Insurance carriers were originally attracted to outsourcing and offshoring by the potential for significant cost reduction in back-office activities such as claim processing. However, as confidence in these arrangements has grown, as providers have become more sophisticated, and as insurers have faced a challenging economic and competitive landscape, it has become clear that efficiency improvement in the back office is not enough. Offshore providers can now offer many more value-added services cost effectively, and carriers are starting to take notice.

Thriving in this new environment requires a fundamental shift in carriers' philosophy away from the use of offshoring for cost reduction purposes alone. Instead, offshoring must be evaluated as nothing less than part and parcel of insurers' strategic efforts to increase growth and profitability.

The State of Offshoring

Although originally lagging other financial services sectors, the insurance industry has been involved in outsourcing for several years now. Starting with an earlier reliance on onshore TPAs, in more recent years insurers have experienced significant growth in the outsourcing of low-complexity, high-volume processes to offshore providers. Initially, the objective was to achieve savings through labor arbitrage, as large carriers such as HSBC and GE launched captive operations in India. Third-party providers such as Firstsource and EXL soon started setting up shop, at least partly because of demand by carriers that could not achieve the requisite scale in offshore captive operations on their own. It took some time for carriers to gain confidence in the arrangement. However, as illustrated by growth in BPO spending - an estimated 20 percent annually between 2005 and 2008 - the industry is achieving a level of maturity that allows carriers of all sizes to explore outsourcing their back-end operations to control costs.

While the initial focus was on back-end claim processes, medical claims, review, as well as voice for such services as first notice of loss (FNOL), sales lead generation, and other basic customer service interactions, the current mix of services provided by offshore entities is more varied and can be broken down into three key service types, as illustrated in the table below.

Despite this broad range of available services, the essential objective for going offshore remains the same: carriers contemplate and undertake offshoring efforts for the primary reason of achieving operational cost savings.

However, several critical developments are challenging this traditional view of offshoring.

A number of trends are joining forces to fundamentally alter the offshoring landscape. While these changes affect numerous industries that use BPO services, they are particularly relevant for the insurance industry, as it is highly competitive.

? More offshore locations: Known once as the 'back office of the world,' India is facing increasing competition from other offshore locations. The Philippines, Vietnam, and Malaysia, in particular, have been successfully taking away call center work. Meanwhile, companies in eastern Europe are pushing for European language and complex transaction work, while China remains a strong provider of BPO services, particularly for companies based in Japan and South Korea.

? Rise of the KPO: Similar to BPO activities, Knowledge Process Outsourcing (KPO) services started with captive units staffed with cheaper skilled labor, such as IBM India Research Labs, GE's Analytics Center of Excellence, and the McKinsey Knowledge Center. These were followed a few years later by start-up analytics KPO organizations such as Adventity and Inductis. Traditional BPO companies like Genpact and Firstsource are now being challenged by these companies for the much higher value-add, higher margin analytics business.

? Advent of the ITO/BPOs: A significant number of IT outsourcing companies now also provide BPO services to the insurance industry, positioning themselves as end-to-end service providers. Examples include Accenture, Infosys, and IBM.

? Growth through acquisitions: As a result of increased competition and the rise of KPOs, the BPO industry has seen considerable merger activity recently. Examples include the recent acquisition of Adventity by Sutherland Global Services, of Inductis by EXL, and several acquisitions by Aegis over the past few years.

? Fall of the captive: While carriers continue to operate entities offshore, captive organizations cannot always achieve the requisite scale, and several insurers have been selling their captive operations. Examples include Aviva Plc's sale of its global back-office unit in India to WNS Holdings, and the acquisition of AIG's India IT captive by Mphasis. Others have been trying to maintain critical volumes by attempting to sell excess capacity to other carriers, but these efforts have not achieved broad success.

? Arrival of the "industry expert" BPO: Provider organizations are rapidly developing insurance industry expertise in-house, and moving towards industry-specific transformational services as opposed to purely transactional ones. Examples include EXL, which, through Inductis, has done considerable analytics-based marketing work with Aetna and Sutherland Global Services, which supports carriers' claim management, underwriting, sales, and policy servicing functions. This movement of providers "up the food chain," offering services well beyond traditional back-office support, is perhaps the most important recent development for insurance services outsourcing.

Positive Implications for Carriers

The above developments provide significant opportunity to insurers struggling in a tough economic and competitive environment.

? Broader range of services: Third-party offshore providers can now supply a far greater range of services than before, including several higher value activities. Examples in claim processing include claim adjudication, indemnification, and recovery/subrogation. BPO providers with onshore presence in the United States (for example, EXL, Sutherland) are also looking to add locally based services such as claim adjustment and negotiations.

? Access for mid-sized carriers: Because mid-market companies didn't see the same sort of cost savings that larger enterprises did, they had been reluctant to outsource for reasons of cost savings alone. In fact, Mid-market or smaller-sized companies have always looked to third-party service providers for cheap access to new skills and technology as well. With the industry's ability to now provide more higher value-add services cost effectively, going offshore is more attractive and viable for mid-sized (and even smaller) carriers than ever before.

? Improved risk management: Offshoring risks remain significant. However, the industry has matured significantly and there is now much more information available about how to address risks effectively. Tools to manage operational risks such as SLAs, data security management tools, and methodologies to control intellectual property, have evolved and are more reliable. Sophisticated, creative approaches to risk mitigation, such as methods to deepen relationships through performance based pricing models, are also being used. Greater interaction between the carrier and the provider at the executive level, systematic performance reviews (including customer reviews), ongoing BPO metrics reporting, and periodic benchmarking against other BPO providers all ensure a far more effective operational environment. Non-operational risks, such as the risks of political instability, remain; however, these can also be systematically evaluated and addressed when selecting a location or a partner.

Given these recent developments, offshoring can now generate much greater value than has been realized to date. Carriers contemplating the offshore migration of certain functions, or even those already using BPO services, should therefore approach BPO as an essential part of their long-term strategic objectives for growth and profitability - the aggressive offshore captive strategy of Chartis/AIG is an early example of this. The winners in this next phase will be carriers that rapidly move up the food chain to the outsourcing of more middle office, even front office processes - improving such key drivers as claim performance, underwriting quality, policy management, and customer satisfaction. This will entail approaching offshoring in a far broader, more strategic, and more sophisticated fashion than ever before. The effort will be challenging but the rewards will be significant.

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Offshoring Trends: From Cost Reduction to Growth Strategies

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