Outsourcing typically consumes 20 percent of insurers' IT budgets and represents between 20 and 40 percent of their IT headcount. It's an important part of insurer CIOs' toolkits, and usage is widespread. But a recent Novarica study showed that while many of those who currently outsource at a moderate level are planning to expand, some heavy users are planning to cut back. Insurers need to find their own optimal level, balancing costs and capacity benefits against service levels, quality, and their own abilities to manage external providers.

Application development and maintenance (ADM) outsourcing is the most common type of insurance IT outsourcing and accounts for the majority of outsourcing activity at insurers. This category includes ongoing staff augmentation, also called blended sourcing, as well as project-based external services usage.

In Novarica's recent survey of 95 insurance company CIOs, 85 percent reported outsourcing at least some ADM. Large property/casualty insurers were most likely to be heavy users of ADM outsourcing; 38 percent of large P&C insurers considered themselves heavy users, compared to 22 percent of midsize P&C insurers.

More than 40 percent of the heavy ADM outsourcing users likely will decrease their reliance on outsourcing in 2014, according to our survey. Some of this decrease may be attributable to having completed a specific project, or making changes to their requirements, or recalibrating their internal/external mix of staff based on a reevaluation of service levels, management resources and or pricing.

SCARCITY OF TALENT

It's no secret that technology talent in the United States is in very short supply, and recruiting specialized talent into insurance IT groups often means overcoming geographic scarcity, uncompetitive enterprise pay scales and the technology community's lack of excitement about the insurance industry.

In Novarica's 2012 report "Managing IT Skills Portfolios and Enterprise Architecture in a Changing Environment," a survey of 88 insurer CIOs, we found that:

* More than 30 percent of insurance IT departments supplement their internal staff with outsourcing for mobile development, Web development and QA/testing.

* More than 20 percent use external providers to supplement their internal database administrators and application developers.

* More than 15 percent use external providers to supplement their internal data architecture requirements.

* More recently, we've seen growth in the use of external data and analytics talent, which is becoming increasingly scarce.

ADDING VALUE

Infrastructure, including data centers, servers and networks, etc., is critical to insurers' abilities to deliver technology-enabled business capabilities, but few insurer IT groups would say their abilities to manage this infrastructure creates any sort of competitive value for their company.

Close to two-thirds of those who participated in our survey reported outsourcing at least some infrastructure or infrastructure management, and among those who outsource some, more than half are planning to expand.

Customer satisfaction with outsourcers varies widely, with onshore resources delivering higher satisfaction levels on average than offshore resources. Some of the lower-satisfaction levels with offshore outsourcing comes from challenges in managing communication, due to time zones and cultural issues, as well as an increased staff turn-over rate at many offshore providers, as the offshore outsourcers engage in talent wars in lower-cost countries.

During the past decade, there has been an important shift in the business drivers for outsourcing. There are few pure cost-reduction initiatives undertaken today. More of the demand now centers on enabling new capabilities rather than reducing the costs of current capabilities. Few organizations have the ability to meet demand peaks or to attract and support staff to meet specialized needs. In addition, many insurers find that infrastructure and commodity tasks can be done more effectively by partners. Outsourcing is an important part of insurance company CIOs' toolkits. Like any good tool, it can deliver great value when used effectively, and cause pain when used recklessly.

Outsourcing decisions should involve careful consideration of business goals, current capabilities and skills, how external partners will be managed, and how external staff will integrated into the company's culture as part of any cost/benefit analysis.

INNSight is exclusive commentary from Novarica. Matthew Josefowicz is partner and managing director at Novarica. This column was adapted from the firm's report, "Insurance IT Outsourcing Update."

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