A steady balance

Whether or not he intended to, former Singapore prime minister Lee Kuan Yew left a lasting legacy to the international business community with his saying: “If you deprive yourself of outsourcing and your competitors do not, you’re putting yourself out of business.”

The London insurance market is certainly prominent among those sectors to have listened, with outsourcing organisations appearing to have sprung up everywhere to offer the chance to save money, improve quality and free up company resources for other activities.

The outsourcers can handle everything from payroll and IT to underwriting and claims services, although loosening their own grip on the latter two functions still represents a step too far for some organisations.

Calvin Cole, head of underwriting and claims at RGA UK, says: “As a specialist life and health reinsurer, we consider it essential to retain local control of our underwriting and claims functions. Our mortality and morbidity results are directly impacted by our ability to manage the risks we take on our books, and cases that are referred to us are often complex and multi-factorial.

So our underwriting and claims teams need to have high levels of expertise. “Our clients look to us for expert advice on unusual risks and in view of this we feel it is essential to utilise resources which are close to the sourcing market. We also provide training for the underwriters and assessors working for our clients, and this needs to be high quality.”

In general, however, there is far less reluctance to outsource underwriting than claims. Capita, for example, singles out underwriting as being a notable growth area. It says its senior management team increasingly realises that controlling expenses is one of the last levers they can pull during a period of intense competition and poor investment returns.

Core versus non-core

Because one of the key attractions of outsourcing is to enable insurers and reinsurers to focus on core competencies, exactly what they outsource is inevitably going to vary according to what they consider their core competencies to be.

RSA currently outsources a large part of its infrastructure and of its development and maintenance. It also outsources its data networks and phone networks.

Giles Baxter, information services and change director for UK and Western Europe at RSA, says: “We run through the capabilities we want to provide as an insurer across personal and commercial lines and consider which ones we want to hold on to because they give us strategic advantages and are core competencies. Some of the more commoditised and strategically less important activities we might consider outsourcing.

“We will go through a robust process and run a business case. For a big infrastructure issue it could take us a year to consider whether to outsource, and then to choose the outsourcing provider. We will assess who the leading players are and whether they can be better value in terms of giving us better quality and performance than if we did it ourselves.”

The size factor

As a general rule, the bigger the organisation the less likely it is to outsource, so the practice is least popular with the very largest reinsurers.

Even these, however, can still outsource specific projects if, for example, they have a particular problem type of business and an outsourcer may have the ideal specification to oversee the run-off. Some also create their own offshore platforms and effectively outsource work to them, even though they technically own them.

Richard Lawson, CEO of Pro Insurance Solutions UK, an outsourcer of technology for insurers and reinsurers, also feels that the current comparative profitability of the reinsurance market reduces the attraction of outsourcing to reinsurers generally. But Pro Insurance Solutions UK is providing a lot of underwriting support for small to medium-sized reinsurers who don’t want to outsource the underwriting function as a whole but who need extra support during periods such as the renewal season, when there is a sudden surge in activity.

“We will assess who the leading players are and whether they can be better value in terms of giving us better quality and performance than if we did it ourselves.”

MGAS embrace outsourcing

One sector of the insurance markets that has enthusiastically embraced outsourcing in recent years has been managing general agents (MGAs), according to some.

Stephen Card, chief executive at Charles Taylor Insurance Services, a provider of outsourced services to the Lloyd’s, London and global insurance markets, says he has seen a big increase in demand from this sector.

As investment margins have tightened in recent years and with rates stagnating and reserves running low, he says the outsourcing of claims management and underwriting support has increased exponentially in all sectors of the London Market in recent years.

“The market is changing and we have definitely experienced an increase in demand for both claims and underwriting support,” says Card.

He estimates that as much as a third of Lloyds’ income comes from delegated underwriting MGA activities and the demand for outsourced services from this market has grown rapidly over the last 18 months.

“Underwriting support is now big business,” says Card. “Dealing with data is now, due to Solvency II, a big problem for the UK and US. Everyone is trying to get their arms around the reams of data and some people are all over the place.”

But, he adds, claims management has been the biggest growth area for his firm. “There is a lot of emphasis on performance nowadays. Once a claim has been settled, it’s easier for a company to hand it over to a shared service and not have to worry about it.”

