It may sound too good to be true: An outsourcing provider promises to take over a business process that consumes a lot of your company's resources. What's more, the outsourcing company claims it will perform the work more efficiently and at lower cost than you can do in-house.What right-minded insurance executive who's worth his salary, bonuses and stock options wouldn't consider such an offer?

As it turns out, more carriers are considering it. "We're seeing established insurance companies show a strong interest in contact center outsourcing, and a more limited interest in outsourcing their core processes, such as policy administration and claims processing," says Susan Cournoyer, senior analyst at Gartner Inc., a Stamford, Conn.-based research and consulting firm.

The potential benefits of business process outsourcing (BPO) are tempting-so tempting, in fact, that the insurance industry is doing a lot of "soul searching," according to Cournoyer. Insurance executives are thinking about whether or not those (core) processes-which account for about 40% of their IT budgets-can be outsourced, she says.

What is BPO? According to Gartner, business process outsourcing is the delegation of one or more IT-intensive business processes to an external provider that, in turn, owns, administers and manages the selected processes, based on defined and measurable performance metrics.

BPO can range from a single process such as payroll processing to a set of processes such as policy administration or claims processing.

Among its benefits, BPO can enable an insurer to focus on its core business, which was a key driver in Allmerica Financial Corp.'s decision to outsource IT application maintenance three years ago to Keane Inc., a Boston-based IT outsourcing firm.

"Our strategy was to bring Keane in to do our baseline (IT) activity," says Greg Tranter, CIO of Worcester, Mass.-based Allmerica. That way, "we could move our employees to focus on the more strategic development and newer applications."

Variable vs. fixed costs

Indeed, many insurers that have had success with IT outsourcing are now considering business process outsourcing. "Two or three years ago, the business was very skeptical about doing any outsourcing," Tranter says. "But we've proven it works. So now (business managers) are more willing to at least look at other alternatives."

Prudential Financial Inc. has been outsourcing IT projects since the mid-1990s. The Newark, N.J.-based financial services firm also has had success with Prumerica Systems Ireland Ltd., which it launched in 2002 to address the shortage of IT talent in the United States at that time. So, it's not surprising that in January 2002, Prudential signed a 10-year deal with Exult Inc., an Irvine, Calif.-based human resources BPO provider.

In a phased transition throughout 2002, Exult assumed operation of Prudential's accounts payable, payroll, benefits administration, employee data management, the employee call center, some staffing, training and compensation functions, third-party HR vendor management, and IT functions that support human resources.

Prudential retained "core" HR activities-those that are strategic or related to policy or design-"work that is closely tied to the company's business objectives," says Sekhar Ramaswamy, Prudential's vice president of human resources.

By outsourcing the transactional and administrative tasks to a firm with expertise and other clients, Prudential will be able to achieve scalability and variability of costs, Ramaswamy says. "We ran a pretty good (human resources) operation when we benchmarked it. But we didn't have the scale to keep pushing unit costs down."

In fact, variability of cost is a key driver in insurers' outsourcing decisions-for both IT and business processes. "When I became CIO three years ago, I brought in the strategy of multisourcing because I wanted to bring variability of cost into the organization-in case the business changes," says Allmerica's Tranter.

Peter Hanby, managing director of Royal & SunAlliance UK Life, has the same view. The Liverpool, U.K.-based insurer negotiated a variable cost structure in its 10-year, $450-million agreement with Unisys Insurance Services Ltd. (UISL).

R&SA UK Life closed its life insurance business last August, and UISL-a wholly owned subsidiary of Unisys Corp., Blue Bell, Pa.-will perform the processing and administration for R&SA UK Life's existing 2.4 million life and pension policies.

"We're running off our existing book," says Hanby. "And in these circumstances you need to get a variable cost-so that, as your policies mature and come off, you can keep taking out the cost associated with those policies."

Variability of cost was important in the Prudential/Exult BPO deal as well. Prudential went public in December 2001. As a result, it will become more active in mergers and acquisitions, according to Ramaswamy.

"We wanted to make sure we could shift up or down on our varying transactions," he says. "As the number of employees grows or shrinks, we (now) have a variable model as opposed to internal fixed costs."

Solid growth expected

Apparently, many other insurance executives are thinking along these same lines. "Some of our larger customers realize that back-office processing is not core to differentiating themselves in the marketplace, so they've asked us to take that over for them, which we have done," says Terry Meenahan, senior vice president of sales and account management in the life and health division of CSC's Finanical Services Group.

