Perspectives

Published Article

Realizing Promise of Strategic Sourcing Claims, Underwriting, are Next Frontiers for Systematic Cost Cutting Approach

March 2005

|

By Sean O’Neil, Published in P&C National Underwriter

"Strategic sourcing" is a cost-reduction method that many insurers have attempted to implement. While they have had successes in lowering basic office management costs, these insurers have failed to recognize the greater potential savings of applying "strategic sourcing" methods to claims and underwriting functions.

Beginning in the 1990s, large insurers started to take more systematic approaches to the procurement of goods and services, especially the basic goods and services associated with running the business — office supplies, desktop computers, temporary labor and printed forms.

Strategic sourcing grew in popularity throughout the 1990s and became a staple of post-merger integration efforts, as companies sought to identify and eliminate overlapping costs in the wake of a merger. As companies acquired scale, they generated "early wins" for their many integration efforts by rationalizing overlapping vendors and achieving better product (or service) pricing.

While the majority of these efforts succeeded, opportunities for further improvement remain for two primary reasons.

First, in many instances, initial sourcing efforts did not address all the expenses they could have. Too many focused on basic commodities and ignored significant outside vendor expenses in the claims and underwriting functions.

Second, there was a failure to embed key principles of strategic sourcing into the organization, so that it would benefit from this discipline not just once but on an ongoing basis.

As such, many companies simply underestimated the savings potential of many sourcing efforts, and the ongoing savings they did achieve have fallen short of expectations. Using auto insurance as an example, we will explore how some companies are starting to address this missed opportunity and realize the full promise of strategic sourcing.

Seizing New Opportunities

Sourcing programs in insurance companies have tended to focus on basic expense items such as paper, printing and computer equipment, even though these expenses represent only a fraction of the overall cost structure. Sourcing was not applied to expenses within the claims and underwriting areas for three primary reasons:

  • Some believed that these expenses are too close to the customer and thus too sensitive to address.
  • Others believed that the intricacies of the function needed to be understood for sourcing to truly succeed, and that neither the organization’s procurement professionals nor its outside consultants had the necessary expertise.
  • Also, these expenses did not come under the responsibility of the person sponsoring the sourcing effort (often the chief financial officer), and thus simply were considered out of scope.

Today, leading insurance companies are questioning these reasons and are pushing strategic sourcing into the claims and underwriting areas. In the process, they’re finding that many of these expenses are absolutely sourceable.

In the claims area, auto insurance companies have begun applying sourcing techniques to many of the outside vendor expenses — costs for outside legal, court reporting services, independent claims adjusters, medical records services, towing services, dealer repair programs, glass, salvage reclamation, and medical networks to name a few.

By applying a disciplined sourcing approach to these expense areas, companies can conduct fact-based negotiations to attain favorable pricing and improved service levels. Savings in these areas can be as significant as in basic expense categories.

For example, one auto insurance company lowered its costs for collecting, copying and returning medical records by 35 percent — without sacrificing coverage — by reducing the number of vendors and by standardizing service levels across all vendors.

In another instance, an auto insurer applied sourcing techniques to salvage reclamation services. Leveraging an understanding of the rapidly consolidating market and the associated implications on vendor economics, a new pricing arrangement was put in place, along with a set of service levels and incentives to ensure the timely sale of salvage. With this disciplined approach, the company raised its salvage proceeds by 7-to-10 percent.

It is a similar story in underwriting. For example, companies are applying disciplined sourcing approaches to the various information services used in underwriting. Understanding a vendor’s cost to serve and unbundling specific service elements for information services such as data pulls, list management services and credit reporting has enabled some companies to develop creative pricing contracts, complete with pricing tiers and volume rebates.

With credit scoring, for example, individual components such as pre-scores, post-scores and aggregated scores can be examined and negotiated separately. By negotiating the best price for each activity, companies can save up to 20 percent in this high-volume area.

By expanding the traditional reach of strategic sourcing, companies are starting to address expenses previously untouched by sourcing, and in the process are generating significant bottom-line savings — 10-45 percent — in many expense categories.

