The joys of outsourcing

The use of 11,000 mercenaries by Egyptian pharaoh Ramses II to fight a military campaign some 3,250 years ago is one of the earliest documented examples of outsourcing in human history. The idea makes sense: raising armies is an expensive diversion of labour and resources, and military skill is little use in peacetime and therefore should be bought in only when needed.

However, the fact that most nation states in the world today maintain standing armies of professional soldiers suggests that outsourcing has its pitfalls. By losing control of military resources, clients lose control of costs, and worse, expose themselves to predatory mercenary behaviour. In the 18th century, Indian rajahs found that the East India Company's military forces came in handy for settling local conflicts; a generation later, the British had taken over India.

The insurance and pensions industry has long been a bastion of outsourcing. Insurers outsource areas like risk management and the building of technology platforms. UK pension fund trustees, following the time-honoured amateur tradition, outsourced just about everything from administration to actuarial valuation to investment management.

The results have been mixed. Consultants, asset managers and advisory banks - the main beneficiaries of outsourcing - are quick to point out the advantages. By aggregating a number of experts, whether they be software developers or actuaries, and exposing them to the problems of multiple clients, outsourcing firms add value to these clients.

Moreover, the governance of some insurance and pension companies, and trustee boards, leaves something to be desired. The use of an outsourcing firm with a reputation to protect can be a useful corrective to such deficiencies - at a price.

But the changes in regulation and risk management philosophy that helped bring about Life & Pensions magazine are proving a challenge for the outsourcing industry. Pension scheme sponsors handing over shareholder cash to plug deficits are reluctant to outsource liability-driven investment decisions to consultants that are not on the hook if things go wrong.

Insurance companies are growing wary of allowing consulting firms or advisory banks to crawl over their portfolios. They have seen too many people working for these consultants being hired by competitors, and they fear that outsourcing too much asset-liability management to banks can move markets prior to hedging transactions.

This is an important debate that we will continue to stay abreast of. To do this, we are planning a number of surveys and more in 2007, starting with a directory of technology providers in February. We will also be asking for your feedback on how to best serve your needs in 2007 and beyond.