From call centers to data centers, the insurance industry continues to turn to outsourcing in an effort to manage costs and secure access to resources. Information technology assets have become vital to ongoing operations and new growth, making these outsourcing relationships more than technology arrangements-they are now critical to business success. Combined with new regulatory mandates, this trend may be forcing carriers to push deeper and engage more proactively with outsourcing vendors.IT industry analyst firm Gartner Inc., Stamford, Conn., calculates that outsourcing will capture up to 33% of all IT services spending across industries by 2008-up from 26% in 2003. The analyst firm also predicts the insurance sector will be spending more than $10 billion on outsourced services by that time.

Historically, the insurance industry is no stranger to the practice of outsourcing, relates David Greenwell, vice president of the insurance practice for The Revere Group Ltd., a Chicago-based IT consulting firm. "The insurance industry was an adopter of outsourcing even before it was called 'outsourcing,'" he says. "We started using TPAs [third party administrators] for claims and benefits processing dozens of years ago."

Now, the practice of outsourcing is rapidly encompassing processes involving all aspects of IT and management. Many insurance industry observers say the industry is increasingly relying on outsourcing services firms to handle functions such as call-center operations, application development, testing, e-mail and e-business, and help-desk operations. Often, these engagements extend well beyond technology management, addressing processes that are core to the business and need to be treated accordingly. "You have to wear several hats when you work with an outsourcing solution. In one manner of speaking you are the customer, yet your ability to directly drive or control results may be constrained due to the contractual agreement with the vendor," says Rod Chamberlain, associate vice president for Farmers Insurance Group of Cos., Los Angeles, Calif.

"Technology is now a vital enabler of how we do business," says David Gordon, director of the outsourcing advisory practice for PricewaterhouseCoopers LLP, New York. "Your enterprise architecture is a key component of how successful you're going to be. IT is now core to businesses and creates value for the organization."

A recent report from LOMA, Atlanta, Ga., concludes that the practice of both outsourcing and offshoring has been rapidly rising and will have a huge impact on business operations in the years to come.

Ryan Savage, director of life and annuity application outsourcing for Computer Sciences Corp. (CSC), El Segundo, Calif., agrees with this assessment, noting that he has seen a significant rise in offshore outsourcing in recent years in his practice area. Savage says nearly all business processes can be broken down into manageable "chunks" that more easily lend themselves to outsourcing and offshoring arrangements.

"If you look at a total business process, you may think you can't offshore that," he says. "But if you start to chunk it, you can really offshore a lot of it for different reasons." A payment process, for example, would be cumbersome to administer offshore, but the various components that make up the process can be divided, he illustrates. "Once the money gets into the account, you can look at how the actual premium application visits the transaction system."

Outsourcing-both domestic and offshore-is proving to be a valuable tool for IT and related business operations of Zurich North America, Schaumburg, Ill. The carrier has initiated a number of significant engagements, including a $1.3-billion agreement with CSC in which 1,600 Zurich employees would be transferred to CSC.

"We're focusing our core expertise toward the insurance business-not toward the technical elements of IT and software development," says Andy Maier, CIO of Zurich. "We wanted to increase our flexibility on a global basis and be able to ramp our application capabilities up in those countries and business situations where Zurich financial services is allocating capital," he adds. In addition, Zurich was seeking improvements in process productivity and cost reduction.

FRAUGHT WITH RISK

However, since outsourcing arrangements are often complex transactions, they are fraught with risks. A cross-industry study from Deloitte Consulting LLP, New York, finds that 70% of large companies it studied last year report unsuccessful experiences with outsourcing projects. Almost half say the arrangements did not save money, and one-quarter of those companies brought functions back in-house.

"The outsourcing of services requires a complex series of tradeoffs: cost savings versus growth, speed versus quality of service delivery and maintaining organizational cohesion versus knowledge and innovation," according to the Deloitte report. "Vendors and organizations have inherently conflicting objectives, putting the latter's objective for innovation, cost savings and quality at risk."

Such conflicting objectives often surface in the form of perceptions of underperformance, cited by a majority of enterprises (59%) in the Deloitte study as the main reason for failures of outsourcing arrangements. The leading issues behind underperformance were over-expectations on the part of the enterprise, poor management and lack of skills and expertise.

The best way to overcome such mismatches in expectations is to approach outsourcing providers as partners in business processes, industry executives say. "It often requires a culture change to manage a sourcing partner as a partner and not as a typical supplier from whom you try to get the best price," says Maier.

