Outsourcing finding efficiency

The recent advancement of outsourcing within the property and casualty insurance industry – which today has seen the breadth of functions affected ranging across the various areas of the business compared with the past’s narrow application to the investment management and non-core areas of operations – prompted the Office of the Superintendent of Financial Institutions (OSFI) to issue a “Best Practices for Outsourcing” guideline last January.

Up to the point of OSFI releasing the guideline, very little public attention was given to what insurers were outsourcing. In fact, as an industry, little appears to have been done in researching potential efficiencies of outsourcing, and for that matter, inefficiencies that may arise in doing so. As such, ventures into outsourcing have been pioneered by companies on an individual basis, and successes and failures remain generally unknown. The result of which has produced mixed views to the potential long-term advantages of outsourcing.

Zurich Canada therefore surprised many in the industry when, in November last year, the insurer announced that it will outsource its “express claims” and call center for the initial reporting of claims functions to Cunningham Lindsey Canada Ltd., a global third party claims management administrator. Express claims, which average less than 30 days for settlement and do not involve any form of litigation with payouts rarely exceeding a $10,000 threshold for auto and $6,000 for property, account for about two-thirds of Zurich’s claim volume. In doing so, Zurich is transferring approximately 65% of the 75,000 claims it handles each year, outside. “We needed an environment with enhanced technology with respect to telephones and other underlining claims management system,” says Julie Welborn, Zurich’s senior vice president of claims. “Cunningham Lindsay has already created that environment. We found we could link up with that very efficiently.” Welborn says it is too early to talk about savings, but some competitors are already trying to add up the costs.

“Zurich may have very legitimate reasons for doing what they are doing,” explains George Cooke, president of Dominion Insurance. “But I see claims as part of my core business. I want to be able to control it so that it is done better than somebody else. Otherwise, you’ve lost your advantage.”

Dominion contracts equities and fixed income to outside investment managers, and will ‘throw’ single claims in remote parts of the country to an independent on an ad hoc basis. But expect groups such as Dominion’s actuarial department — another function several insurers are shifting out the door — will remain firmly inhouse. “There’s certain things I have to be better at than other people to give me a strategic advantage. That level of expertise is hard to duplicate over a short period,” Cooke insists.

Welborn does not believe, however, that Zurich is giving up control or expertise by shifting express claims out of its Ottawa and Moncton call centers, and into the Hamilton and Montreal centers of Cunningham Lindsey. “We’ve put into place a very comprehensive service level agreement. And, we are surrounding the partnership with internal Zurich claims management employees. We have implemented proper internal controls.”

Gregg Hanson, president of Winnipeg-based Wawanesa Insurance Co., was not surprised by Zurich’s expanded outsourcing strategy, noting that this trend is already firmly imbedded in the U.S. market. And outsourcing of claims may fit well with the philosophy of some industry analysts. “There can be too much influence both ways between claims and underwriting when you’re under the same roof,” Hanson points out. “There are some senior managers at our company who believe that claims should not only be a separate department — but a separate subsidiary.”

Nevertheless, Wawanesa appears content outsourcing periphery services such as promotional catalogues and investment functions. “There are all kinds of investment specialists. You can’t find that in one investment manager, let alone have all your investments managed internally. It is better to have a stable of investment managers in different specialties,”

Growing popularity

The demarcation appears to be the customer service point. But Hanson notes that there is no single model for success. “Outsourcing is a growing trend. As we get closer to full employment there are a lot of suggestions of what to do as the size of the workforce diminishes. There are an awful lot of challenges in attracting and maintaining staff. I can see that some companies would see a business model where they may like to outsource certain functions so they don’t have those challenges.”

Employment — including adjusting staff levels to accommodate peaks in business volume — is just one of the factors driving a renewed focus on outsourcing. There are others. And with them, risks. “I suspect the trend toward outsourcing has little to do with the specifics of the property and casualty insurance industry, and more to do with the broader financial services picture,” Cooke muses. “Banks, lifecos and trust companies are all involved in a variety of outsourcing arrangements.”

