IT OUTSOURCING

Outsourcing is becoming more popular as a way of jumping straight to the latest IT platforms and e-business. It traditionally comprised (in the industry sector for example) functions such as run-offs and claims handling. In the computer age, fashions have come and gone as to how much expertise should be retained within the organization or contracted in from outside. The era of the bureau service was followed by moving data processing back in-house; then companies began exploring the advantages of facilities management and applications management.

What is now sometimes being called ‘‘traditional’’ IT outsourcing usually involved farming out the data center operations to a third party, and reduced cost was usually the prime motivation. But now the nature of the activities being considered for outsourcing, and the motives behind such a decision, are both changing.

The big issue at the moment is business process outsourcing (BPO) – putting whole business functions previously carried out inhouse into the hands of a third party, thereby benefiting fromeconomies of scale.

In extreme cases this may result in a scenario where, for example, an insurance company itself is concerned purely with the product design, the underwriting criteria, and the marketing strategy, leaving all other functions and processes in the hands of an outsourcing provider. Thus we arrive at the virtual model, where all that remains of the insurance company is a handful of experts focused purely on core activities. The lines distinguishing ‘‘IT outsourcing’’ from BPO may not always be clear, given that IT capabilities are crucial to all these functions, but it does take the concept a stage further from straightforward IT support and maintenance to putting customer and business-to-business contact in the hands of a third party.

Also, the drivers behind this trend go beyond cost considerations. They include increased competition, pressure on margins, fear of new entrants, increased cross border activity in Europe driven by the single market – together leading to a desire for more flexibility and faster time to market for new products. Also, and inevitably, the growth of e-business is an influence.

Faced with the need to get to grips with the world of electronic delivery channels, whether business-to-consumer or businessto- business, some insurance companies are looking to outsourcers to help them make that step change in technology overnight, rather than waiting for in-house development to run its course. Established insurance providers are uncomfortably aware that start-ups can benefit from the latest technology, without the baggage of integration with legacy systems. One way to combat them is to set up a separate e-business subsidiary operation (though this does nothing to improve the cost ratios of the parent operation) and the quickest way to set up such a subsidiary is to use a platform readily available from an outsourcer. This is the path already being taken by companies in the US, and Europe appears set to follow suit. The virtual company may be at the extreme end of the outsourcing spectrum, but the signs are that outsourcing in one form or another is a growth area.

Research published last year by Datamonitor predicted that expenditure by the European insurance sector on outsourcing would rise from $698mn in 1998 to $1.4bn in 2003, a compound annual growth rate of 15.8%. Commenting on the research, Datamonitor analyst Daniel Mayo said, ‘‘Outsourcing by insurers is set for dramatic growth. To capitalize on this technology, vendors are increasingly attempting to provide the business rather than the IT processes. However, in the short to medium term, it will be the basic IT services that experience greatest growth.’’

The drivers behind this growth identified by Datamonitor include the pressure to exploit multiple distribution channels, and the constraints on getting new products on to the market experienced by insurance companies burdened with multiple legacy systems – outsourcing can be a short-cut to achieving the required flexibility. Yet the prime driver identified by Datamonitor remains cost pressure, forcing insurers increasingly to focus on their core competencies.

At the same time, insurers are cautious as to which suppliers they will trust. The factor that deters some from going into outsourcing is a fear of putting business-critical processes and customer contact into the hands of a third party, over whom it may prove difficult to exert control. Datamonitor found that both life and general insurance companies quoted previous experience as the most significant factor in choosing an outsourcing supplier, rating a good reference site above pricing considerations. They also required potential outsourcing suppliers to be able to demonstrate a thorough understanding of the business issues facing the insurance sector. According to figures produced by IDC, the leading outsourcer world-wide is IBM Global Services, which recently secured a ten-year contract for outsourcing the host and backup systems of Meiji Life in Japan.

