One of my first projects when I started my insurance industry journey in the late 1980s was the creation of an in-house general ledger system for a large, mutual life insurer – involving hundreds of people and, undoubtedly, costing millions of dollars. But with shrinking margins, the days of spending on big systems that don’t lead to top- or bottom-line growth are long gone – life insurance companies are more concerned about increasing revenues, reducing cost and expanding return on equity (ROE).

Any basic economic course includes the concept of opportunity cost. Roughly stated, an opportunity cost is the benefit a person or business forgoes by taking a different course of action. When faced with multiple choices, businesses typically choose the option that provides the greatest return on investment (ROI).

Fishing for return

Just to give you an example, on any given day, a fisherman might fish for either striped bass or bluefish. The fisherman will choose the fish that provides the greatest expected return in the market, not necessarily the one that produces the largest catch. Of course, the average insurance company is different to our fisherman, simply because they typically have more resources to deploy. But in this low margin, competitive environment, the insurer – similar to the fisherman – is looking to focus its efforts on functions that maximize return, and devoting its time and resources to “core functions” that provide competitive or strategic advantage will help the insurer increase both its top and bottom line.

Core functions for a life insurer vary from company to company and across lines of business but typically include product development, pricing, underwriting and distribution – items that provide potential differentiation from its competitors. As such, the majority of a life insurer’s available resources should be devoted to these functions. Administrative functions that insurance companies traditionally perform, including operations, premium collection and claims, still need to be completed, but are typically “non-core,” as they don’t usually lead to a competitive or strategic advantage.

Headcount growth dedicated to non-core administrative functions has been climbing, fueled by legacy systems and processes that have led to manual workarounds requiring increased personnel. As the number of people dedicated to non-core, operational processes grow, the resources available for core functions have become more limited.

Therefore, in order to align resources to functions that provide competitive or strategic advantage, an insurer has two options:

  • Install a new administrative platform – although investing in non-core functions seems to violate the core process concept, the efficiency gains and error reductions created by a platform that contains significant process automation and artificial intelligence should outweigh the costs of system implementation, leading to a significant return on investment. Post implementation, the time and resources dedicated to these non-core functions will decrease, allowing the insurer to concentrate on its market differentiation activities.
  • Outsource non-core activities – a third-party administrator (TPA) enables insurers to outsource some or all of their non-core functions. Done correctly, third-party administration is virtually transparent to the insurer’s policyholders. The decision to use a TPA can deliver cost savings while allowing an insurer to focus on their core functions.

The case for outsourcing non-core tasks

A product line CEO, when approving a move to cloud-based storage, once reminded me that he was “in the insurance business, not the data storage business,” and, indeed, technology departments of insurance companies have been outsourcing certain, non-core functions for several years.

Although the term “opportunity cost” may never have been uttered, IT leaders have determined that outsourcing is both cost and resource efficient – Software-as-a-Service (SaaS), Platform-as-a-Service (PaaS) and cloud-based storage all shift non-core functions from the insurance company to specialist firms. This shift towards outsourcing of certain technology-based functions has led to insurer’s housing smaller IT departments more focused on solutions that provide strategic advantages.

However, with declining margins, insurance companies should now apply this same discipline to other non-core functions – determining its core and non-core functions based on the lines of business it writes and its value proposition to the market. Insurers need to increase operating efficiencies while maintaining focus on core functions that heighten their marketplace advantages. And by finding more efficient ways to execute non-core tasks, an insurance company can focus its resources on core functions leading to higher sales, increased margins, greater returns and, of course, a lot more of the right kind of fish.