According to Card, Lloyd’s has always focused on outsourcing. “Nearly all Lloyd’s syndicates delegate work to external parties; we work with 32 out of the 52 Lloyd’s syndicates and manage 80 percent of static claims in the Lloyd’s market.”

Card believes that the outsourcing sector will continue to grow. “The options that outsourcing offers will continue to drive the market forwards, attracting more business at least for the next few years,” he adds. “I don’t see it taking over, but it will definitely continue to grow.”

Potential downsides

When it comes to considering the possible downsides of outsourcing, the potential costs involved and the risks of redundancies are not commonly highlighted as major issues. Outsourcers point out that job losses don’t have to result as staff can be either TUPE’d over (transferred) or redeployed and that no investment is necessarily required, as the benefits of outsourcing can accrue very quickly. Furthermore, although outsourcing takes management time, not doing it may create management drag.

In practice, however, cost savings can be difficult to prove. Lawson says: “It can be hard to work out whether the outcome is delivering value for money, as lots of insurers and reinsurers don’t understand their own cost bases properly and may not really make the savings they aim to.”

But the risks of failing to hang on to core competencies in-house figure prominently on many commentators’ lips.

“If there‘s an insight that I’ve personally gained it’s that creating an adversarial relationship with a third party over something core to your business is very difficult; if it’s with something peripheral like stationery or photocopying, then it can be OK,” says Alastair Speare-Cole, CEO of JLT Re.

“If you move 99 percent of your policies from something being done in 45 days to 30 days it often makes little difference. It’s the 1 percent that gets placed in the ‘too difficult’ basket that causes the biggest damage for clients. Outsourcing creates too much focus on achieving service-level agreements and therefore gives less attention to non-core things that can affect your reputation.”

It is apparently not uncommon for an outsourcing organisation to think it has won a competitive contract following a tender process and then to find it is making a loss. It may therefore direct some of its best personnel to other projects and try to raise the price the moment the client suggests changes. The friction that results could lead to a mid-term breakup in the relationship that proves hugely costly when a core competency is involved, although a trend away from 10-year deals to those lasting five—or even three—years is helping to reduce this risk.

“If you have to fall back on the commercial details then that’s the first sign that the relationship has become toxic,” says Baxter. “A lot boils down to how the management teams get on and part of our selection process is making sure senior management teams meet. When the relationship and quality falls away that’s when you’ve got problems.”

Break clauses within licence agreements, typically involving three to six months’ notice, enable either party to terminate without compensation if they have an adequate reason, such as failure to deliver on key performance indicators. But in practice it is not that common for breaks to occur mid-contract because agreement wordings will also contain a resolution process giving outsourcing organisations a chance to turn around their performance.

Baxter continues: “The outsourcers know their measure of success is how successful we are as a business, so if our customers are moving, the first thing we’ll be doing is to show them this and give them a chance to fix it. It’s important to have discussions early enough to never actually have to mention breach of contract.”

Even switching at renewal doesn’t happen that often because, although insurers and reinsurers are increasingly focusing on cost control, they may well offer their existing outsourcers the chance to realise further efficiencies before looking elsewhere.

“If you are perceived to be giving good service you would hope to have the renewal in the bag because companies in the London Market don’t tend to change for the sake of it,” says David Hay, business development director at TIW Group, which outsources technology for a dozen insurers and half a dozen reinsurers.

Looking to the future

There is a definite trend developing for insurers and reinsurers to conduct more intelligent outsourcing by placing different functions with several different organisations with the appropriate core skills, as opposed to using a single outsourcer for everything. Innovation is also increasing the options available.

Capita, for example, in May piloted a service in Singapore for a number of different parties to share outsourcing services. This will become a full Singapore service in September and the aim is to offer it to the whole of the Lloyd’s market as early as the fourth quarter of this year.

Similarly, TIW Group is trying to encourage insures and brokers to use electronic placing—not to replace the traditional face-to-face placing associated with Lloyd’s but to take away all the paperwork resulting from such personal contact. It is also clearly eyeing up opportunities created by a marked increase in insurance legislation.

Hay says: “Insurance legislation has proliferated, so have financial penalties for non-compliance. At the moment only some companies are outsourcing this but I see it as a major growth area for the future. While companies are continually evaluating global operations and product innovations to meet regulatory and claimant requirements, they are hindered by inefficient processes, inadequate resources and outdated technology platforms.”