The information technology initiative that Toronto-based Manulife Financial Corp. and IBM Corp. announced in April is receiving its fair share of scrutiny within the insurance community due to several wide-ranging implications.

Under the terms of the 10-year, $563-million agreement, IBM Global Services agreed to operate and maintain Manulife's IT infrastructure that supports the company's North American operations. The alliance entrusted IBM with assuming control of Manulife's data centers, help desks, desktop computers, and voice and data networks. Within the transition, roughly 400 Manulife employees were permanently transferred to IBM Global Services.

For an industry considered by many to be conservative for its implementation of technology, ceding day-to-day control of a major corporate artery is not a prevalent occurrence. Most carriers regard their data operations and everything with which it's associated-including the proprietary data-as a sacrosanct internal resource.

Moreover, Manulife's information services unit had actually established a reputation for meeting or exceeding corporate IT service benchmarks, effectively delivering on time and on budget. If the expression, "If it ain't broke, don't fix it," still holds merit, why then relinquish control of a perceived asset to a third party?

For Manulife, the agreement represents a concept known as "strategic outsourcing."

"When Manulife Financial outsourced its IT infrastructure to us, it was a recognized strength," explains Bill Pieroni, general manager of global insurance for White Plains, N.Y.-based IBM Global Solutions. "Many people equate outsourcing with poor performance. That's a misconception. Manulife was actually smart enough to realize they could outsource the unit to enable them to better redirect their IT priorities."

Choosing The Right Path

The IBM-Manulife initiative represents a three-tiered approach to "sourcing" in the insurance industry, which also includes so-called in-sourcing and up-sourcing, Pieroni notes. The key for carriers is determining which of these three paths to take, where to apply it, when to embark on it and with whom.

This type of decision-making will be even more critical as carriers conduct business in a brutally competitive market, one that has placed heightened emphasis on cultivating strategic areas such as claims processing, underwriting, new-product development and customer relationship management (CRM).

Managing their IT resources more productively will enable carriers to better stimulate both the top-line and bottom-line growth that for many has been so elusive. "We're not unlike other companies that are being asked to contain IT expenditures during critical times," Billy McCarter, chief information officer for Novato, Calif.-based Fireman's Fund Insurance Co., points out. "If we can reduce infrastructure costs we can shift the savings to our application development organization while retaining a flat budget."

Similar to Manulife, Fireman's Fund recognized the need to outsource its IT infrastructure resources last fall when it inked an ambitious 10-year, $380-million outsourcing agreement with Montreal-based CGI Group Inc. In explaining the rationale behind the agreement, McCarter declares: "The way we looked at it, we could run the best data center in the world and Fireman's market cap wasn't going to grow (any larger)."

Sourcing Power

As insurance carriers face competitive pressures to reduce operating costs and streamline business operations, many are turning to traditional business process and IT outsourcing to achieve these objectives.

Several motivating factors are making outsourcing the route often traveled by carriers, says Pieroni of IBM. For starters, carriers are finding it increasingly hard to both recruit and retain the best IT talent that's available. As such, it makes sense to outsource to providers that possess the best people.

Carriers also can reduce their fixed costs by no longer having to be burdened with the overhead connected with hard assets-such as a data center or a print operation-and the risk associated with owning those assets.

And, some carriers decide to implement outsourcing so they can address other pressing issues.

"When carriers target specific areas for outsourcing, this enables them to concentrate on three core areas-underwriting, risk management and investment management," says Faith Trapp, managing director, insurance strategy for Plano, Texas-based Electronic Data Systems (EDS).

Outsourcing initiatives in the insurance industry have been occurring for decades. However, it's only been over the past two years where outsourcing has achieved a higher plateau, explains Susan Cornoyer, senior analyst for Gartner Data-quest's IT services group.

"Over the past two years, it's grown beyond testing and pilots. One reason is that demutualization has placed more pressure on carriers to demonstrate their worth on the open market," she says. "The other has been the emergence of the Web. Linking the front end to back-end mainframes prompted the engagement of a third party to create a flexible architecture. It's all served to produce a 180-degree turnaround in the way carriers now view outsourcing."

Jane Landon, CIO for Newark, N.J.-based Prudential Institutional Services, adds that in addition to these factors, another trigger event that served as a precursor to a greater degree of outsourcing were the Y2K projects occurring in the late 1990s. This enabled carriers to better grasp the idea of third-party intervention within their operations.

Industry research supports these theories. According to Gartner Inc., 51% of life and health insurers and 48% of property/casualty insurers outsourced at least one business process in 2001. The study of 114 U.S. insurance carriers with net written premiums of $100 million or more reveals that an additional 6% of life and health insurers and 9% of P&C insurers have plans to outsource some business processes in 2002.

