Insurers should review delegated underwriting, say experts

In June the FCA released the final report of its thematic review on so-called 'delegated authority' in the general insurance market. The report concluded that firms did not appear to have adequately considered or recognised their regulatory obligations in connection with these arrangements, with a major cause of this being that some insurers did not treat the delegation of authority as outsourcing.

By drawing this link with outsourcing, the FCA aims to remind firms of the importance of having the right systems and controls in place to manage delegated authorities. Having clear and comprehensive contracts is an important part of achieving this aim. It also emphasises the importance of managing delegated authorities through other means as well: effective risk-based due diligence of all new opportunities; appropriate monitoring and control of the delegated authority and the product itself throughout the relationship; and effective post-termination rights in respect of the product and policyholders.

The report: the customer experience

Insurers use delegated authority, or 'coverholder', arrangements, to outsource certain functions to third parties. These can include underwriting and claims handling activities. During its review, the FCA focussed on the potential conduct risks associated with delegating these activities to third parties and the allocation of related functions between those parties. It found that, in many cases, firms did not consider these arrangements to be outsourcing.

When an insurer outsources 'significant functions' to a third party, these functions remain subject to the relevant requirements in the FCA Handbook. The most relevant of these are within the Threshold Conditions, Principles for Businesses, SYSC, ICOBS and RPPD. Outsourcings under Solvency II, the EU-wide regulatory regime that comes into force on 1 January 2016, will also be subject to EIOPA's guidelines, which expressly include the external delegation of underwriting authority.

RPPD is the FCA's regulatory guide on the responsibilities of providers and distributors for the treatment of customers. This guidance sets out the FCA's views on what the rules require of providers and distributors which supply products and services to retail customers. Crucially, it confirms that it is not the firm's status as insurer or intermediary that determines its responsibilities but their function and role throughout the product lifecycle. For example, where an intermediary specifies the criteria for an insurance product, many of the responsibilities fall to the intermediary as 'retail manufacturer' rather than to the insurer as 'pure manufacturer'.

The customer experience has always been a central element of the FCA's agenda, so it was not surprising to read the FCA's focus on customer outcomes as part of its thematic review. The final report emphasised that neither insurers nor distributors should consider the customer's experience as the sole responsibility of the other. This relates not just to the product itself but also to the way that it is distributed under the delegated authority. This can pose a real challenge for insurers and wholesale intermediaries that may not have any direct dealings with the customer, particularly in extended distribution chains. However, the FCA report makes it clear that they will nonetheless have responsibility in these cases as well.

The FCA's future expectations of firms

The regulator's renewed emphasis on the customer's experience of a particular product will require a considerable shift in the relationship between the insurer and its distributor, at least in relation to some distribution arrangements. Going forward, it may be necessary for some insurers to have relationships with their distributors that are much more akin to partnerships, with clearly apportioned responsibilities, in the way in which products are developed, marketed and sold, and also to the way in which claims are handled under delegated authorities.

The FCA has said that it will focus on the issues highlighted in the report in its ongoing supervisory work with firms. Some of its expectations for UK firms are outlined below.

Insurers

• Recognise that you are outsourcing when delegating underwriting or other authority, and consider whether you have effective, risk-based controls in place that appropriately consider conduct risk. These controls should address both the initial decision to outsource, and ongoing monitoring of the performance of the outsourced function and resultant products(s). Take steps to address any gaps you identify in the control framework, and review your existing outsourcing relationships to identify and fix any shortcomings.
• Assess whether your claims handling approach, or the processes in place where you have outsourced claims handling, are appropriate and will ensure that claims are handled promptly and fairly - particularly where these are inherited as part of a new relationship or involve multiple parties. This assessment should include–consideration of whether any potential conflicts of interest arising from incentive arrangements are appropriately mitigated. Where you identify deficiencies, ensure that these are addressed and that you can demonstrate that this has been done.
• Consider forthcoming changes to governance requirements arising from Solvency II and assess how these will impact your activities, particularly in relation to outsourcing. Assess what actions you need to take to ensure that you are able to comply with these requirements.

Insurers and intermediaries

• Consider the extent to which you may be performing the function of a 'product provider', and clearly identify what responsibilities flow from that including for product design and ongoing monitoring. To the extent that the circumstances and regulatory responsibilities allow firms to agree the apportionment of responsibilities, this should be reasonable and clear to both parties. Insurers should in all cases carry out sufficient due diligence and ongoing monitoring around the performance of the insurance product for customers to ensure that they can demonstrate to the regulator that these customers are being treated fairly.
• Review your existing monitoring activity and management information (MI) in relation to outsourced arrangements and allocated functions to assess whether this is appropriate and allows you to identify poor customer outcomes and instances where customers are not being treated fairly. Insurers should also consider whether this information is reviewed appropriately, shared as necessary and acted upon. This might include receiving data about how and by whom products are sold, levels of cancellations, claims frequency, claims repudiations, claims service standards and complaints volumes. Insurers should meet regularly with the intermediary to review this information, conduct root-cause analyses and remediate issues to improve customer outcomes. Where gaps and shortcomings are identified, these should be addressed.
• If acting as 'product provider', you should assess the appropriateness of the existing distribution channel and sales activities, the efficacy of the arrangements and processes in place to mitigate the risks to customers posed by the distribution channel and the adequacy of ongoing oversight and monitoring of the distribution chain. Any gaps or shortcomings identified should be addressed.

Incoming firms that 'passport' into the UK on a services basis

• The FCA expects that these firms will have to consider whether or not they have established a branch by virtue of the functions they have outsourced to agents in the UK. This consideration will depend on the facts and various factors in line with established case law. The European Commission has also produced guidance on this issue. If you are unsure of your position, the FCA expects that you will obtain appropriate advice. Where firms identify that they have established a branch in the UK, they need to act promptly to adjust their permissions accordingly.

Insurers and intermediaries should note that the recast Insurance Distribution Directive (IDD) also includes measures relating to product oversight and governance (Article 21a). (The final compromise text of the Insurance Distribution Directive (IDD) was published on 16 July 2015 and will now be submitted to the European Parliament for a vote at first reading and to the European Council for final adoption). Additionally, EIOPA consulted earlier this year on product oversight and governance guidelines in relation to insurance undertakings manufacturing insurance products. These have the potential to strengthen the requirements placed on firms that manufacture insurance products and firms are expected to ensure that their practices are adjusted to meet any new requirements.

These increased expectations around oversight and control of delegated authorities will almost certainly give rise to additional costs for insurers and intermediaries. This may well lead to a reduction in the number of delegated authorities in some markets and products, and to change in some insurers' distribution models.

Iain Sawers and Alexis Roberts are insurance experts at Pinsent Masons, the law firm behind Out-Law.com