Risky Business?

Risky Business?

A summary of the "Risks of Being Virtual" session from the 2006 SOA Annual Meeting

Claims handling in Mexico, application data entry in China, experience analysis in India – what risk officer was asleep when these arrangements were put in place? This topic – the risks of outsourcing – was explored during a recent session at the Society of Actuaries (SOA) annual meeting in Chicago. To the surprise of many in attendance, the experience of the panel suggests that there may be as much (or more) risk mitigated through outsourcing as is assumed. Maybe the risk officer was driving these decisions…

The diverse panel included perspectives from a manager of an insurance company with extensive "virtual" operations and two executives from providers of outsourcing services (although the approaches to providing these services are very different). The session was driven by Mike O'Brien, Chief Insurance Analyst at Old Mutual. Old Mutual has been at the forefront of the outsourcing trend in the insurance industry. A fundamental strategy which Mike has been instrumental in executing has been "be the best or contract the best." Mike Kerrey, from TAG (a Perot Systems company), is an EVP with the Nebraska–based Third–Party Administrator. Mike provided a perspective on risk gleaned from working with companies who are leveraging TAG's core administration capabilities. Faith Trapp, VP of Business Development with Genpact, brought over 30 years of experience in delivering solutions to the insurance industry to the panel. Faith's broad understanding of risk issues reflects Genpact's comprehensive set of services and experience that spans the entire insurance value chain (including actuarial services – more on that later).

The Outsourcing Decision

The outsourcing trend – particularly the movement of services and process of "offshore" locations (e.g., India, China, Russia, etc.) – has received a lot of attention in recent years. "The world is flat," Thomas Friedman has proclaimed. But why are organizations outsourcing today? Mike O'Brien suggests "there are many drivers – financial necessity, coverage during peak periods of activity, access to expertise, desperation – but increasingly outsourcing is a matter of strategic choice." The strategic drivers include:

  • Transfer of volume risk
  • Gain access to expertise
  • Reduce cost and speed of market entrance
  • Secure predictable and reliable pricing
  • Leverage outsourcers higher volumes and continued investment
  • Focus on core differentiating activities

As Faith pointed out, "labor arbitrage gets the most attention, but companies do not typically choose to outsource a function based on price alone – and price alone certainly won't keep clients satisfied in the long term." Mike Kerrey also reflected that "the strategic drivers are creating the sustained demand for third–party services."

Risk Assessment from a Buyer's Perspective

There are risk considerations throughout the lifespan of an outsourcing partnership, but the decisions and analysis with greatest impact on the risk profile of the arrangement occur before the partnership begins – during due diligence and contract negotiation. Mike O'Brien recommends that the following risk dimensions should be assessed:

  • Operational Risk
  • Financial Risk
  • International Risk
  • Contractual Risk

The components of each risk – as applicable to evaluating an outsource provider – were detailed during the presentation and were explored by the panel. Although all are critical, Mike O'Brien emphasized that "not all risks should carry equal weighting." For example, exit provisions and strategies are of utmost importance from a risk management perspective.

The panel agreed that the initial risk assessment was the biggest determinant of the overall risk profile of the outsource partnership. Faith provided an interesting twist when she pointed out that Genpact could provide these risk assessment services (on an outsourced basis) through their actuarial and analytics unit, based in Bangalore and Gurgaon, India. The 150 strong group (which includes over 25 actuaries studying for their life insurance FSA designation) currently provides actuarial and analytics services to several Tier 1 insurers. Mike Kerrey also pointed out that TAG has helped many of their clients formulate and communicate risk impact assessments related to their outsourcing arrangements. "We have been through this process many times before and want the client to be comfortable with the terms. If it's not a win–win for us and the client, the relationship won't work."

The session concluded with Mike O'Brien reflecting upon his experiences with Old Mutual and the overall risk to his organization before and after the strategic decision to become more virtual. "Risk was a key reason why we chose to leverage our core competencies through outsourcing. Before using outsourced services, we had tremendous risk – we needed scale, but could not profitably manage our growth. We now have high–quality service, predictable expenses, and scalability. With our partners, we were able to achieve tremendous growth, and mitigate our growth–related risks at the same time." Results that would make any risk manager proud.