Jan Tomlinson, president of Chubb Canada is not as convinced. “It would appear that the industry is looking more at outsourcing than what they were two years go, but I don’t think it’s the new players. You take a look at the banks and their expense ratios are no better than the industry’s ratios. What’s driving outsourcing is expense ratios overall. There is an interest in outsourcing as a result of economies of scale. It may be the better alternative if you can’t build the expertise inside.”

Chubb outsources functions such as payroll. “Our business is very specialized. Our premise is, we’ve got to deliver product — which is the policy — and insurance which is the claims — very carefully,” Tomlinson adds.

Welborn, who also worked for Zurich in the U.S., discounts a suggestion that Canadian insurers are racing to catch up with their southern counterparts. “I have, over the past nine months, had to look at the Canadian marketplace and compare it with the U.S. In terms of outsourcing, it’s an emerging trend in both countries. But I couldn’t say that Canada is further behind.”

Gaining flexibility

If the reasons for an increase in p&c outsourcing appear blurred, the benefits and risks are very clear. According to OSFI, outsourcing can convert a fixed cost into a variable expense, thereby providing improved operational flexibility. It can also free capital funds for other purposes or enable management to focus on strategic business services. “It’s what your strategic plan is and how you are able to use outsourcing to leverage resources,” Welborn adds. “We did a comprehensive due diligence, internally as well as externally. We had to determine whether or not we had the capacity to build a new call center environment internally.”

A factor which many insurers tend to regard as a serious disadvantage to outsourcing is management delays. Hanson notes, “it’s inherent when you do some outsourcing there are going to be delays in decision making. You either have to give up control and let [a third-party] settle the claim, or you have to set authority levels and parameters where they prepare a neat and tidy report and put their initials on it.”

One risk that appears to be widely overlooked is re-building inhouse core competencies when outsourcing strategies fall below expectation. “If you outsource any particular function you risk losing the skill inhouse,” Hanson says. “It’s really difficult to return that skill into the operation if you decide you don’t want to outsource, or outsourcing isn’t working — or you have not found the right partner.”

Setting parameters

To reduce the level of risk associated with outsourcing, OSFI is insisting on a comprehensive risk management program for all federally regulated financial institutions (FRFI), including:

Establishing an outsourcing risk policy;

Identifying existing or potential outsourcing risks;

Establishing policies governing the ris ks which arise; and

Developing arrangements to monitor and control associated risks.

Cooke suggests, however, that OSFI’s guidelines apply more to financial institutions outside of the p&c industry. “I can’t imagine the particular guideline they issued was occasioned by what’s going on in p&c industry. We came along for the ride with our own little twist.” Even so, Cooke says OSFI’s guidelines have added to the regulatory paper burden already faced by the industry.

What OSFI has done is draw up a framework for a practice that is expected to increase over the next five years, whether or not other insurers follow Zurich’s lead.

“There are opportunities in the market place to look at other outsourcing opportunities as they come up,” Welborn says. Two such areas are in the specialized niche markets and e-business.

“The greater driver down the road will be the Internet,” Tomlinson contends. “As customers become more comfortable with the ‘web there will be more means of creating cost efficiency. There is going to be more outside expertise with Internet enabled products.”

What is clear is that there will be no set strategic formula to outsourcing in the p&c field, although some predict a common approach will be guided by OSFI. “Outsourcing has been around for sometime and it will continue to be here,” Cooke points out, “I doubt very much that companies will follow Zurich’s lead and outsource claims handling, although it might be they see something the rest of us have missed.”

If that is the case, Cooke predicts that other insurers will reach to grab a similar advantage. Uniformity — that too is one of the hidden risks of outsourcing. “If there is something there, it is there for everyone else to grab onto,” he adds.

Outsourcing as a cost-efficiency option is finally garnering attention in Canada’s property and casualty insurance industry. Insurers are looking to third-party contracts to address changes in technology, improve profit margins and confront tight labor markets.