SHOULD BENEFIT ADMINISTRATION BE OUTSOURCED?

Historically, most organizations have fully administered their benefit programs with their own employees. However, it has not been unusual for an organization to outsource some administrative functions to other parties. For example, third-party administrators have been used to administer self-funded medical expense plans, and actuaries have been used to perform some of the compliance functions for qualified retirement plans.

More recently there has been a significant increase in the outsourcing of employee benefit administration, with estimates indicating that between 40 and 50 percent of all employers currently use outsourcing to some degree. Surveys also indicate that another 15 to 20 percent of employers are actively exploring the use of outsourcing. The reasons for outsourcing are identified. In addition, the types of functions commonly outsourced and the types of vendors used for outsourcing are described. Finally, the factors that must be considered when entering into a contract for outsourcing are discussed.

Reasons for Outsourcing
There are many reasons why an employer might decide to outsource benefit administration. The most common reason is that the organization lacks the technical and regulatory expertise to perform many of the necessary functions. For example, few employers have a staff with the expertise to perform actuarial calculations or utilization reviews. Functions of this nature are best left to firms that have a staff of specialists in these areas. Closely correlated with this reason is the desire of firms to seek more value for the dollars spent on benefits. While outsourcing costs money, it is often cheaper than performing the same functions in-house. Some of this savings is because of the high cost of the hardware and software that is increasingly needed. An outside vendor can spread this cost over many customers.

Better service to employees is also an often cited reason for outsourcing. Vendors frequently have toll-free numbers and a staff that specializes in specific benefit functions. Persons who answer telephones are typically trained to have the ability to handle 90 percent or more of the inquiries they receive. But more important, they have the ability to transfer the more complex calls to the appropriate person to handle the issue.

Another cited reason for outsourcing is that the organization should focus its attention on the firm's core activities. Outsourcing enables a firm to lower the size of the staff that administers its benefits or at least have the staff remain stable or grow more slowly in an era when benefit administration is becoming increasingly complex.

Functions Outsourced
Significant variations exist with respect to the benefit functions that are outsourced. Systems, staff, or both can be outsourced. Systems outsourcing refers to the use of an outsourcing organization's computer and other systems while retaining an in-house staff to perform administrative functions. Staff outsourcing refers to the outsourcing of people but the continued use of the organization's systems.

Outsourcing can also be classified as either partial or full. With partial outsourcing, an employer uses an outsourcing organization's personnel and/or staff for some benefit functions but continues other functions in-house. The term full outsourcing refers to those situations where most benefit functions are outsourced. Even with full outsourcing, some functions, such as financial management of benefit plans and benefit plan design, remain the responsibility of senior personnel at the firm.

Most employers use partial outsourcing. Among the most common functions to be outsourced are the following:

- COBRA administration

- Administration of medical and dental claims

- Utilization review

- Vision care programs

- Record keeping of defined-benefit pension plans

- Record keeping and administration of defined-contribution retirement plans

- Record keeping and administration of flexible spending accounts

- Preretirement planning

- Benefit communication

Vendors Used for Outsourcing
Many types of organizations operate as vendors for outsourcing. In addition, employers who outsource may use several vendors because vendors often specialize in a limited number of activities. In fact, some vendors are very specialized. For example, some vendors may specialize in only one type of benefit such as vision care.

The major providers of outsourcing services include benefit consulting firms, insurance companies, stock brokerage firms, mutual funds, and third-party administrators. Stock brokerage firms and mutual funds tend to be involved almost solely in functions relating to retirement plans. While the other vendors often engage in a wide variety of activities, they may also specialize in a limited number of outsourcing services. For example, benefit consulting firms frequently focus their activities on regulatory compliance, eligibility determination, and enrollment.

Recently a small number of large organizations have been marketing themselves as having the ability to provide complete outsourcing for an employer. The number of firms that do all their outsourcing with only one vendor is still very small but likely to grow.

The Decision To Outsource
The decision to outsource is not a simple task. An organization must determine what functions should be outsourced and what functions can best be performed in-house. Consideration also needs to be given to the firm's personnel. Outsourcing often involves working with computers and other systems. It is important that people with expertise in these areas be involved. In addition, the help of the internal benefit staff is vital. However, their assistance may be affected by the fact—either real or perceived—that outsourcing may result in the loss of their jobs.

Once a vendor has been selected to provide an outsourcing service, the process of changing vendors can be complex and expensive. Therefore a high degree of care should go into the vendor-selection process. There should also be contingency plans for changing vendors if that need arises.

A formal outsourcing process begins with a request for proposal (RFP) in which vendors are asked to bid to provide services. The RFP should clearly spell out the goals of outsourcing and identify the major responsibilities of the potential parties to an outsourcing contract.

The outsourcing contract itself needs to clearly establish responsibilities of both the vendor and the employer but yet be flexible enough to address situations that may arise in the future. Proper planning must be done with respect to data to make sure data important to the employer are not destroyed by the vendor—for example, while converting the data to the vendor's systems. It is also important for the employer to be able to retrieve data if the contract with the vendor terminates.

A good outsourcing contract (at least from the employer's standpoint) will contain performance guarantees. These guarantees may relate to factors such as timeliness, accuracy, productivity improvements, and employee complaints.

Because the primary purpose of outsourcing is to save money in the long run, it is also very important to address vendor compensation. The contract should not be so open-ended that unforeseen costs are automatically passed on to the employer. Even fixed-price contracts may prove to be expensive if a firm downsizes but the vendor gets the same compensation for servicing a smaller number of employers.

Some other issues that must be addressed include confidentiality and security of data, vendor responsibility for systems upgrades and employer responsibility to pay for them, insurance and/or bonding requirements, and procedures for resolving disputes among the parties.