Insurers need 'clear and comprehensive contracts' when delegating business functions to third parties, says expert

Insurance regulation specialist Alexis Roberts of Pinsent Masons, the law firm behind Out-Law.com, said insurers also need to monitor outsourcing arrangements throughout their duration to ensure that good outcomes for customers are being delivered.

Roberts was commenting after the UK's Financial Conduct Authority (FCA) "identified concerns over firms’ oversight of outsourced arrangements and the potential impacts any shortcomings could have upon the delivery of products and related services to customers" in a review it undertook of outsourcing in the general insurance market (40-page / 448KB PDF).

The FCA said its review highlighted that some insurers are failing to "demonstrate clear arrangements for assessing conduct risks associated with delegating authority". It said that delegate underwriting or claims handling functions to third parties "do not appear to regard" doing so as outsourcing. There were examples of insufficient due diligence in selecting suppliers and of "insufficient control" being exerted by insurers over claims handling activities performed by the delegated authority, it said.

"Some insurers relied disproportionately on the audit of the third party rather than having appropriate internal controls around outsourcing," the FCA said. "This over-reliance had the potential to produce a ‘false positive’ when the scope or quality of the audit was insufficient, particularly in relation to conduct issues."

The regulator said that there was also sometimes "no clear allocation of responsibilities" between insurers and intermediaries for performing business activities and that some intermediaries tasked with designing insurance products "did not appear to recognise the extent of the product provider responsibilities they had acquired". This meant that "customer needs" were not always properly reflected., the FCA said.

Many insurers and intermediaries involved in selling insurance products also lacked "appropriate oversight and monitoring … of the delivery and performance of the product" and this sometimes led to "shortcomings in complaint processes, handling and outcomes", the FCA said.

The FCA said: "Our principle concern is the increased risk of poor customer outcomes arising from the division of knowledge and responsibility that occurs in outsourcing underwriting and claims handling authority and other related functions to third parties."

Roberts said the FCA's review should serve to remind insurers about "the importance of having the right systems and controls in place to manage the delegated authority".

"Having clear and comprehensive contracts is an important part of achieving this aim," Roberts said. "It also emphasises the importance of managing the delegated authority through other means as well: whether through due diligence prior to the delegation taking effect, through making sure that the insurer’s rights to monitor and control the delegation of authority are properly utilised during the relationship, and also through having effective post-termination rights in respect of the products and the customers."

"An important element of this from the FCA’s perspective is customer outcomes.'Customer centricity' has always been a key element of the FCA’s agenda. This review emphasises that insurers should not regard customer outcomes as the responsibility of the distributor. This relates not just to the product itself but also to the way in which it is distributed under the delegated authority. Particularly in an extended distribution chain this can pose a real challenge for insurers, but the FCA’s review is clear that the insurer will nonetheless have responsibility in these cases as well," Roberts said.

Roberts said the approach demanded by the FCA will "lead to quite a shift in the relationship between the insurer and its distributors" and require those businesses to act more as a partnership when developing, marketing and selling insurance products.