European financial services companies are among the most heavily regulated and complex in the EU – and the European Financial Services Action Plan (FSAP) has further increased the legislative burden.
Of the many initiatives under way to help harmonise financial services business, the recently introduced Solvency 1 directives, which outline the solvency requirements with which insurers in the EU are obliged to comply, as well as the requirements of their individual governments, are among the most significant elements for life and pensions companies to come out of the FSAP – and they are just the start.
The European Commission is currently undertaking a project known as Solvency 2 which will further tighten the financial constraints on European financial services companies.
The basic objective is to better match solvency requirements to the risk associated with business written and to encourage insurers to improve measurement and monitoring of risks they are exposed to. This project is not yet complete but it is clear that European insurers will in future need to have greater control over their data, costs and business processes.
The FSAP itself aimed to break down barriers between EU member states and create a single financial market by 2005. Progress has been made in many areas – to the extent that there has been a call for a pause in further developments to give insurers time to act on, consolidate and improve the legislation put in place.
The resource and time demands placed on financial services companies to implement such changes are great, leading them to look at outsourcing as a strategy to reduce fixed costs. However, although cost reduction is one of the benefits companies can derive from outsourcing, this alone paints rather a simplistic picture of the benefits of high-quality outsourcing.
In addition to cost cuts, upper quartile service standards and the mitigation of operational risk should be regarded as primary benefits. For a financial services company to deliver these benefits internally – at the same time as controlled cost reduction – has time and again proved to be difficult. An increasingly common solution has been to adopt an outsourcing strategy.
Outsourcing is set to grow
Outsourcing has become an accepted business model for European life and pensions operations, with numerous success stories coming from the leading outsourced services providers. Unsurprisingly, given its ability to reduce operational costs, outsourcing is expected to grow rapidly, with a number of significant high-volume, high-value deals being made. This growth is already under way as providers critique their operations and rationalise infrastructure.
The larger outsourcing deals will continue to cater for the administration of closed books, by the nature of the volumes of in-force business within them. However, outsourcing is not just for closed books.
Increasingly, outsourcing is being used to dramatically reduce the cost of market entry for new players, or the introduction of new product ranges from existing providers. By outsourcing administration functions from the outset, resources can be focused solely on customer proposition areas such as new product development and sales and marketing. Outsourcing from the outset also gives providers access to the most modern technology.
A model for outsourcing
The ideal model for both new business and closed book outsourcing is shown in the figure. The product provider need only retain a small, specialised corporate governance team, with all other operational functions fulfilled by the outsourced services provider, underpinned by cost and service level guarantees. This delivers not only a virtual life company operating model, but also achieves true end-to-end electronic straight-through processing.
A role for offshore outsourcing
Offshore outsourcing has become a popular strategy in recent times as companies look to reduce costs. Moreover, the EU’s ‘freedom of establishment’ and ‘freedom to provide services’ rules could see more providers choosing to outsource operations to a country offering the best balance of cost and expertise.
However, offshoring jobs simply to take advantage of lower salaries is not likely to be in the best-long term interests of financial services companies or their customers. It can only be at best, problematic – at worst, very high risk – to take legacy systems and processes overseas. Systems replacement and business process re-engineering can offer significant long-term efficiencies and cost savings without the inherent risks of offshoring.
Countries such as South Africa and India offer significantly cheaper resources that can make a compelling case. Although running an offshore outsourcing operation has the potential to incur higher management costs, this approach is undoubtedly the key to achieving the lowest running cost per policy without a negative impact on service quality. But what of risks?
Offshore risks are important because they are largely out of the provider’s control – political instability, inflation, rising labour costs and regulatory change should be top of mind. Additionally, the ability to move operations relatively easily between countries is vital. Companies must retain the flexibility to relocate to another territory if it emerges as a more commercially attractive destination – or worse, operational failures mean that the regulator demands that they repatriate the operation. In this scenario, cumbersome legacy platforms will pose providers significant logistical and, ultimately, financial problems.
Re-engineering is vital
First and foremost, companies need to update core systems and re-engineer business processes, either via an internal implementation or via an appropriate outsourcing contract. It is this combination – best practice processes and modern technology – that will realise the benefits that life companies need to achieve. Full end-to-end electronic straight-through processing comes as a useful by-product.
We expect outsourcing to continue to create new industry cost benchmarks, demonstrating how existing and new product providers can transform their competitiveness, positioning them strongly to thrive in the new world that increasingly demands low cost operating models.
Brian Please is head of life and pensions sales at Marlborough Stirling