The El Segundo, Calif.-based provider of systems integration and outsourcing is ramping up its BPO business because the company expects solid growth in the market. And, according to analysts' projections, CSC is on the right track.

Gartner Inc. predicts the worldwide BPO market will grow at a compound annual rate of 9.2% over the next few years, reaching $178.5 billion by 2005. Financial services will account for 33% of the total (see "Worldwide BPO Market Forecast," page 26).

Although the insurance industry will be slower than banking and securities to adopt BPO, insurers will be "a force to be reckoned with in this market," Gartner's Cournoyer says.

Insurers tend to be conservative and risk-averse to new technologies and services, she notes. "Carriers came late to the game of e-business." But now they're actively launching e-business initiatives. "We can expect to see the same thing happen with business process outsourcing," she says.

Ron Pruett, managing partner of Boston Associates International, a Boston-based insurance venture advisory firm, thinks insurers are embracing outsourcing-and offshore outsourcing-three-to-five times faster than they've adopted e-commerce.

"Three or four years ago, if you tried to get an online auto quote and binder, it was difficult," he says. "Three or four years later, it's still difficult." Yet, he notes, thousands of citizens from India are working for American insurers in outsourcing arrangements.

Indeed, India has developed rapidly into a hub of both IT outsourcing and call-center activity (see "India Answers the Call," November 2002). With a highly educated workforce that earns a fraction of what U.S. workers earn, India has captured 57% of the offshore business processing market.

Many offshore Indian firms have developed successful IT outsourcing relationships with U.S. insurance companies, says Kimberly Harris, research director at Gartner Inc. As a result, "some of those firms are not only providing IT maintenance and development-they are now helping insurers with business strategy," she says.

"They're inching their way into the business side to leverage their relationship with existing customers who are already confident with their service."

Allmerica turned to Keane three years ago to create capacity, improve quality, and to "put its toe in the water" with outsourcing out of the states, says Tranter. At that time, the insurer was understaffed by 100 people and had difficulty finding IT employees before the dot-com era ended.

In the initial agreement, Keane took over maintenance of one Allmerica application supported by 24 people.

Because Keane has a "nearshore" operation in Halifax, Nova Scotia, 18 people were sourced in Canada. Today, Allmerica's partnership with Keane-now supported by 220 people-also includes 30 people working in India.

Not all about costs

Allmerica also became involved with Keane because the IT outsourcer has project management expertise.

"We wanted to bring some of that into our own organization-and we thought a good way to do that was through an outsourcing relationship," Tranter says. To be sure, Allmerica has saved money through its outsourcing relationship with Keane. "But that wasn't the main reason we did it," he says.

Surprisingly, that's what many insurers say when asked about their reasons for outsourcing.

In a survey of 114 U.S. insurance carriers, Gartner found that "not enough time" and "lack of staff with the appropriate skills" were more important factors for using BPO than lower costs.

Migrating to new technology is also a factor.

"Many companies are experiencing difficulties with existing legacy systems that they need to abandon," says Rob Bulthaup, executive vice president in the business engineering services unit of Swiss Re Life & Health America, Armonk, N.Y.

"One way to do that is to outsource that legacy system to a provider that will-as part of the agreement-upgrade it into a state-of-the-art system," he says.

Swiss Re Life & Health's Administrative Reinsurance business acquires existing blocks of business and puts them in runoff mode. The reinsurer outsources noncore processing and administrative functions of its Administrative Re business to third-party provider CSC.

Technology migration was part of the agreement between R&SA UK Life and Unisys. Unisys will transfer 90% to 95% of R&SA's policies to the most current Unisys platform. The upgrade was an expense that R&SA would have found difficult to justify if the policies were kept in-house.

"When a company is in runoff mode, shareholders are reluctant to invest in new technology," says R&SA's Hanby.

In addition, if the relationship between Unisys and R&SA UK Life turns sour, the modern technology platform will enable R&SA to find another outsourcing provider more easily.

"It would be far easier to find someone in the marketplace (with a new, consolidated platform) than if I went to market with 2.5 million policies on a 'ragbag' of systems and technologies," Hanby says.

That's not to say that Hanby is planning for the relationship to turn sour. In fact, he conducted intensive due diligence to avoid a parting of the ways with Unisys.

