The FSCA and the Prudential Authority (PA) have published a Joint Standard that will regulate “material” outsourcing activities by non-life and life insurers, including microinsurers.
According to the Statement of Need, Joint Standard 1 of 2024 addresses a range of concerns related to the outsourcing of material functions by insurers. These include the need for adequate risk management, effective governance frameworks, a consistent approach to regulation, the protection of policyholders’ interests, and ensuring the financial soundness of insurers.
Most of the Joint Standard’s requirements are already provided for in Prudential Standard GOI 5: Outsourcing by Insurers. The Joint Standard repeals and replaces GOI 5.
GOI 5, which replaced Directive 159.A.i, was issued by the PA under the Insurance Act. This resulted in outsourcing falling within the regulatory scope of the PA and created a gap from a conduct of business perspective, the Statement of Need says.
As a result, there is a need to expand the current outsourcing regulatory framework beyond GOI 5, to provide an appropriate and comprehensive regulatory framework governing outsourcing by insurers from a prudential and a conduct perspective.
A single outsourcing standard ensures that the requirements are applied uniformly, with the FSCA and the PA assessing compliance in pursuit of their respective conduct and prudential supervisory functions.
The Joint Standard comes into operation on 1 December this year, and insurers have six months from the commencement date to comply, during which time they must continue to comply with GOI 5 as if it had not been repealed.
An outsourcing arrangement entered before 1 December 2024 must comply with the Joint Standard within 24 months of the commencement date or upon the renewal or renegotiation of the outsourcing arrangement, whichever comes first.
Although the Joint Standard does not explicitly state as much, it appears the standard does not apply to binder arrangements and intermediary services. In the Consultation Report, the Authorities said although binder arrangements are a form of outsourcing, the functions performed by the parties to a binder agreement and intermediary services are different from a material outsourcing arrangement. “The Binder Regulations clearly and sufficiently deal with binder arrangements,” they said.
The Joint Standard regulates all functions, whether they are core or non-core activities, material to an insurer licensed under the Insurance Act, except for Lloyd’s and branches of foreign reinsurers.
The Joint Standard does not define “core” and “non-core” activities, despite requests from some industry stakeholders for it to distinguish between the outsourcing of non-insurance-related activities, such as IT and marketing, and the outsourcing of activities that would generally be performed by an insurer.
In the Consultation Report, the Authorities said the risk of an outsourcing arrangement does not turn on nor is it distinguished by “non-insurance-related activities” and “core insurance business” but on the risk that may be introduced by the outsourcing arrangement and the materiality of the risk.
‘Material risks’
The Joint Standard defines a “material function” as a function or activity relating to an insurer’s business that has the potential to have a significant impact on the insurer’s business operations or its ability to manage risks effectively if it is disrupted.
It does not provide a list of functions deemed to be material.
The Authorities said the responsibility for assessing whether a business activity or function is material rests with the insurer. The materiality assessment, as specified in section 8 of the standard, must be applied in determining the materiality of the function or activity.
“Adherence to these assessment criteria would be demonstrative to the Authorities of due consideration on the specific function or activity,” they said in the Consultation Report.
Key changes
The important changes introduced by the Joint Standard relative to GOI 5 are:
- An insurer must, to identify and manage the risks that may be introduced by an outsourcing arrangement, undertake an appropriate due diligence for every activity or function to be outsourced before entering the outsourcing arrangement.
- When terminating a material outsourcing arrangement, an insurer must assess the potential impact, consequences, and risks of the proposed termination to policyholders and the insurer’s business, and report thereon to its board of directors.
- The notice of termination of an outsourcing arrangement that must be submitted to the PA and the FSCA must, inter alia:
- include proof that the insurer approved the termination;
- explain whether there are any outstanding issues that could have a potential impact on the service to policyholders and how these issues will be managed to ensure policyholders are not adversely affected; and
- highlight any outstanding fees and how such fees will be paid.
The FSCA and the PA said they will adopt a risk-based approach to supervision of the Joint Standard, which means that regulatory interventions will be commensurate to the risks and impact that entities pose to the financial sector.
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