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Insurer outsourcing: Pros and cons

White paper explores business strategies and legal risks

By Phil Zinkewicz

It has been said that during the Revolutionary War, the comic tag line was “Let George do it.” In other words, when it came to tasks that were viewed as too difficult or time consuming, they were considered best handled by the man who would later become known as “The Father of Our Country.” Today, we call that passing the buck.

These days, a good many businesses are embracing the “Let George do it” philosophy—that is, outsourcing specific business functions for economic reasons. The insurance industry is no different, with many insurers on both the life and P-C sides of the business outsourcing certain areas of their operations in an effort to cut costs. However, the insurance industry is different from many other businesses in that insurers have always prided themselves on the relationships they have built with agents and insureds. By outsourcing certain operations, are insurers sacrificing those once-cherished relationships?

The Lawson Firm, a Cleveland-based law firm that provides legal services to insurers and the companies they serve, recently completed a white paper on that subject. The paper is titled “Business Process Outsourcing and the Insurance Industry: Managing Business and Legal Risks.” The paper’s author, Scott Lawson, says that, over the past several years, outsourcing has proved to be a profitable strategy for many U.S. companies. He says studies have shown that companies can dramatically reduce costs by outsourcing selected business functions such as payment processing, computer program development and call center administration.

“Within the insurance sector,” says Lawson, “it has been estimated that roughly half of all insurers currently outsource one or more business processes or plan to do so during 2006. Major business process areas that have proved well suited to business process outsourcing (BPO) include quotation generation, underwriting and associated compliance activities, financial administration (e.g., premium accounting), claims adjudication and processing, policyholder servicing (including endorsement processing with and without underwriting), documentation fulfillment and, of course, IT (e.g., general data processing, programming, etc.),” Lawson says.

However, Lawson cautions that the purportedly significant cost savings associated with BPO must be balanced against some substantial risks. Failing to select a qualified and compatible service provider, and to put into place a well-structured outsourcing agreement, may lead to costly operational problems or even significant business disruptions, Lawson maintains. “Further, outsourcing arrangements introduce new and unique legal risks,” he says. “For example, the transfer of policyholder information to a service provider introduces the risk of potential violations of state and federal privacy protections, either due to security issues during the transfer itself or due to potential gaps in the provider’s internal control mechanisms. Violations such as these can also generate negative publicity for the company, which in turn can have a corrosive effect on the insurer’s reputation and brand identity.”

The paper goes on to suggest strategies for managing business and legal risks associated with outsourcing insurance company business processes within the United States. It does not address management and legal issues connected with outsourcing functions to other countries.

A key issue discussed in the white paper is legal notification requirements and their potential impact. “Federal laws as well as the laws of several states require companies to provide notice of their intention to outsource business functions if such outsourcing will result in a workforce reduction at one or more locations,” says Lawson. “Given the political sensitivity both nationally and, for some regions, locally with respect to outsourcing transactions resulting in job losses, it is prudent to consider not only whether the BPO transactions trigger reporting requirements, but the impact of such disclosures on the company’s public image. Recent opinion polls show that outsourcing, in the broad sense of the term, evokes negative feelings among Americans. When asked how they felt generally about companies that engage in outsourcing, almost three in four of Americans polled responded that outsourcing has to do with ‘corporate greed.’ While BPO may present an attractive alternative to the company from the standpoint of reducing operational costs, those benefits can be quickly offset should it result in reputational damage.”

The paper also addresses the importance of pre-contractual due diligence, noting that, while the day-to-day processing and handling of specific business functions or the administration of distinct blocks of business may be delegated to an outsourcing company, the overall responsibility for that business remains, in both a business and legal sense, squarely with the insurer. “Further, outsourced blocks of business or business functions can be extremely difficult, if not impossible, to take back in house,” says Lawson.

Other sections of the white paper deal with disclosure requirements in contractual arrangements regarding outsourcing, negotiating strong contractual safeguards, due diligence in market conduct and financial reporting, protection of customer data and the BPO contract itself.

One section of the white paper that may be of particular concern to property and casualty insurers addresses appropriate licensing regarding claims handling. Says Lawson: “If the provider will be involved in processing property or casualty claims, it is necessary to closely examine the specific duties to be performed in order to determine whether the provider will need to be licensed as an adjuster. If the provider will have any prepayment contact with the claimants, or is involved in any way in the determination of the settlement amount, it is likely that a license will be required. If, on the other hand, the provider’s role is strictly limited to back-office processing of pre-negotiated, predetermined claim payments, then it is possible that no additional licenses will be required. The consequences for outsourcing functions requiring an adjuster’s license to a non-licensed person or entity include both regulatory fines as well as liability for bad faith.”

