Life insurance is a long-tail business: decades can elapse between the time when a policy is sold and the claim is made. Managing a portfolio of these policies, each with its own approximately 40-year time horizon, can present an operational and IT headache. As more and more policies expire, the overhead and servicing costs for the systems that manage legacy products are spread across a dwindling number of active accounts, driving per-policy administration costs higher. Since insurers are required to book capital reserves against future expenses, those costs and their anticipated increase over time can weigh heavily on the balance sheet.
The outsourcing of “legacy books” (or “closed books,” as they are also called) can provide a big lift to the industry, freeing insurers from managing the processes and IT that support these mature product lines. In addition, engaging providers that specialize in these areas typically yields substantial cost savings and can help insurers lower their capital requirements.
Despite the promise of outsourcing legacy products, the practice has yet to spread beyond the United Kingdom. There, regulatory requirements on the life insurance industry, enacted at the beginning of the decade, put severe pressure on margins and costs. While some insurers sold their legacy books outright, others turned to outsourcing. What began as an effort to relieve a growing administrative burden gained traction as insurers recognized that providers could drive down servicing costs through more efficient processes and better IT integration.
Outside the United Kingdom, however, insurers have remained skittish about handing over a large part of their operations to inexperienced vendors. Likewise, vendors have stayed on the sidelines, wary of investing in an unproven market. That chicken-and-egg dilemma may be about to crack as players in North America and continental Europe, prompted by rising administrative costs and persistently soft insurance markets, consider outsourcing their legacy book management.
Legacy Policies: Significant Processing and IT Costs
Servicing legacy books requires significant processing costs and heavy IT support on everything from policy and eligibility reviews to client statements and payouts. The core IT running most insurance processes has grown organically and through acquisitions, leaving insurers to grapple with a tangle of fragmented and outdated applications. The resulting complexity can account for up to 75 percent of the operating and underlying IT costs associated with servicing policies. Best-practice improvements such as process automation, platform consolidation, and data standardization can be difficult and costly to implement across large-scale enterprises. Moreover, such initiatives lie outside an insurer’s core business (see sidebar below, “Checklist: Getting started”).
In the cases we’ve seen, companies have achieved significant benefits by offloading this burden to a third party. With legacy book outsourcing, a provider manages the portfolio and all its support systems, including the IT assets, infrastructure, call centers, and support staff. While the insurer owns the customer relationship, the outsourcer assumes the day-to-day administration, such as taking customer calls and issuing statements and payouts. This arrangement enables providers to drive economies of scale in two ways. While an insurer may manage only one or two legacy book portfolios, providers can service several clients at once, spreading fixed costs over a larger volume of policies. Their experience in IT integration, process design, and work flow management means they can better target bottlenecks and inefficiencies. In addition, the greater visibility from streamlined systems helps managers track costs and performance measures more effectively. Together, these improvements typically reduce the total IT and operations cost per policy charged by the provider as much as 50 percent.
Under this arrangement, an insurer pays the outsourcer a fixed price per policy, turning an uncertain operational expense into a guaranteed cost. When talking to regulators, insurers can point to this fixed, lower-cost outsourcing fee to calculate their overall cost position more accurately, potentially reducing the capital reserves associated with legacy books.
In one case, executives at a life insurer asked its chosen outsourcing provider to manage its legacy portfolio. Their goal was to reduce business complexity, improve customer satisfaction, and trim costs. A joint vendor–insurer project team (composed of IT, operations, and business staff) implemented the effort in phases, first defining its scope and then identifying the systems, databases, and operational activities to transfer. The vendor’s mandate also was to improve service levels. It created a performance-management system to allocate resources to areas that had the greatest customer impact. As a result, the vendor reduced the number of customer complaints by 30 percent in four weeks, surpassing the initial target of 20 percent in six weeks. Next, it applied lean-management techniques to smooth process flows and improve transparency—for instance, by using simple imaging solutions to scan documents, thereby cutting down on paperwork and making information more accessible. With those milestones met, the vendor began simplifying the insurer’s IT architecture, trimming the number of platforms to seven (from ten) by merging systems and applications. In all, these actions cut servicing costs per policy by 40 percent.
The Path to Greater Adoption
Unlike other niche outsourcing markets, where small operators can step in as specialists, legacy book outsourcing is a volume business. Therefore, providers must secure a steady stream of new deals to maintain the scale needed to generate savings. They must also be willing to build teams with the ability to run and consolidate legacy insurance IT systems. This dynamic means that players must reach scale fast and establish themselves as leaders to thrive. Since the market leaves no room for second-tier players, even the more successful UK vendors have been reluctant to invest in other regions without some assurance of volume.
A few trends could open up the market significantly. Some vendors, hungry for growth, may pursue legacy outsourcing and its potential global market size of $3 billion to $7 billion as a strategic business opportunity. Alternatively, the magnitude of cost savings that some UK insurers have achieved may spur them to seek the same service for their non-UK operations. Outside investors, such as private-equity firms, might also step in as aggregators to buy legacy portfolios and outsource their management.
Legacy book outsourcing can help insurers respond to the challenges of today’s economic environment. By getting out of the time-consuming and expensive responsibility of managing these slow-growth businesses, insurers can concentrate on pursuing new opportunities with higher returns. This approach can also be applied to other financial-services products, such as mortgages, that require long-term servicing after the primary revenue-generating period has ended.
This article was originally published in McKinsey Quarterly. Copyright (c) 2010 McKinsey & Company. All rights reserved. Reprinted by permission.
Matthias Daub is an associate principal in McKinsey’s Frankfurt office, and Ferruccio Lagutaine is a principal in the Zurich office.
Checklist: Getting Started
Outsourcing legacy books can help relieve insurers of a major operating burden. To get started, CIOs and COOs should consider these four steps:
1. Analyze legacy portfolios and related systems and determine the financial case for outsourcing by comparing the internal cost to the average annual cost per policy that a provider charges.
2. Assess whether current IT and business-process-outsourcing partners have the necessary skills.
3. Compile an inventory of all affected systems, processes, and databases to determine what platform, software, and application environment the vendor will need to support.
4. Map the transition and conduct pilots to evaluate system performance, identify compatibility issues, and manage risk.
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Corrected December 10, 2010 at 2:55PM: yes