These activities encompassed such functions as billing, information services, CRM, payroll, payments, mutual funds, back-office administration and document management.

"With increasing pressures to reduce operating costs and launch new products, many insurers are finding those objectives difficult to meet," declares Kimberly Harris, research director for Gartner, which is based in Stamford, Conn. "They have inadequate internal resources, such as people and skilled workers, or they are so overwhelmed with other priorities that they simply cannot complete all the requirements in the necessary time frame. Many insurers are looking to gain competitive advantages and are using BPO and technology outsourcing services as a means to accomplish that."

To obtain an optimum return on investment from outsourcing, Gartner says insurers must have a corporate strategy that includes reasons to outsource. "Insurers will find greater success from having a corporate outsourcing strategy in place rather than haphazardly responding to institutional constraints," Harris says. "The focus should be on market distinction with an emphasis on core competency rather than tactical requirements."

Letting Go

Experts note that it's often difficult for an owner of an internal function to let go. One health insurance industry executive reveals that Bridgeport, Conn.-based Oxford Health Plans Inc., the leading managed care organization in the New York metropolitan area, found that out the hard way.

"Oxford could not process claims quick enough to reimburse its provider affiliates," says the executive, who declined to be identified. "Oxford considered it one of the company's core competencies, but many providers did not get paid in a timely fashion.

State regulations have made it mandatory for payers to reimburse providers within a certain time cycle, and if they fail to meet the deadline, they can be penalized."

Until they determined that outsourcing the claims function was the best alternative, "Oxford was bogged down in manual claims deficiencies and was unable to implement the automation processes that could quickly determine the reimbursement amount," the health executive adds.

The tendency of many carriers when they perform their due diligence is to pinpoint one area for outsourcing and then branch out. They may opt to outsource all their call centers or all their claims functions.

"Carriers often begin with a single business process for outsourcing and then increase it," says Trapp of EDS. "Often a carrier will ask if they are achieving best practices for a particular business function. But best practices is a moving target. Over the past year, we have seen a lot of activity with outsourcing of policy administration. If you're a company that's been on an acquisition binge, you're going to inherit multiple operating systems. (EDS) would be able to manage the back office and build a common system on one common platform."

Carriers often make two mistakes about moving a core competency out of their day-to-day control: they outsource for tactical and not strategic reasons. And they often equate the concept to be a magic bullet for containing internal costs.

Corporate Assessment

"Often it's not cheaper to outsource-it may actually cost more. However, while it may cost more, the value the outsourcer receives in return may also be greater. You have to look at value and performance," says Rick Enright, marketing director, CIMR, a subsidiary of BlueCross BlueShield of South Carolina, Columbia, S.C.

When Fireman's Fund explored the idea of outsourcing its IT infrastructure function, stimulating performance and creating additional value were two of its top priorities.

"In 2000, I launched an assessment of the IT unit at Fireman's," McCarter explains. "We broke the assessment down into two pieces-infrastructure and software. We asked ourselves whether our own capabilities could meet the emerging requirements in these two areas. By the end of that year, we determined that the best path would be to identify a third-party to operate the IT infrastructure side. In 2001, we identified six candidates, narrowed it down to two and then to one-CGI."

In performing due diligence, McCarter explains that Fireman's found it imperative to seek legal expertise in the selection of a long-term partner. "It's wrong if anyone believes they can negotiate an alliance like this on their own," McCarter says. "You need the counsel of a third-party legal team. In our case, we choose Shaw Pittman. The fact is that the people within your own organization are too vested in the business to be able to objectively assess an effort of this magnitude."

Engaging employees

Fireman's also knew it had to engage the employees who would be involved in the eventual transition. That's because once the deal was inked, CGI inherited 336 Fireman's employees. Some of them were informed during the transition that their positions would eventually be phased out.

"From the start, each one of those 336 individuals knew whether they had a long-term or short-term position, and some of them are starting to leave," says McCarter. "The important thing is that we didn't spring this initiative on the employees at the back end of the contract negotiation period. We got them involved from Day 1, and asked many tough questions during the process, which proved to be an effective strategy."

"Fireman's Fund took a progressive and strategic examination of their core competencies and took a hard look at where they wanted to go with their data," says Karen Furtado, vice president, insurance practice, CGI. "We incorporated the management framework and took over the data center, but at the same time Fireman's Fund remained fully in control of their data."

CGI, which provides niche business process outsourcing services in the U.S. and a larger degree of end-to-end projects in Canada, assumed control of Fireman's Fund's 40,000-sq.ft. Phoenix-based data center in late 2001. It is from the Arizona facility, as well as from its own Canada-based data centers, that CGI will provide ongoing maintenance of 500 NT servers and large Unix platforms that support more than 11,000 desktops, laptops and printers of Fireman's Fund. All told, CGI will provide around-the-clock services to some 80 Fireman's Fund offices across the U.S.

