- March 27, 2010 11:35 am
- Rick McCord
- No Comments
Why Outsource to a TPA?
Many insurers, reinsurers, self-insured firms or organizations, or governmental entities of some type elect to contract the handling of claims to an outside party. A firm which agrees to handle claims for a fee of some sort is generally referred to as a Third Party Claim Administrator, typically abbreviated as a “TPA”.
Outsourcing certain tasks has been commonplace for many years in some industries. Cities and municipalities may contract for certain services requiring specific skills or expertise such as community planning or traffic engineering. Businesses such as hospitals learned that outsourcing work such as maintenance and food services can create efficiencies and save them money. States and other governmental entities have contracted to outside firms the running of their prisons and even schools. Many companies routinely hire outside experts to take care of their legal, accounting, data systems, and other processes that can require particular specialized skills.
The insurance industry, which tends to be somewhat conservative by nature, was for much of its history behind this curve to some extent. Some claim processing and claim handling functions, particularly in very specialized and highly systems driven areas such as Employee Benefits or Workers’ Compensation, have been contracted out to third party specialists for many years. Most insurers, however, traditionally tended to keep the handling of other types of claims, particularly standard property and casualty claims, “in-house” to be handled directly by their own employees. In recent decades this has begun to change.
Why Outsource Claims?:
There are various reasons why an insurer would decide to entrust something as important as the handling of its claims to someone outside its company. The most obvious reason of these have to do with the potential economic benefits.
Claim related expenses represent a huge cost to any insurer. By one estimate, as much as 80% of a typical insurer’s earnings are consumed through claims and claim related expenses, and clearly represent the most significant cash outflow for an insurance organization. Even a small improvement in efficiency or a modest decrease in claim costs can obviously contribute significantly to an insurer’s bottom line.
Various ideas for reducing claim expenses have been considered. For example, insurance organizations have been able to realize some legitimate savings by implementing more automated systems. These benefits, however, have been somewhat limited when it comes to claims. Handling claims remains a hands-on process, one which has been described as “less automated and more highly skilled” than others such as policy issuance or data collection.
However, various industry studies have identified the outsourcing of claims as one of the areas which offers the greatest potential to reduce costs for insurers. One estimate projects the potential savings to an insurer by doing so as high as 15% of overall claim costs, and while specific details will obviously vary from one situation to another, more insurers have begun to focus on savings in the area of claims in looking for ways to improve their bottom lines.
A big part of the overall cost of claims to an insurer comes from maintaining a clam staff. One industry study concluded that over 40% of the time spent by insurance company employees on claims handling is associated with routine overhead functions which have little impact on the actual outcome of those claims. Many insurers have come to the realization that outsourcing claims can significantly affect the need to recruit, hire, and train their own claim staff. Those fixed internal salary and benefit expenses can then be converted to external service fees. Those fees, which are typically based on transaction volume, then will rise and fall with the flow of business. The insurer can also smooth out cash flows by avoiding periodic capital expenditures for in-house processes and systems related to claims.
In some cases the decision might be based on a particularly specialized knowledge base or skill set that is not readily available among its own staff. For example, an insurer may issue policies covering Fine Arts such as rare and expensive paintings, and outsource the handling of the resulting claims to a firm which has the required expertise to investigate and analyze those claims. In some instances, it can be simply a matter of overall staffing. An insurer may not have, or may not want to spend the resources to have, a full claims staff to handle a surge in claims, and may refer the “overflow” to an outside source.
As a growing number of insurers have recognized, outsourcing such operations as claims can also allow them to focus on their true core competencies such as writing new business, underwriting policies, and developing new product lines. In short, they can concentrate on growing their business and lowering overall costs rather than on day to day operations such as claim handling. As mergers and acquisitions by and between insurers have become more widespread, outsourcing can also minimize administrative costs for involvement in multiple claim programs. Another unexpected benefit realized by a number of insurers is that outsourcing claim functions has allowed them to recognize previously hidden overhead costs which now become visible and can be better managed.