It is also the market leader in the UK insurance sector, and late last year announced a seven-year outsourcing contract with CGU, following on from a similar arrangement pre-merger with General Accident. Similarly, IBM was a provider of outsourcing services to Sun Alliance before its merger with Royal Insurance, and now provides IT outsourcing to the merged entity, Royal & Sun Alliance. This conforms to a pattern some observers detect whereby, after a merger where one party uses an outsourcer, the merged business is more likely to transfer the other side of the business to the outsourced operation too, thus leaving the outsourcing supplier to sort out the problems of integrating the two companies’ systems. ‘‘Outsourcing the data center was once done primarily for cost purposes or maybe to get rid of a problem, whereas now the customers are maturing,’’ comments Malcolm Carter, director of insurance services at IBM Global Services. Costs and service delivery are still important but now customers are looking for added value. ‘‘In general terms it’s about how to survive the next ten years.’’ As an example, Carter quotes the deal announced last year between IBM and Parion, the German composite insurance company formed from the merger of Gather Versicherungen and Berlin-Kolnische Versicherungen (BKV) in 1997. Gather already had an outsourcing arrangement of a fairly conventional kind with IBM, covering data and desktop services, but post-merger the contract was renewed on a broader basis. It now constitutes more of a long-term partnership, covering application maintenance and development, and charged with the need to develop an IT solution strategy for the merged corporation. Carter characterizes this sort of deal as something more than the traditional IT outsourcing arrangement, being ‘‘a fuller-scope outsourcing for information technology’’ – though not yet extending as far as BPO.

This, he says, is a trend evident across the industry. IBM’s main business consists of ‘‘traditional’’ IT outsourcing, but it is now moving into BPO, starting with generic areas such as call centers, procurement systems, and human resources systems. Policy administration is also on the list of targets. ‘‘Technology may be the solution to some of the cost and delivery issues, but it’s also the problem,’’ says Carter. ‘‘A lot of insurance companies are saying they don’t know how to keep up to date.’’ As IT moves ahead, the skills of the applications developers get rapidly out of date. Hence the attraction of outsourcing IT and just concentrating on the core competencies, and even outsourcing key functions such as claims – although maintaining control is, Carter acknowledges, still a big issue. Towry Law has recently embarked on a major change program that involves outsourcing most of its back-office operations.

This may be described both as a strategic business process and a transitional outsourcing partnership, in that the company has turned to a third party – CMG – to run major areas of its operation and to advise on and implement the introduction of new technology platforms. The IFA has signed a ten-year contract with CMG to cover management consultancy, IFA software systems, and technical expertise. Together with arrangements with other third party suppliers to cover its finance and investment areas and payroll systems, this will create a virtual operations company, allowing Towry Law to concentrate on relationships with clients through its sales operation, which remains in-house. IT projects on which CMG will provide consultancy include the implementation of Towry Law’s e-commerce strategy and its preparations for the introduction of stakeholder pensions. Keith Webb, chief operating officer at Towry Law since 1998, says that the company had to take a fresh look at the whole of the back-office operation, including new IT and new human resources practices, and to address the financial and regulatory implications of a policy of growth by acquisition. ‘‘Technology is the key to moving forward and you need the full range of skills to do so. A small organization can’t possibly employ that range of skills, so it has to look at utilizing the professionals,’’ he says. Insurance companies, saysWebb, have traditionally prioritized work by setting out how much they can afford to spend, how many personnel they can afford, and then seeing how many projects they can attempt within these constraints. An alternative approach, he suggests, in such a scenario where a major investment in IT is clearly required to drive the business forward, is to bring in third parties to provide the technology and the necessary manpower but without swelling the in-house headcount. In the case of Towry Law, he says, there were two options.

‘‘One was to recruit people directly, but it’s hard to get the right caliber of people when you are a small company, and it takes time. The other option was to identify organizations that could work with us and deliver the skills we needed.’’ In the event, Towry Law has chosen to go beyond a conventional outsourcing set up and form a strategic, longterm partnership: ‘‘CMG will not only manage our existing applications but also advise us what systems we should deploy.’’ Kevin McCarthy, sales director for life and pensions at CMG, says: ‘‘The major change we have seen in the last ten years is the outsourcing of what have historically been considered core activities. Providing you have a strong brand you can get almost anyone to provide the services.’’ In the US, PMSC operates a substantial outsourcing operation and its clients include a number that can be said to be truly virtual insurers, where the core company is stripped down to the absolute minimum. Kenneth Branham, senior vice president at PMSC in Atlanta, explains that outsourcing in general, and also the virtual insurer model, has seen strong growth in recent years. ‘‘Our second quarter results [1999] showed a huge increase in outsourcing revenues for us – a 43% increase over last year. We are currently outsourcing for 70 companies on the property/casualty side and 15 on the financial and life side.’’ Branham says US insurers are increasingly accepting the proposition that they can outsource the execution of their business processes without relinquishing control over key factors, such as underwriting rules, claims guidelines, financial investment decisions, and customer service standards. While ‘‘traditional’’ data center and IT outsourcing is still a big market, the significant growth is in BPO. And there is ‘‘a big, big trend’’ towards the virtual concept.