Outsourcing the claims function is of particular concern to insurance producers. Many independent agents and brokers have spent years establishing strong relationships with insurance company claims people. They ordinarily do not have relationships with outsourcing firms. Can an agent or broker suffer when the claims function of an insurance company is outsourced? Even more important, can the insured suffer?

Rough Notes spoke with Eric Seidel, president and CEO of eAutoclaims, which provides claims management services to the insurance industry. Seidel numbers among his clients 35 property and casualty insurers. “Insurance companies are looking for what I call ‘pain points’ that are expensive to operate and are considered to be part of best practices in the industry,” Seidel says. “The pain point that we service for insurers is automobile physical damage. Our use of our network of 2,800 body shops, which have contracted with us with preferred terms and discounted rates, is considered to be best practices. In addition to having to deal with the cost of auto physical damage, insurers also face a liability exposure when the quality of repairs is not good. We harness the Internet as a processing application so that it is easier to look for those parts of the process or parts of an insurance company’s workflow that can be seamlessly integrated.”

Seidel explained how his firm assists insurers in processing auto physical damage claims. “When an insured calls his or her insurance company to report a claim, the claims person can obtain an appraisal application online. Step two, while the company claims person is talking to the insured, he or she asks the address where the car was kept. The claims person hits a button and the names of 20 or so auto body shops that are contracted with us pop up on the screen. The claims person then suggests that the insured might want to use one of those body shops nearest his or her residence.

“We work on a direct bill basis, so the insured doesn’t have to wait for a check,” Seidel continues. “If one of our body shops is used, the insured gets a guarantee on the job for the life of the automobile. The insurance company, which is not only saving money on the claim because of our discounted arrangements, also can offer the insured swift claims service. In addition, the insurer gets a processing tool that cuts out mail expenses, and the system tracks every step of the claim. We do not settle the claim. That’s how we are distinct from other outsourcing services. The insurance company deals directly with the insured and settles the claim.”

Seidel says that some firms provide total outsourcing services, probably for smaller carriers. “All we do is the physical damage portion of the claim.”

Some agents and brokers are not particularly happy with insurance company outsourcing in the claims area. Ray L. Peretti, owner of the Hub Insurance Agency in Renton, Washington, and current president of the National Association of Professional Insurance Agents (PIA National), is one agent who questions the worth of outsourcing claims.

“There are decisions being made in insurance company corporate towers that are not the best ones for the company or for the industry,” he says. “In the last few years, insurers have lost touch with the personal service they used to boast about. They don’t understand that when you outsource a particular function, the quality of service diminishes, particularly in the claims area. I have a small commercial strip building that houses my agency. Recently, in the middle of the night, a car jumped the sidewalk outside my building and struck it. Of course, we were never able to identify the owner of the car because it happened at night. There was not a lot of damage, but it was something that needed to be taken care of. I notified my insurance company claims department and they notified a third party. The third party gave me a check for $1,700. The building repair people gave me an appraisal of $10,000. The outside claims adjuster then asked for more papers and the whole thing has become a nightmare. It’s been more than a month, and the thing hasn’t been settled yet.”

Peretti said that outsourcing brings more people into the loop, which results in a drop in service. “It’s very frustrating for the consumer to have to deal with middlemen. The industry is losing its relationships with its clients.”

Donna L. Pile, of AG Perry Insurance Agency in Lexington, Kentucky, and president-elect of PIA National, also has concerns about the outsourcing of claims handling. “It’s not the independent claims adjusters so much as it is the preferred contractors—firms that use certain body shops or home repair people,” says Pile. “In the old days, our insurers didn’t want us to suggest auto body or home repair shops to our clients. They wanted the client to make the choice. I worry that this kind of outsourcing may not be in the best interests of the carriers.

“My son’s house burned down recently and he went to ‘a local association of public adjusters’ which recommended a preferred contractor to bring people to do the cleanup,” Pile explains. “After a time, he didn’t know whom he was taking to, there were so many people involved. There were too many hoops he had to jump through to get the answers he needed. Furthermore, today the agent is continually taken out of the loop. There is a phenomenon today that says the independent agent works for the carrier. I came into this business believing that agents were working for the client. The waters are getting muddied, and it’s getting more difficult to know who the players are. I guess some outsourcing is inevitable, but I think the insured public is finding it more difficult to delineate between the cast of characters.” *

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