Outsourcing partners are often deeply embedded in critical business processes, he explains. "You can't just switch from one partner to another; it would be too risky. You need to capitalize on the skills that your sourcing partner has built on your behalf. You need to manage the relationship in a very frequent way and gather data about how day-to-day service delivery is going. You need to analyze data; you need to have skills in supplier, contract and service management, as well as in finance and accounting. You're managing a strategic relationship, not a single transaction," says Maier.

Successful outsourcing arrangements, in fact, look beyond vendor and enterprise interests to the ultimate consumers of the enterprise's services.

"My responsibility is not only to look at my operations, but to look at the agent who actually uses the product," says Chamberlain. Farmers has outsourced its e-mail functions to USA.Net Inc., Denver, and regards the relationship as a key enabler of its online business capabilities.

"Always take into consideration the end user," Chamberlain advises. "What would their experience be? How can we improve their efficiency, their productivity, or how can we reduce the frustration in the use of the application or the experience?"

To ensure success in an outsourcing relationship, the service firm needs to provide advantages that the client company is unable to provide itself.

According to the Deloitte report, "vendors' structural advantages do not always translate into cheaper, better or faster services." In fact, such advantages could even easily be replicated by large enterprises themselves. This harkens back to many of the first major forays into outsourcing, when companies sought, often unsuccessfully, to offload inefficient processes.

YOUR MESS FOR LESS

"A phrase service providers used to throw around is 'your mess for less,'" PricewaterhouseCoopers' Gordon relates. "You give us your IT infrastructure, your IT organization, and we'll run it and drive costs out for you. In some cases, it's been very successful; in other cases, there have been some major problems on the contracts."

Since companies look to outsourcers to provide advantages they can't create on their own, Greenwell recommends that enterprises first make the processes under consideration for outsourcing as efficient as possible.

"Fix the processes to where they're low cost or best practice as much as you can before they're outsourced, and then let the outsourcer make its money off labor arbitrage-not off the fact that they're doing the same work more efficiently," he says. "You should be doing those processes as efficiently as you can to start with."

This calls for a well-thought-out governance structure, in which the outsourcing relationships are well-defined, authority is assigned to appropriate individuals or points of contact, information is systematically shared with all project participants, success is tracked and measured, and there is accountability and responsibility at all levels of the relationship.

In fact, the greatest risk in outsourcing arrangements has been a lack of governance, says Troy DuMoulin, executive consultant and practice lead in IT governance for Toronto-based best practices consulting firm Pink Elephant Inc., in which the project is not continually monitored and measured. However, many complex outsourcing arrangements occur on different levels, creating differing expectations about the relationship.

At Zurich, "we manage sourcing transactions on various levels," says Maier. "We have governance set up on a global level, and the contract is managed by two global teams, one from the Zurich side and one from the CSC side."

Contract milestones are measured with a scorecard approach that includes 28 service levels and 34 key indicators, he says. "If our supplier does not meet the prescribed service level, Zurich will receive a performance credit. Those are summarized, and the supplier then owes us money. Actually, this is not what we want-we want performance. We want our supplier to earn service credits by over-performing."

Driving the movement to better governance of outsourcing relationships are government regulations that mandate transparency across all critical processes, including IT projects that are outsourced. Thanks to a spate of new government regulations-Sarbanes-Oxley being one of them-ultimate responsibility for the actions and practices of outsourcing providers falls on the client.

"There's actually a philosophy change happening in the outsourcing market around governance," says DuMoulin. "There's a realization you can't separate IT from the business process. Legislation has acknowledged you can't outsource accountability for IT services and control. You can only outsource execution. You have to have one consistent practice, policy and process across all groups, regardless of who's paying your salary, whether they're considered internal or external."

DRIVE FOR BEST PRACTICES

This shift in outsourcing relationships is driving initiatives such as adoption of Information Technology Infrastructure Library (ITIL), a set of best practices sponsored by the United Kingdom's Office of Government Commerce that has seen widespread adoption in Europe and is now catching on in North America.

By adopting ITIL processes-such as service delivery, incident management, problem management, configuration management, change management and release management best practices-outsourcers may be able to validate that their best practices are in sync with and transparent to enterprise customers.

"ITIL gives you a general best-practice understanding of what the processes for IT should be and that a process is consistent across all groups, whether they're internal or external to the organization," DuMoulin says. "If you're going to do that, you need to line up behind an industry best-practice standard for what that process should be."