One of CGI's strengths, Furtado says, is the competencies of its people. "Our value-added strength is knowing and understanding the insurance market," she says. "You have to be able to offer one-to-one customized BPO arrangements that create flexible terms and conditions."

CGI also offers a leverage mechanism that state-side outsource specialists cannot-CGI can reduce its costs and pass those along to clients like Fireman's Fund because labor rates in Canada are significantly lower than they are in the states. It's one of the incentives that's enticing carriers to explore what's known as offshore or near-shore outsourcing arrangements (see story on pg. 30).

Fireman's, which generated gross premiums of $4.5 billion in 2000, expects to save about 25% a year from the greater degree of efficiencies that CGI can provide.

Spreading the costs

For instance, Fireman's infrastructure costs are based on actual usage, an arrangement that has proved to be far more economical than if Fireman's still owned and maintained the data center itself. The key is CGI deploys its data-center network so that it's equipped to provide services to other customers as well.

As a result, the costs are spread among all the various users. So, a large printing operation that Fireman's previously operated at half capacity out of its Phoenix data center is now being used around the clock to deliver print services to other customers. This results in lower printing costs per customer.

New Mentality

Embracing the concept of outsourcing involves a significant mindset shift within a carrier operation-particularly when the outsourced function is as significant as one's IT infrastructure division.

Some insurers aren't prepared to take such a leap. The idea of divesting day-to-day control of an internal nerve center such as a help desk or a print operation is still fraught with negative ramifications. Moreover, many insurers still place a great deal of emphasis on internally controlling their own destiny.

"We think that we understand our operations environment best and can manage it better than a third party," says a spokesperson for Bloomington, Ill.-based State Farm Insurance Cos. "We may bring in a third party who has a particular expertise, absorb the knowledge they provide and then take it from there."

One of the sticking points that insurers have identified is how to measure results of an outsourced area. However, new technology is enabling carrier-customers to more effectively gauge progress and results, even on a daily basis. Monitoring a provider's competencies within an outsourcing agreement can be performed various ways to ensure that service levels and other specified deliverables are being attained. EDS developed a Web-based tool called Service Excellence Dashboard so clients can have hands-on input on all outsourced activities. "The way the dashboard works, 'green' means 'go' as in the initiative is achieving service levels, and red means 'stop.' You never want to see a 'red' on the dashboard," says Trapp.

In measuring the results derived from an outsourced function, Prudential's Landon says that outsourcers can't take "a cookie-cutter approach. We do have baseline requirements with all projects, but within each particular arrangement you have to assess the people involved, the hours worked, state reporting. It involves a great deal of checks and balances."

Landon says Prudential has been exceedingly pleased with the decisions it's made in selecting the right outsourcing partners, and with the way it's been able to measure the results of such endeavors. "Each year we benchmark against the industry to determine if we are meeting best-practices and determine whether a third party can do it cheaper and better," Landon says. "We believe all our sourcing strategies have created true business value. We've seen it though streamlined efficiency in areas such as our call centers, the Web and the back-office legacy environment."

Fireman's Fund's McCarter says there have been minor "bumps" in the road during the transition from owning and operating its IT infrastructure to becoming a CGI customer. Fireman's business customers have given the program "a thumbs up-it's exceeded their expectations. The IT infrastructure under CGI's stewardship is producing heightened service levels," he says.

However, despite not owning the division anymore, Fireman's Fund still remains actively involved in the day-to-day operations of the data center in conjunction with CGI. "We are presently in what I would call a 'funneling' mode, where eventually we'll evolve into a 'monitoring' mode," he explains.

Direct conduits

Fireman's has designated several individuals within its organization to assume the role of direct conduits to CGI to ensure quality control and to measure results of their activities. But Fireman's must also closely monitor the way that its own business organizations use the services now that it's under CGI's control.

For instance, when CGI assumed control of Fireman's IT infrastructure, it meant that Fireman's Fund would be charged based on overall usage and services rendered.

"We have an IT infrastructure budget, and our businesses all have established IT wish lists. The key is to manage that demand with the supply. When you embark on a program like this, it involves a great deal of corporate governance."

To illustrate how the concept of outsourcing has evolved over the years-and the possibilities that exist for tomorrow-Enright of CIMR says that a large number of businesses across America now outsource human resources, payroll and employee benefits responsibilities. Years ago, this idea seemed ludicrous.

"There was a time when many businesses couldn't fathom the idea of a third party handling their payroll," says Enright. 'You mean someone else is going to pay our people?' Once, every bank on every corner had its own computer system and had complete local control over that system. The majority of them now outsource."

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