Outsourcing can also provide a great “exit strategy” for an insurer. Rather than spend considerable money for staffing and offices for a particular program that may go away in a few years, it can be economically much more feasible to refer that program’s claims to a third party. When the insurer does decide to discontinue writing a particular program or line of business and focus its efforts and resources elsewhere, the existing claims, or those claims that may still arise, from this “run-off” program will have to be handled until they are concluded. It must maintain an infrastructure to service those claims, which might take as long as 5 to 10 years after the last policy was written, depending on the type of coverages and claims involved. And insurer claim staff costs can increase in run-off situations because of low morale and extra incentives required to retain staff members with reduced long term future prospects. In these circumstances, insurers and reinsurers have increasingly begun to contract with an outside TPA to handle the remaining claims. In addition to the cost savings involved by doing so, the insurance organizations can enter new lines or territories much more quickly without the “baggage” of run-off claims to deal with.
Program Business:
A number of insurers have developed a business model based specifically on the concept of outsourcing various key functions, not just as an “afterthought” or as a means of reducing existing costs, but as a basic cornerstone of their operations. These typically include areas such as underwriting and handling of claims, which traditionally were done by the insurer’s own employees. Some of these companies recognized that they could reduce their expenses by contracting certain processes to outside sources, while maintaining a relatively small home office staff to oversee and audit those functions.
This growing trend, often involving “Program” business, has contributed in recent years to the increased outsourcing of claims and other processes. Often these insurers will form partnerships with Program Administrators or Managing General Agents (MGA’s) which have successfully established a book of business in a particular niche in the market. This might be a fairly narrowly focused group of clients involving, say landfill operations or family owned hardware stores, or something a little more broad such as shuttle buses or small fleet truck operators. In most of these cases, the MGA has developed a detailed understanding of its program, including creative approaches to the risks, rates, and coverage forms involved. It may have built a network of retail agents to concentrate on the specifically targeted accounts involved.
The benefits involved can be significant for both partners in such a relationship. The insurer increases its premium volume by taking on an existing book of business which has already been established, and has a track record. The insurer also has the opportunity to take advantage of the MGA’s expertise and familiarity with the program. The MGA can gain greater control over what business is written and how it is written, and also have access to an established market to do so. In a typical program arrangement, the MGA will be responsible for the underwriting, rating, quoting, and binding of the business, including the issuing and servicing of the policies. In some cases, the MGA may even share a portion of the risk and potential rewards stemming from the program’s results.
Particularly in the recent soft markets, the interest of Property & Casualty insurers in this type of arrangement has increased. This not only includes larger insurers which have typically written certain programs like this in the past, but now includes many smaller insurers looking for new business opportunities. From all indications, this trend appears likely to continue, and the market for program business is expected to grow.
While in some cases a Program insurer may elect to have the claims handled by its own staff of employees, it is not unusual in these situations for the MGA and insurer to select an outside claim TPA to manage the claims that arise from the program.
Other Insurance Organizations:
In some cases, a non-U.S. insurance entity, such as a Lloyd’s of London Underwriting Syndicate acting as an insurer or reinsurer, typically through a broker or middleman in the U.S. or the U.K., may need domestic claims expertise and presence “on the ground” here to handle its claims. One of the simplest ways to do so is to contract with a TPA to handle the claims.
Self-Insureds:
Business firms or organizations sometimes elect to self-insure or retain a certain portion of their risk. In structuring their overall approach to risk management they might purchase some services from a traditional insurer or reinsurer, including excess insurance protection for large losses which exceed their selected level of retained risk, safety and loss control, or data capture and data management. The self-insured may not have the staff or expertise to handle its claims, or may recognize that there is no need to hire and retain highly technical resources for situations that occur only occasionally. It may elect to purchase claim handling services from its excess insurer as well, although in some cases, the services purchased from the insurer may be “unbundled”, and such aspects as claim handling contracted to an outside TPA.
Governmental Entities:
Many governmental or quasi-governmental organizations are also self-insured to some extent. Examples might include county or state agencies, school districts, public utility companies, and others. For many of the same reasons outlined above, these groups frequently elect to contract with an outside firm to handle such things as claim processing.
Conclusions:
A TPA may be able to bring to the table specialized skills and expert services, not to mention lower overhead costs, which can contribute to various benefits for the outsourcing company. These can include increased efficiencies, reduced operating expenses, and in many cases improved customer service. All of these factors can obviously help the insurer, reinsurer, or self-insured be more competitive. With greater competition, drastically reduced investment incomes, and various other market factors affecting profitability, more insurance organizations are coming to recognize the potential benefits of outsourcing, and this increasingly includes the claim process
Tags: government entities, insurance organizations, self-insureds