Such fusion between business and IT processes requires insurers to approach outsourcing firms as equal partners. To ensure the successful management of an outsourcing arrangement, the relationship should be mutually beneficial to both the end-user enterprise and the service provider.

Such alignment between client and service provider does not grow in a vacuum; it needs to be developed and managed on a proactive and ongoing basis.

"You cannot manage an outsourcing contract for exclusive benefit on one side," says Zurich's Maier. "You need to manage it to achieve a steady win-win situation."

Maier admits that no matter how much work is outsourced, "we are ultimately responsible for the total service delivery to the business. We have not sourced accountability and responsibility."

At Farmers, outsourcing partners are closely tied into the operations of the company. "We are not looking to outsource to a vendor, but rather build a relationship with a business partner in which both companies benefit from the arrangement," says Chamberlain.

For example, Farmers has a hands-on, daily working relationship with USA.Net, he says. "We have regular communication meetings, sometimes those will happen on a daily basis, if we're going through a change, modification or upgrade. We understand very clearly the roles and responsibilities of the relationship, and we have a very open and candid relationship. We're looking for somebody to come in and talk about problems and issues. Unless you have open dialog, you cannot resolve issues."

Chamberlain adds that he does not look at outsourcing engagements as "vendor management, but as partner management. My job is to work alongside the various companies with which we have forged a relationship. We manage those relationships, and for any relationship to grow, you have to nourish them. Sometimes it's better for them, sometimes, it's better for us. But at the end of the day, we have to make sure that the customer is satisfied, and that the customer's needs are being met in a very efficient and cost-effective manner. That openness has allowed us to get better value for our dollar, because it's easier for the vendor to understand the ground rules in which we operate."

Outsourcing Best Practices

* Get organizational buy-in to the outsourcing relationship. "Aside from cultural and skill differences, aspects such as internal communication structures, internal resistance and cultural sensitization may need to be adequately addressed" prior to commencing an outsourced relationship, according to a report from neoIT Inc., a global outsourcing consulting firm based in San Ramon, Calif.

* Clearly lay down the rules and responsibilities of the relationship. Both parties need to know what is expected of them. A study of major outsourcing deals conducted by Deloitte Consulting LLP, New York, finds that over-expectations on the part of the outsource customer is the single greatest reason for breakdowns in outsourcing engagements.

* Treat the outsourcing provider as a partner. "The most effective relations do not have the procurement-driven attitude of, 'we've got a contract, we do a contract, you hit these marks and if you don't, we beat you over the head,'" says David Gordon, director of the outsourcing advisory practice for PricewaterhouseCoopers LLP, New York. "Successful relationships are much more partnership relationships."

* Treat the outsourcing providers' staff as your own. The drive for auditability and accountability in IT and business processes-spurred by regulation-will result in more "business units 're-insourcing' the ownership of business processes, data and technology," says Troy DuMoulin, executive consultant and practice lead in IT governance for Toronto-based Pink Elephant Inc. DuMoulin emphasizes, however, that outsourcing is not being scaled back, but rather, the onus for "ownership" of relationships is being brought back in house. "You can't give away ownership and hold accountability," he explains. "This means the outsourcer needs to be treated as an extension of your organization. You're only outsourcing the people, not the management. The outsourcer now has to be viewed just as another group within the organization, which is just being paid by someone else."

* Give outsourcing partners the flexibility to improve the relationship. In the Deloitte Consulting study, 17% of enterprises cited loss of flexibility "as a major risk introducing rigidity and friction into the organizational value chain, thus impacting corporate growth and the speed and quality of service delivery. "Keep asking the question, 'how do you think your services can be changed or modified to improve the end result for the customer?" says Rod Chamberlain, associate vice president for Farmers Insurance Group of Cos., Los Angeles, Calif. Rigidity in the relationship can also come out of an engagement driven solely by cost savings, he adds. "If the principal comes in with the expectation to reduce costs, but ends up with a very rigid solution, the true cost for that less expensive solution is lack of responsiveness to the interaction between the two parties."

* Monitor and manage performance. "Regular monitoring of the status of deliverables, schedules, unresolved issues and collaborative planning of future work can go a long way in creating an atmosphere conducive to success," according to neoIT.

*Have an exit strategy. "The best way to get into a relationship is to understand how you will get out of a relationship," Chamberlain advises. "Establish your rules for success up front."

Joe McKendrick is an author and consultant specializing in information technology, based in Doylestown, Pa.

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