of 25 to 30 percent savings in annual policy administration expenses. According to the report published by Insurance Technology magazine, “the savings result from economies of scale, process innovations, and the provider’s ability to spread its investment in new technologies – for example, new universal life systems applications, imaging, work-flow and call-center operations – across many companies, reducing the costs to each one.” _______________________________________________________________________

Another benefit of outsourcing, experts say, is that previously hidden costs are now visible and are better managed. For example, when Fortis handled its own policy administration information systems, program changes were not clearly defined, resulting in inefficiencies. Now that Fortis receives explicit bills from its outsourcing provider, it has learned to better define exactly what is needed and why, before involving the provider in systems development. 20 McPhie cites the following, less obvious factors as having 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 maintenance 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 P&C provider takes on a business process, the provider 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.

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Companies looking into entering new lines of business or those considering mergers are prime candidates to benefit from outsourcing to TPAs. A 2001 study conducted by Gartner, a research and advisory firm, concludes that an additional 9 percent of insurers outsourced core functions in 2002 than did in 2001.

The study lists the top reasons for the change as inappropriate skills set; lack of time; and faster turn-around time. These reasons indicate that if companies want to broaden their reach, it may be wise for them to let TPAs handle their initial entry into new lines because of TPAs’ specialized skills. Indeed, insurers looking to redefine themselves, when they are losing ground to the competition, particularly once there is a new product launch, should turn to outsourcing.

“New product lines can lead an insurer to re-define itself. The core competencies change,” says Mike McCarthy, vice president, business process One T PA handling claims administration for insurance industry clients reported that its clients have seen an average of 25 percent to 30 percent savings in annual policy administration expenses, added market value for the services and that BPO flexibility.



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C o n cl u s i o n

P&C insurers are learning that now, more than ever, is the time to seriously look at having an experienced TPA handle claims administration. In order to focus on core competencies, increase shareholder value, and work more productively, doing away with traditional methods management, for one outsourcing company. “They [insurers] need to know where they’ve been, but they don’t want to add payroll.”

Competition, according to a Technology Decisions magazine report, is a key factor. If the average unit cost of a product is higher for a company than the cost is for the competition, carriers have to know if they can sell enough to make up the difference. “A lot of times companies can sell as effectively as the competition, but they can’t deal with administering services as well,” McCarthy says.

“Marketing people may find a new opportunity to increase revenue, but that often means staffing up on the administration side.”

According to McCarthy, this is a prime time to look to outsourcing the function. BPO provides young companies with a much quicker time to market. QualSure Insurance Corp., a Sarasota, Florida, insurance company, has been outsourcing some of its functions to a TPA since its inception in January 2000, says Larry Greenemeier in an Information Week news report. According to the report, the damage that Hurricane Andrew caused in 1992 put some insurance companies out of business and caused others to cease writing certain policies. The state stepped in and formed the Florida Joint Underwriting Association to write insurance policies for people who couldn’t find policies in the private market. Unfortunately, the state didn’t stay in the insurance business long term and soon began looking to refer business to insurance companies. Three companies, Nemwill, Siebels Bruce, and U.S. Reinsurance formed QualSure with nine employees as a way to seize what they considered a lucrative opportunity.

QualSure’s management decided it needed to focus on ways to grow the business rather than on day-today operations such as claims processing, says Jim Brown, QualSure’s director of Marketing and Policy Processing. The company looked at IT capabilities as much as at business processes. A TPA won QualSure’s business.

The TPAs role was to qualify customers, ensure that policy premiums were paid, distribute copies of contracts to customers, mail payments, and operate a customer-support call center. Although QualSure won’t discuss the terms of its contract with the TPA, Brown told Information Week that he’s paying fair

New product lines can lead an insurer to re-define itself. The core competencies change. They need to know where they ve been, but they don t want to add payroll.

Maintaining a competitive edge, while sustaining healthy cash reserves is key in the global marketplace where specialization is becoming more of the requirement than a dispensable asset. Instead of asking what will be the risks if they do participate in BPO, P&C insurers should be asking themselves what will be the risks if they don’t. _______________________________________________________________________

N o t e s

ACC Wishes to than the Crawford Company along with:

1 Outsourcing to Play Larger Role Among Insurance Companies, Outsourcing insurance, January 2003 2 National Underwriter, P-C Insurers Record First Net Loss Ever, April 22, 2002 3 Processing Claims, Dataquest, October 17,2002 4 Ibid. 5 Thumbs Up On Outsourcing, Insurance & Technology, July 9, 2002 6 Ibid. 7 Outsourcing to Play Larger Role Among Insurance Companies, Outsourcing Insurance, January, 2003 8 Ibid. 9 Ibid. 10 Transforming Claims Processes Could Save Insurers Billions, Claims Magazine, July, 2002 11 Ibid. 12 Ibid. 13 Thumbs Up On Outsourcing, Insurance & Technology, July