"You need to find an organization that is committed to the long-term," he says. "You don't want to tout your book around the marketplace every five or six years. It is an immensely disruptive exercise to do this."

Even with due diligence, however, disruptions do occur. Of all outsourcing contracts, 70% are renegotiated or cancelled, says Michael LaPorta, senior partner for insurance at Braxton, formerly Deloitte Consulting, New York.

Most contracts are cancelled or rewritten because the business changes in a way that has not been anticipated by either party, he says. "What may have looked like a good deal becomes a bad deal."

A poorly designed contract was an issue for Los Angeles-based Farmers Insurance Group, according to CIO magazine. After Farmers accquired Foremost Insurance in 2000, Farmers terminated a 10-year, $150 million IT outsourcing agreement that Foremost had signed with Integrated Systems Solutions, a division of IBM Corp.

According to Farmers' CIO Celia Claudio, the arrangement was supposed to save money, but the contract didn't enable the insurer to reap the benefits of total cost of ownership going down over time. Farmers brought the IT work back in house, and within the first year, began saving about $6 million per year.

Be flexible

To avoid bad deals, BPO contracts should be carefully designed and flexible, according to industry sources.

"People used to consider changing business circumstances to be a problem. But they're not a problem; they are a condition," says CSC's Meenahan. "So the contract must contemplate changing business circumstances. And you need to have a process in place by which both parties amicably sit down and deal with (changes)."

Insurers should also understand the savings that are available to them by redesigning a business process before they sign a contract with an outsourcing firms, says Braxton's LaPorta.

"If your cost to operate a business process is $10 million a year and you know you can drop that to $4 million by outsourcing it, why not also understand what you can reduce it to by redesigning the process?" he asks.

That way, an insurer can reap the savings of a tranformational outsourcing project-one that includes process redesign, he says. "That's the biggest mistake companies are making: They're leaving money on the table when they outsource without doing the redesign analysis first."

Successful outsourcing arrangements also hinge on open communication, flexibility and trust, according to insurers with experience.

Allmerica was looking for a business partner, not a vendor, when it initiated its relationship with Keane, says Tranter. "The relationship really matters," he says. "I wouldn't do business with someone whom I didn't feel really comfortable with-because you're going to have situations that are going to be very difficult to work through."

R&SA's Hanby concurs. A deal such as the between R&SA and Unisys has to be a partnership, he says. "You cannot run this through the contract every day. You either trust the person sitting opposite you or you don't."

Allmerica's Tranter credits the "give and take" his company has with Keane with enabling Allmerica to make difficult business decisions less painful.

More than a year into the IT outsourcing relationship, Allmerica had to reduce headcount. "Our business changed dramatically," says Tranter. "We had too many people."

The two companies negotiated another deal, whereby Allmerica transitioned 139 of its employees to Keane's payroll. Most went with work from Allmerica, but Keane placed 24 Allmerica staff members on other accounts. As a result, says Tranter, "we didn't have to lay off as many people."

Keane helped Allmerica solve a serious business problem. In turn, Allmerica aims to make Keane more successful, Tranter says. "How can I make this a win for them, instead of only a win for me?" That's good business, he says, because "if it's just a win for me and a loss for them, then it's ultimately a loss for me."

Similar to Allmerica's IT outsourcing contract, the R&SA/

Unisys BPO agreement also took into account staff issues. Approximately 1,700 R&SA employees will transfer in May to UISL. Only 150 R&SA employees will remain to handle actuarial duties, accounting for the overall book of business, regulatory reporting, and management of the BPO relationship.

"In the life business, you want to keep access to all the corporate knowledge and to the staff who understand your policies," says Hanby.

However, if R&SA had retained the staff, the company would have laid people off over the years-as its policies expired.

Instead, the outsourcing arrangement benefits the employees, as well as R&SA and Unisys. "Unisys can bring in more work (for the staff)," says Hanby. "That's the company's key drive. They want to use our sites and our people as a platform to bring in more business. And they will maintain that investment."

Indeed, it's important to have a good relationship with an outsourcing provider, but it's also prudent to have backup, advises Swiss Re's Bulthaup. Swiss Re outsources a small percentage of its business with Lincoln, Neb.-based TAG, even though it is happy with CSC, he says. "Vendors need to realize they have to stay competitive, and that you have other options."

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