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Outsourcing: Regulators Take Notice


March 1, 2004   by Brian Reeve


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Outsourcing is a trend that is likely to continue to increase within the property and casualty insurance industry. The issue of exporting jobs to offshore jurisdictions is rapidly becoming an important political issue. The outsourcing to India by English insurance companies has become a particularly sensitive issue.

The basic advantage of outsourcing is that it allows the insurance company to focus on its key business functions. It allows an insurance company to avoid additional costs as its business expands. It allows “variable costs” to be substituted for “fixed costs”. Offshore outsourcing also allows for significant reductions in processing costs.

Insurance companies that wish to be involved in offshore outsourcing will face additional problems in addition to business risks and perception issues. Insurance regulators will likely become increasingly concerned as outsourcing becomes more popular.

OUTSOURCING TYPES

The most common type of outsourcing currently done by insurers companies is with respect to data processing. Many insurance companies have transferred parts of their data processing operations to companies such as IBM.

The running of call centers for telemarketing is another common type of outsourcing. The call center trains the required employees. It also provides licensed agents and insurance brokers if required.

It is likely that business process outsourcing (BPO) will become more important to insurers over the coming years. BPO involves the outsourcing of entire business functions such as underwriting and claims handling to third parties. BPO is increasingly being done to offshore companies. BPO is different from traditional types of outsourcing such as data processing as it transfers entire business functions to a third party. As such, there is already some precedent in the insurance industry for the use of BPO. Some insurance companies have used managing general agents (MGAs) for specific programs or lines of business. It is normal for a MGA to provide all of the functions for a specific line of business including underwriting, claims handling and accounting.

The trend to BPO outsourcing is increasing as certain types of business functions are transferred to companies in India. A major competitive advantage exists for India since it has a large number of highly educated, English speaking employees that work for significantly lower salaries than in North America or Europe. The traditional view of offshore outsourcing is that it is only suitable for large volume, repetitive transactions. The new view is that outsourcing companies in countries such as India are able to offer a full range of business functions on a sophisticated basis with quality and service better than North America at a much lower price. The types of insurance outsourcing currently being done in India include licensing of agents, underwriting, customer complaints, administration of in-force business, claims handling and accounting.

REGULATORY ISSUES

The Office of the Superintendent of Financial Institutions (OSFI) has a number of concerns with respect to the outsourcing of business functions by federally regulated financial institutions. The main concern of OSFI is that outsourcing to third-parties will increase business risk. If the outsourcing is to an offshore company there will also be political risk as well as cultural issues. OSFI has recently introduced a new guideline with respect to outsourcing. The guideline replaces a similar one that was issued in 2001. As a result, the control of outsourcing has clearly become an important regulatory issue.

OSFI requires all insurance companies to develop an outsourcing policy. The outsourcing policy requires a risk assessment to be done of any outsourcing arrangement. The main issues that OSFI expects to be assessed with respect to the materiality of an outsourcing arrangement include:

The impact of the outsourcing arrangement on the operations of the insurance company;

The ability of the insurance company to maintain appropriate internal controls and meet regulatory requirements;

The costs of the outsourcing arrangement; and

The ability to find an alternative service provider if the outsourcing arrangement is no longer available.

It will also be necessary for a risk management program to be implemented. The risk management program will have different requirements depending on the materiality of the outsourcing arrangement. The materiality of an outsourcing arrangement will depend upon how important an influence it will have on a significant line of business of an insurance company.

As part of the requirements of the new guideline, OSFI will require a written agreement for all outsourcing arrangements. The requirement for a written agreement will also be applicable for services provided by the head office of a foreign insurance company. OSFI considers services that are provided by the head office of an insurance company to also be outsourcing.

OSFI’s outsourcing guideline does not require the federal regulator’s approval for an outsourcing arrangement. However, it is necessary for any arrangement to be in compliance with the outsourcing policy of an insurance company. It is likely that as additional outsourcing to India and other jurisdictions outside of Canada occurs, OSFI will develop additional outsourcing rules. One of the current concerns of the federal regulator is that the outsourcing company has adequate provisions for disaster recovery and back-up. It is also necessary for the outsourcing company to allow access to OSFI in the event that it wishes to review its operations.

NEW ERA

Greater use of outsourcing is inevitable for the insurance industry. Regardless of whether outsourcing occurs in traditional forms such as the use of MGAs or call centers, or in new forms such as BPO arrangements in India, regulators will be required to spend more time determining how to control these activities.

Perhaps the most important strategic value of outsourcing is it allows insurers to focus on core operational areas such as distribution, product development and customer service. The challenge for insurance regulators will be that, as more of an insurance company’s business functions are outsourced, it will be increasingly difficult to regulate them.