Moving Beyond Supplier Selection

Aside from the opportunities associated with expanding sourcing to other categories, companies can drive sustainable savings by revisiting the actual sourcing process itself and taking a more comprehensive approach.

In the past, many companies have focused heavily on supplier selection with the emphasis clearly on consolidating vendors and putting in place better contractual pricing. While this approach is effective at achieving near-term savings, it does not embed the process in the organization and often results in savings leakage over time.

In contrast, companies that have fully embraced sourcing have leveraged a variety of highly effective tactics, such as effectively managing demand, negotiating specific service level agreements (SLAs) in conjunction with price negotiations, and objectively monitoring and managing supplier performance.

Opportunities For Smaller Companies

Many smaller insurers have dismissed strategic sourcing because they believe it requires greater scale to be successful. However, smaller companies can and are dramatically improving their performance by undertaking targeted sourcing efforts.

The key for smaller companies to make their sourcing efforts successful is twofold.

First, they must quickly hone in on the areas of opportunity, selecting their sourcing categories carefully by balancing the size of each opportunity with ease of implementation.

Second, they must "right size" their approach for each category, based on its size and potential benefit. While traditional processes may work for some expense areas, others may benefit from accelerated approaches such as reverse auctions (where the "winner" provides services for the lowest price) or focusing the effort exclusively on incumbent vendors and fast-pathing to negotiations.

Why Should You Care?

As the property-casualty market continues to adjust to excess capacity with a clear softening in rates evident in 2004, insurers need to again focus on their cost positions to preserve profitability levels. Companies of all sizes are discovering that strategic sourcing can provide a powerful lever for reducing expenses and increasing underwriting profits.

For large companies, that may mean revisiting their existing sourcing programs to ensure there has been no leakage of savings. In addition, these companies will benefit from taking the same disciplined sourcing approach to key expense categories within the claims and underwriting areas.

For midsized and smaller companies (less than $2 billion in premiums), it may mean replacing current ad hoc purchasing processes and taking a more systematic sourcing approach, as outlined herein, for the first time.

Making Sourcing Gains Stick

How can insurance companies optimize the long-term success of their strategic sourcing programs?

The following best practices have yielded powerful results:

Demand Management

Developing a thorough understanding of the goods and services being purchased is a prerequisite for effective demand management. Too often, companies are focused on controlling pricing and are not equally focused on controlling what is being purchased or on implementing appropriate usage policies.

The key to managing demand is timely category-specific information. To this end, it is sometimes best to leverage the vendor to collect this information and to put in place specific controls. For example, it may be determined that temporary employees should not have tenures exceeding 12 months. Having the vendor produce tenure data for each of their placements on a monthly basis would provide the information to manage compliance with this policy.

Service level agreements

Development of service levels is frequently an oversight in the sourcing process. We advocate developing detailed service level expectations in the request-for-proposal process. These SLAs should be drafted in "contract form" and carried forward into the contracting process if agreed to by the vendor, or negotiated accordingly.

For example, to ensure independent claims adjusters are available when required, it’s important to include in the negotiations process specific timelines for delivering the résumés of adjusters who meet requirements, with penalties for non-performance.

Supplier scorecards

To fully embed their sourcing processes, companies must put tools in place to manage their vendors on a going-forward basis. Developing a rigorous fact base is not only critical for the actual sourcing process itself, but also should be carried forward in the management of the vendor relationships.

Scorecards should reflect pricing compliance, service satisfaction, and should be bi-directional in nature. (Is the buyer meeting its obligations?)

The scorecard becomes a focal point of vendor management meetings.

Sean O’Neill is a partner with Bridge Strategy Group, a Chicago-based management consulting firm with deep expertise in the insurance industry. Mr. O’Neill can be reached at SONeill(at)BridgeStrategy.com

Reproduced from National Underwriter Edition, March 25, 2005.

Copyright © 2005 by The National Underwriter Company in the serial publication. All rights reserved. Copyright in this article as an independent work may be held by the author.