UK: Successful Outsourcing for Insurers

The recent economic climate has resulted in many businesses reviewing their business models with a view to reducing overheads. One of the tried and tested (if not completely trusted) methods of saving costs is outsourcing, and it comes as no surprise that in recent times there has been a significant surge in the extent to which businesses are outsourcing IT and business process (i.e. back-office) services.

The insurance industry is no different to any other in this respect. Indeed, several outsourcing suppliers have picked up on this trend and focused their efforts on meeting the specific needs of the insurance industry. As a firm, BLG has advised on many significant outsourcing projects, from both a supplier and user perspective. In this article, we distil some of the key considerations which can make the difference between success and failure in outsourcing.

One of the key contributors to successful outsourcing is an understanding of the outsource process itself. Those procuring outsourcing services may not have a great deal of previous experience of such projects, but an understanding of the process is critical and will then enable the project to be carefully managed and controlled. Whilst there are any number of variations, the basic model is as follows:

• Scoping – The customer (ie insurer) must identify its business objectives (these will often include improving service levels and achieving cost reductions), and have a clear understanding of the services and service levels expected from the supplier. This may sound simple, but the process can take many months.
• Invitation to Tender/ Request for Proposal – Based on the scoping exercise, the insurer issues an Invitation to Tender to selected suppliers.
• Evaluation – The insurer evaluates the suppliers’ proposals (this evaluation usually covers the technical, commercial and legal elements of each proposal) and selects the chosen supplier. Frequently the insurer will select two suppliers and negotiate these proposals in tandem to retain negotiating leverage in the final stages of contract negotiation.
• Contract negotiations – Given that many of these projects are complex and business critical, negotiation of the outsource contract is a significant task. Some of the key contractual issues are set out below.
• Transition and service provision commences – The size of these projects can make transition complex and time consuming, particularly where there are a number of incumbent third party suppliers to be replaced by the chosen outsource supplier.

In every outsourcing arrangement there are a number of key contractual issues which must be addressed. Some of these are highlighted below.

Service Description and Measurement – These schedules should be as detailed as possible and, where the outsourcing project is complex, a transition plan should also be developed to facilitate the smooth transfer of the outsourced services (and any related assets and agreements) to the new supplier. An exit plan should also be agreed early on to deal with the transfer of the services at the end of the agreement, either to a new supplier or back in-house. The service description should then be coupled with appropriate mechanisms to manage the supplier’s performance; these usually include service levels (with the service credits that will be payable where those levels are not met), the insurer’s right to "step-in" and take over performance of the services in certain circumstances and the right to benchmark the supplier’s performance against that of other suppliers.

Statutory and Regulatory Requirements – It is usual to require the supplier to comply with all relevant statutory and regulatory requirements, but in a regulated industry such as insurance, insurers should ensure that their outsource suppliers comply with the FSA guidance on outsourcing and should be aware that outsourcing a function does not absolve an insurer from its own compliance obligations. Another regulatory issue which has particular relevance for insurers is the data protection regime. Particular care should be taken where insurers are engaged in "off-shore" outsourcing and send clients’ or staff personal data to suppliers based in countries such as India where the levels of protection for personal data are unlikely to satisfy the "adequacy test" for data transfer unless express contractual provisions are negotiated.

Transfer of Employees – Careful consideration should be given to what is to happen to the insurer’s employees who are involved in the provision of the services pre-outsource and, in particular, whether the Transfer of Undertakings (Protection of Employment) Regulations 1981 ("TUPE") will apply. The parties should agree a list of transferring employees to try to avoid later disputes about who should transfer, and will also need to agree who will bear liability in respect of those employees, and on what basis.

Flexibility – As outsourcing agreements are often long-term arrangements, enshrining a mechanism to enable the parties to change the extent and scope of the services is essential. The insurer should seek to limit the cost implications of such changes by including a metric for setting the price of new or re-scoped services, and suitable obligations on the supplier with regards to providing technology refresh services (e.g. hardware and software upgrades).

Term and Termination – The duration of the agreement should obviously be documented, as should any rights of early termination to which the insurer is entitled. Any right of early termination is likely to require the payment of termination charges (as there will be a cost implication for the supplier), and these should be clearly documented at the outset to prevent disputes at the time of termination.

Intellectual Property Rights – The issue of which party is to own the various intellectual property rights related to the provision of the services is invariably complex. Each party will normally retain ownership of its pre-existing intellectual property, and the ownership of standard third party software obviously remains with the licensor. However, one area which is frequently debated is whether the insurer or the supplier will own work products created as a result of the outsourced services (which can include, for example, enhancements to existing supplier products). The insurer’s general objective is to ensure that it either owns or has sufficiently wide licence rights in respect of all materials (including software) that are relevant to the services.

The cost benefits of outsourcing are well publicised; however, the associated risks can be high if the process is not properly considered and managed. Insurers should contract carefully to mitigate these risks and budget wisely so as to ensure that projected cost savings are actually achieved.