Types of outsourcing and when to outsource actuarial functions

Introduction

Outsourcing the implementation and management of actuarial functions has established its presence among insurers and reinsurers in the past couple of decades. Many businesses have successfully adopted outsourcing into various aspects of their operations and functions. Outsourcing functions such as business-as-usual (BAU) work—where third-party service providers assume ownership of end-to-end actuarial reporting process—remains the core offering as it continues to add value through cost reduction, process efficiency, and access to industry best practices.

As companies continue to face challenges to enhance their competitive position in the current economic environment, there is a gradual shift from a vertically integrated business model to one that can seamlessly adapt to be more elastic and flexible. Types of outsourcing engagements have evolved over the years. Companies have since expanded outsourcing from the traditional BAU work to model development, model modernization, and model governance support, as well as resource augmentation at various roles, including Appointed Actuary responsibilities. These outsourcing areas continue to grow as companies are seeing benefits such as strong technical modeling support, capacity to scale the team to meet changing regulatory environment, and incorporation of industry best practices and subject matter expertise.

Outsourcing, in varying capacities, has become an emerging strategic tool for companies to fine-tune their value chain and to strengthen their core competencies. Understanding the various types of outsourcing and when to outsource can help better prepare companies to make an informed decision regarding the potential benefits outsourcing can bring to their existing functions.

Types of actuarial outsourcing

BAU financial reporting outsourcing

BAU financial reporting outsourcing traditionally has been viewed as the core function of outsourcing arrangements. Companies outsource either their complete actuarial production process or partial functions to a third-party service provider, who would then assume BAU ownership of the end-to-end reporting process or tailor to an agreement based on specific company needs. Examples of BAU outsourcing engagements would include U.S. GAAP, IFRS, MCEV, and local statutory production of various open, closed, or reinsured lines of business. Scope typically includes all or a subset of periodic (e.g., monthly, quarterly, etc.) results production, attribution analysis, sensitivity analysis, and Sarbanes-Oxley Act (SOX) reporting. Scope may also include the development and testing of changes to the processes, models, and/or technology for reserve calculations, pricing, business plan projections, policy data transformation, experience studies, audits, and other ad hoc queries. Depending on the agreement established with the insurers, the outsourcing team maintains all models, documentation, and reports. In some instances, insurers may have no actuarial internal resources dedicated to the business unit, and the outsourcing team works and communicates results directly with the management.

Many insurers find outsourcing a competitive strategic solution to resolve challenges such as complexity associated with results production, process inefficiencies, lack of staffing, and subject matter expertise. Over the years, BAU financial reporting outsourcing has proven to show cost effectiveness, scalability, flexibility, high-quality work, access to local regulatory knowledge, and automation efficiency.

This article illustrates a client case study on how BAU outsourcing helped a large U.S. insurer increase the efficiency of its ongoing operations.

Insurers have also benefited from outsourcing implementation support of various new regulatory requirements and reporting standards such as MCEV, IFRS, LDTI, VM21, etc. The introduction of International Financial Reporting Standard 17 (IFRS 17) in recent years has resulted in significant changes to the methodology and assumptions used in the valuation of liabilities for insurance companies. Globally, insurance companies are now transitioning from implementation into production. IFRS 17 requires collaboration with cross-functional teams including the data team, actuarial team, IFRS 17 team, modeling team, finance team, and technology team, in addition to significant needs in technology and systems to create an efficient reporting process. Insurers have incorporated outsourcing as a strategic management initiative for gaining competitive advantage in a more seamless IFRS 17 production process.

This article shows details of how outsourcing is utilized in a client’s BAU IFRS 17 result production.