Established companies are opening up virtual divisions to try to get into e-commerce – sometimes under a different name so as not to cause conflict with the broker channel. E-commerce is the key driver here. Most companies are not equipped for it, though they do recognize that exploiting the Internet can allow them to cut down the number of people required on the processing side. But taking the traditional approach of building the systems in-house loses time in the race to market. The implications of mergers and acquisitions too are starting to create a need for outsourcing in the US, says Branham, with some companies finding that after a merger they are fatter and have higher expense ratios than before. Another more common driver in the US is the desire to expand into new regions, without establishing another office there. But above all, says Branham, e-business and the virtual model are going to drive a boom in outsourcing.

‘‘It’s going to be an explosion – the financials prove this is the way to reduce costs.’’ Nearly three years ago, Reliance National Insurance set up a subsidiary called CyberComp in order to enter a niche area – workers compensation business for small companies with under 50 employees. By using the Internet to reduce its product distribution costs, CyberComp was able to make profitable inroads into a market many insurers regarded as unprofitable and of little interest. Low margins and a product seen as a commodity meant that many companies and agents thought the time spent marketing these policies the traditional way was not cost effective. CyberComp decided both to use the Internet as a low cost route to deliver quotes to its independent sales agents – around 500 of them in 43 states – and to outsource most of its operations. As a consequence it was able to move from concept to launch in only four months. PMSC provides the systems, networks and between 50 and 60 staff to handle underwriting, claims management, commission payment, and all areas of administration.

CyberComp itself has only 35 employees, 25 of whom are regional sales people who liaise with agents and recruit new agents. Control of the rules governing underwriting and claims remains within Cyber- Comp. In its first full year of operation, 1998, CyberComp wrote $81mn of workers compensation business, up from $31.5mn the year before: 70% of the business is written on-line, reducing both costs and the time taken to provide quotes. In the UK, former London market run-off specialist Eastgate has become an established BPO provider, chiefly in the areas of claims management and back-office operations. Eastgate’s latest venture, launched jointly with Cap Gemini in the third quarter of 1999, is very much in tune with the evolving landscape of e-business and may well be a sign of things to come.

Called Consumer Direct, it offers an off-the-shelf, outsourced ebusiness service for personal and volume commercial lines. This could give new entrants a fast track into the insurance market, and may also prove attractive to existing players seeking to establish new ventures. The task of integrating an existing, traditional insurance business with an e-business using new delivery channels is so daunting for some organizations that, rather than be left behind, it seems likely some will opt to set up separate e-operations. Though electronic delivery channels are viewed as low cost by comparison with others, there are capital start-up costs to consider.

Combine this with the desire not to be left behind in the rush to grab market share in these emerging channels and the quickstart outsourced or virtual operation starts to look very appealing. Consumer Direct will be able to operate through a range of new delivery channels, including retail Internet sites, corporate intranets, kiosks, digital TV, and personal digital assistants. The distribution infrastructure will be integrated with Eastgate’s full-cycle business process outsourcing service and is based on Cap Gemini’s Service Delivery Framework, using a mixture of Oracle and Sun technology. Though a version will be ready by 2002 for intermediaries obtaining quotes from a panel of insurers, the first release was aimed at direct insurers, and at banks and retail groups wanting to offer products under their own brand names but sourced from an established insurance company. The service includes policy processing, claims management, help-lines, and assistance services.

Customers will be able to make policy adjustments, renewals, and claims themselves. The claims notification module includes a work queue, alerting agents when to phone customers back, and a claimstracing function that allows customers to log on and check on the progress of their claims. ‘‘Consumer Direct’s pricing will reflect the desire of distributors to have the cost structure tied to premium volumes rather than massive up-front costs,’’ says Max Carruthers, chief executive of Eastgate’s general insurance division. A flexible pricing model aligned with the business volume includes a set-up fee, a charge per transaction, and a charge per new product added or modified. In this way the client avoids the high up-front capital cost normally associated with such a start-up. And it may prove attractive to new entrants with strong brands anxious to make their mark quickly and cost effectively.