Insurance carriers were originally attracted to outsourcing andoffshoring by the potential for significant cost reduction inback-office activities such as claim processing. However, asconfidence in these arrangements has grown, as providers havebecome more sophisticated, and as insurers have faced a challengingeconomic and competitive landscape, it has become clear thatefficiency improvement in the back office is not enough. Offshoreproviders can now offer many more value-added services costeffectively, and carriers are starting to take notice.

Thriving in this new environment requires a fundamental shift incarriers' philosophy away from the use of offshoring for costreduction purposes alone. Instead, offshoring must be evaluated asnothing less than part and parcel of insurers' strategic efforts toincrease growth and profitability.

The State of Offshoring

Although originally lagging other financial services sectors,the insurance industry has been involved in outsourcing for severalyears now. Starting with an earlier reliance on onshore TPAs, inmore recent years insurers have experienced significant growth inthe outsourcing of low-complexity, high-volume processes tooffshore providers. Initially, the objective was to achieve savingsthrough labor arbitrage, as large carriers such as HSBC and GElaunched captive operations in India. Third-party providers such asFirstsource and EXL soon started setting up shop, at least partlybecause of demand by carriers that could not achieve the requisitescale in offshore captive operations on their own. It took sometime for carriers to gain confidence in the arrangement. However,as illustrated by growth in BPO spending - an estimated 20 percentannually between 2005 and 2008 - the industry is achieving a levelof maturity that allows carriers of all sizes to exploreoutsourcing their back-end operations to control costs.

While the initial focus was on back-end claim processes, medicalclaims, review, as well as voice for such services as first noticeof loss (FNOL), sales lead generation, and other basic customerservice interactions, the current mix of services provided byoffshore entities is more varied and can be broken down into threekey service types, as illustrated in the table below.

Despite this broad range of available services, the essentialobjective for going offshore remains the same: carriers contemplateand undertake offshoring efforts for the primary reason ofachieving operational cost savings.

However, several critical developments are challenging thistraditional view of offshoring.

A number of trends are joining forces to fundamentally alter theoffshoring landscape. While these changes affect numerousindustries that use BPO services, they are particularly relevantfor the insurance industry, as it is highly competitive.

? More offshore locations: Known once as the'back office of the world,' India is facing increasing competitionfrom other offshore locations. The Philippines, Vietnam, andMalaysia, in particular, have been successfully taking away callcenter work. Meanwhile, companies in eastern Europe are pushing forEuropean language and complex transaction work, while China remainsa strong provider of BPO services, particularly for companies basedin Japan and South Korea.

? Rise of the KPO: Similar to BPO activities,Knowledge Process Outsourcing (KPO) services started with captiveunits staffed with cheaper skilled labor, such as IBM IndiaResearch Labs, GE's Analytics Center of Excellence, and theMcKinsey Knowledge Center. These were followed a few years later bystart-up analytics KPO organizations such as Adventity andInductis. Traditional BPO companies like Genpact and Firstsourceare now being challenged by these companies for the much highervalue-add, higher margin analytics business.

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

? Growth through acquisitions: As a result ofincreased competition and the rise of KPOs, the BPO industry hasseen considerable merger activity recently. Examples include therecent acquisition of Adventity by Sutherland Global Services, ofInductis by EXL, and several acquisitions by Aegis over the pastfew years.

? Fall of the captive: While carriers continueto operate entities offshore, captive organizations cannot alwaysachieve the requisite scale, and several insurers have been sellingtheir captive operations. Examples include Aviva Plc's sale of itsglobal back-office unit in India to WNS Holdings, and theacquisition of AIG's India IT captive by Mphasis. Others have beentrying to maintain critical volumes by attempting to sell excesscapacity to other carriers, but these efforts have not achievedbroad success.

? Arrival of the "industry expert" BPO:Provider organizations are rapidly developing insurance industryexpertise in-house, and moving towards industry-specifictransformational services as opposed to purely transactional ones.Examples include EXL, which, through Inductis, has doneconsiderable analytics-based marketing work with Aetna andSutherland Global Services, which supports carriers' claimmanagement, underwriting, sales, and policy servicing functions.This movement of providers "up the food chain," offering serviceswell beyond traditional back-office support, is perhaps the mostimportant recent development for insurance servicesoutsourcing.

Positive Implications for Carriers

The above developments provide significant opportunity toinsurers struggling in a tough economic and competitiveenvironment.

? Broader range of services: Third-partyoffshore providers can now supply a far greater range of servicesthan before, including several higher value activities. Examples inclaim processing include claim adjudication, indemnification, andrecovery/subrogation. BPO providers with onshore presence in theUnited States (for example, EXL, Sutherland) are also looking toadd locally based services such as claim adjustment andnegotiations.

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

? Improved risk management: Offshoring risksremain significant. However, the industry has matured significantlyand there is now much more information available about how toaddress risks effectively. Tools to manage operational risks suchas SLAs, data security management tools, and methodologies tocontrol intellectual property, have evolved and are more reliable.Sophisticated, creative approaches to risk mitigation, such asmethods to deepen relationships through performance based pricingmodels, are also being used. Greater interaction between thecarrier and the provider at the executive level, systematicperformance reviews (including customer reviews), ongoing BPOmetrics reporting, and periodic benchmarking against other BPOproviders 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 andaddressed when selecting a location or a partner.

Given these recent developments, offshoring can now generatemuch greater value than has been realized to date. Carrierscontemplating the offshore migration of certain functions, or eventhose already using BPO services, should therefore approach BPO asan essential part of their long-term strategic objectives forgrowth and profitability - the aggressive offshore captive strategyof Chartis/AIG is an early example of this. The winners in thisnext phase will be carriers that rapidly move up the food chain tothe outsourcing of more middle office, even front office processes- improving such key drivers as claim performance, underwritingquality, policy management, and customer satisfaction. This willentail approaching offshoring in a far broader, more strategic, andmore sophisticated fashion than ever before. The effort will bechallenging but the rewards will be significant.