Model risk management/governance support

Model risk management and governance is an important component of an organization’s operation. Model validation ensures that the calculation models produce results that are aligned with the model’s intended purpose. An insurer may have several key functions to support and safeguard the integrity of its model validation:

• Modeling team: The company’s own modeling team makes sure the models are designed, built, and tested with the intended purpose of the model.
• First line of validation: The first line of validation independently reviews the model process, methodology, assumptions, results, model change management, and controls, and makes sure all aspects are in line with the company’s existing risk management discipline.
• Second line of validation: The second line of validation independently reviews the documented report from the first line validation, findings, materialities, and remediations, and ensures that the models are validated and monitored in accordance with model risk management best practice.

Given the increasing scrutiny around model validation and governance, insurers and reinsurers are seeking an additional layer of review by third-party service providers by outsourcing parts of their own risk management functions. Model validations are typically performed in the following steps:

• Interpretation
• Understand model purpose
• Understand the applicable regulations and reporting framework
• Gather model development documentation
• Discussions with model owners
• Validation
• Determine model’s fit for purpose and conceptual soundness
• Validate current end-to-end process against model development documentation
• Evaluate model design and development process
• Test model accuracy by building independent models and performing dry runs
• Perform sensitivity analysis for impacts and reasonableness
• Independent review of asset and liability model
• Develop model confidence score
• Documentation
• Documentation and artefacts related to model methodology and model development process
• Obtain evidence and assess current model governance and controls
• Develop technical documentation

Model risk management and governance outsourcing has proven its capability to scale the team to meet the high demand of changing regulatory environment. It also provides opportunities to improve insurers’ existing model risk management framework by having an additional layer of independent and in-depth assessment incorporating industry best practices.

Model development, conversion, and modernization

For many insurers, ample resource and modeling capacities are dedicated to day-to-day actuarial operations, as they need to be efficient, accurate, and delivered in a timely manner. Over time, demands for model improvement, model development, and model conversions have become more and more pressing. Outsourcing, in varying capacities, has become an emerging strategic tool for companies to fine-tune their modeling needs while continuing to focus internal sources on core competencies. Outsourcing support includes new actuarial model development or updating existing models, model testing, development of model logic for various regulatory requirements, and actuarial system migration support. Outsourcing eases the needs for acquiring additional talent and offers easy access to human resources with varied modeling skills and subject matter expertise.

Globalization, aided by technology, has put model modernization in the spotlight. Modernizing the actuarial function is a continuous process that requires agility amid constant changes. There is an increasing need for optimizing and modernizing existing models to improve model efficiency, functionality, and documentation. Companies can benefit from modernizing their data, tools, and processes to meet their actuarial, finance, IT, controls, and management requirements. Model modernization outsourcing continues to offer a balance between human capital and ongoing best practice productization of actuarial processes with new technology and process.

Resource augmentation

Outsourcing has been around for years in the life insurance industry. Traditionally, life insurance companies have been outsourcing their BAU actuarial processes and aspects of business operations. In recent years, as the global life insurance industry meets the growing demand of actuarial resourcing needs, outsourcing arrangements have expanded to include staff and resource augmentation. Life insurance companies are pivoting towards using skilled and well-trained associates at all levels from third-party service providers to support resource augmentation on a wide range of projects across multiple countries. Resource augmentation has proven to be especially effective for implementation support with new processes and methodologies such as MCEV, IFRS17, stochastic modeling, RBC/SII, product development, data analytics, model development, etc.

Insurers have also considered third-party service providers to assume specific actuarial roles in the company. For example, a staff augmentation of an Appointed Actuary role would include independent peer reviews of reserve methods and assumptions, preparation and sign-off actuarial memorandums, and other related actuarial opinions and certifications, or other responsibilities typically assumed by the Appointed Actuary. Several types of staff augmentation arrangements are available to life insurance companies depending on their operational needs, budget, and timeline constraints.

When to outsource?

Outsourcing has proven to be a beneficial solution for actuarial resource needs under many circumstances. A few of the most common situations where insurance companies tend to outsource their actuarial functions and the corresponding outsourcing considerations are discussed below. In every case, the underlying motivation is to fill resource and knowledge gaps in a cost-effective manner, while ensuring the quality of work and continuity of knowledge.

