A hot potato - responsibility in delegated authority

Posted: 12th January 2016

Firms delegating authority in the UK general insurance market are falling significantly short in the oversight, governance and suitability of their products, the FCA’s July 2015 study of Outsourcing in the general insurance market (TR15/7) found.

The FCA continues to assess conduct in this area and will likely draw their conclusions in 2016. Given the regulator’s findings so far, and the precedent set by recent regulatory change in other areas, firms can expect new rules to be in line with last year’s TR15/7 paper.

Here, we explore how firms can translate the regulator’s findings into practical and relevant actions in order to get ahead of the game on this issue.

To briefly recap the FCA’s findings, the thematic review reported that many insurers:

• Did not assess conduct risks when delegating authority
• Did not conduct due diligence when selecting a third party
• Could not articulate the extent and nature of their oversight in the design or delivery of products by third parties, including in complaints handling
• Had an over-reliance on their initial audit of third parties, rather than developing internal controls to oversee the outsourced work on an ongoing basis
• Third parties undertaking product design did not always understand their regulatory obligations as the retail manufacturers of products

Additionally, some insurers and intermediaries were found not to have considered the appropriate allocation of responsibilities within their agreements, especially in relation to customer outcomes.

How do firms apportion responsibility fairly in order to ensure good customer outcomes, rather than passing it back and forth between the parties of an outsourcing agreement like the proverbial hot potato?

HIGH-LEVEL IMPLICATIONS

Both insurers and intermediaries underperforming in this area should be aware that regulatory eyes will shortly be on them, as the new rules will impact both the insurer and the firm(s) holding authority from those insurers.

The prevailing concerns for firms following the release of TR15/7 will surely be around what new rules will look like, and what they must do to assure the regulator over their delegated authority activities.

The division of knowledge in delegated authority agreements makes achieving good outcomes a more complex proposition, and as such the need for communication between parties becomes doubly important to ensuring work remains compliant.

Final rules from the FCA are likely to draw heavily on firms’ lines of communication, whether MI is comprehensive and actionable, and the need to take a defined, collaborative approach to ensuring good customer outcomes where delegated arrangements exist.

ALIGNING WITH THE REGULATOR

Firms trying to fully understand the regulator’s future supervisory approach to this issue and establish how this applies to their business should consider these key points and actions:

1. DELEGATED AUTHORITY IS OUTSOURCING

The FCA is unambiguous in the assertion that delegating authority does not mean delegating responsibility. Firms must consider how PRIN and SYSC 8 should be applied in their context.

2. DIVIDE RESPONSIBILITY APPROPRIATELY

Responsibility for oversight in both product design and the monitoring of product performance should be divided appropriately between the parties involved in delegated authority agreements. Firms’ compliance functions will be key to mediating this activity, and will help ensure responsibility is apportioned correctly.

3. ASSURE THIRD PARTIES ARE COMPLIANT

If your firm is outsourcing work, consider whether your coverholders have effective, risk-based controls in place to ensure fair customer outcomes. What does your assurance programme currently look like, and is it robust enough? A firm delegating authority may need to be more stringent in its selection of third parties in order to fulfil its due diligence responsibilities.

4. ENSURE YOUR AGREEMENTS ENABLE EFFECTIVE MI

Do contractual agreements enable clear communication and the sharing of important information? What MI do you get from coverholders? Is it insightful and actionable? Does monitoring activity give a clear view of customer outcomes? All of these factors should be considered prior to delegating authority; however there is also cause for reviewing your existing contractual agreements to ensure they facilitate an effective working relationship between parties.

5. ENSURE YOU CAN ARTICULATE HOW CUSTOMERS STAND TO BENEFIT

Firms should not make the decision to outsource on a purely budgetary basis. Therefore, think about the justification for the initial decision within your firm. Were factors such as perceived processing efficiencies, reduced claim times, access to dedicated resource or greater expertise in delivery part of the consideration? Can you evidence this? Showing your firm considered the benefit to customers of outsourcing is important in satisfying regulatory scrutiny.

6. CONSIDER THE NATURE OF YOUR UK-BASED BUSINESS ACTIVITY

Firms passporting into the UK on a services basis must consider whether the level of their activity equates to having “established a branch”. Requirements here align with established case law, and the FCA asserts that firms should have “obtained appropriate advice if they are unsure of the position”. Firms regarded as having established a branch but not having assessed their legal position may be scrutinised.

7. UNDERSTAND YOUR OBLIGATIONS AS A PRODUCT PROVIDER

Insurers and intermediaries acting as product providers (as established as part of the initial delegation agreement) should assess the existing distribution channels and sales processes to make sure they facilitate fair outcomes for customers, which includes assessing the effect of sales incentives on product suitability.

The theme of these actions is consistent. All involve a high level of collaboration between parties and of course, true to the FCA’s ultimate goal, all are focused on customer outcomes.

It’s imperative that firms of any size and position within delegated authority agreements stay focused on this collaborative approach. It’s this which will ensure firms’ responsibilities to customers are correctly apportioned and fulfilled, rather than passed around or dropped altogether.

If you feel that ‘looking under the bonnet’ of your outsourced activity, articulating the reasons behind your decisions or demonstrating the effective controls you’ve developed could be difficult for your firm, then it may be time to ask the tough questions of your agreements, as change is on the horizon in this area.