New company setup/new market entry

Setting up operations in a new market or forming a new entity requires the coordination and implementation of several functions, almost concurrently. It naturally takes some time for a company to build a team with sufficient capacity. During a company’s initial stages, the management is typically very focused on distribution and operational aspects. Financial reporting, including actuarial reporting, aspects are not considered as important in the first couple of years. However, companies are still required to start reporting immediately on incorporation.

Outsourcing BAU reporting to a third party who is familiar with the market and can set up modeling and reporting functions efficiently while adhering to industry standards can be helpful in releasing internal staff to focus on growth and strategic tasks. The third-party service provider can support the development of models and processes required for regulatory and financial reporting and provide insights into best practices from the market. Outsourcing BAU reporting on a growing block of business can also be cost efficient while the business is scaling up. Therefore, market knowledge and expertise as well as cost would be primary considerations in selecting an outsourcing service provider.

With the growth of business and integration of staff, it may make sense to eventually bring the operations in-house. At this point, the outsourcing service provider will have to transfer models, tools and processes, and knowledge to in-house actuaries. Therefore, it is important that the provider maintains sufficient documentation and is prepared to train internal staff to ensure an efficient transfer. Control procedures followed by the outsourced team such as a comprehensive peer-review framework would be an additional consideration when selecting a service provider if the company intends to transfer outsourced functions in-house in the future.

Acquisition of new blocks

Setting up BAU reporting models and processes for a new block of business is a significant task. This involves understanding the reporting requirements and implementing actuarial models, as well as integrating data and reporting with existing processes. While the integration of a new block of business takes time and effort, BAU reporting would have to continue seamlessly. Therefore, outsourcing BAU statutory and financial reporting to a third party would lessen the immediate burden on internal staff.

Similar to outsourcing BAU actuarial work when entering a new market, knowledge and expertise on the type of new business acquired and cost efficiency would be primary considerations when selecting a service provider. It is also possible that the company may want to recapture the outsourced works once the acquired business is fully integrated.

Closed blocks

Closed blocks of business are ideal candidates for outsourcing, especially due to freeing up internal resources to focus on strategic initiatives while the BAU reporting on closed blocks is managed by a third party. Additionally, as discussed in our prior article on closed blocks, outsourcing legacy block operations also addresses the issue of high turnover of resources allocated to noncore operations and makes it possible to transfer and retain domain knowledge.

Year-end reporting/Additional reporting requirements

There is an increased demand for actuarial resources periodically, for example, to meet additional reporting requirements at year-end or the implementation of new regulatory or financial reporting requirements. Often, these are temporary spikes in demands for resources for the specific reporting period, or until implementation is complete. Acquiring temporary resources for these time periods would be a cost-effective solution in order to avoid unnecessary hiring and associated costs. Outsourcing allows the company to easily scale up or down team sizes when required.

Continuity of critical process knowledge and ability to integrate quickly into internal teams are key considerations when filling gaps with temporary external resources. A third-party service provider’s diligence in following company’s internal processes such as documentation and training, as well effective communication with internal stakeholders, is critical for a successful engagement.

Conclusion

Outsourcing can be an effective solution to actuarial resource demands when structured in a way that balances the company’s short- and long-term objectives. While there are many benefits to outsourcing actuarial functions to meet specific skill or resource requirements, there are also several risks that are inherent in outsourcing actuarial functions, including financial, operational, counterparty, and reputational risks. As noted in our prior article, most risks can be mitigated and managed together with a reputed service provider by planning out how the engagement is structured and the optimal allocation of resources to balance skills, knowledge, time, and cost considerations.

Milliman’s success in supporting clients through outsourcing services is driven by having a consulting approach and a long-term view, together with an engagement structure that provides a cost-effective solution for actuarial resource needs under many circumstances.