Joint authorities lay down the law for insurer outsourcing
Stakeholders in the life and non-life insurance sectors have just received another regulatory instrument in their mailboxes, labelled Joint Standard 1 of 2024: Outsourcing by Insurers, published 17 May 2024. The Joint Standard should give the industry’s compliance teams something to chew over while they wait for the next mega regulatory meal to be served; the long-awaited Conduct of Financial Institutions (COFI) Bill has been simmering since its first draft back in 2018, and is surely imminent.
Pertaining to material functions
As is now customary, the Joint Standard was published alongside three other documents, including an explainer titled Join Communication 1 of 2024. Per this explainer, the Financial Sector Conduct Authority (FSCA) and Prudential Authority (PA) have patched together “the minimum expectations in relation to outsourcing by licensed insurers, specifically of material functions”. The joint authorities also offered a quick refresher on how its latest standard came to be; a draft Joint Standard was issued back in September 2021, per the rules in section 98 of the Financial Sector Regulation (FSR) Act.
The usual back and forth between regulators and the industry ensued, and it took more than two years, until 30 November 2023, for the Joint Standard to be tabled in Parliament. Readers who have a morbid curiosity about law making might enjoy some of the documents published alongside the Joint Standard, including a detailed description of “the need, expected impact and intended operation of the Joint Standard. And those who want to explore the process for making regulatory instruments can simply dust off their copy of the FSR Act and flip to Chapter 7. The Joint Standard runs to a mere 12 pages, so it should be a doddle to comply with.
However, for the masochists among you, the joint authorities also published a 97-page marathon titled ‘Joint Standard on Outsourcing for Insurers Consultation Report’ dated November 2022. This document sets out the comments submitted by various industry stakeholders during the public consultation process. This writer did little more than open the document and get the page-count; you are free to knock yourselves out by reading further if you have the time. Returning to the matter at hand, the joint authorities have indicated that Joint Standard 1 of 2024 will commence six months from date of publication, on or around 1 December 2024.
Impact of new outsourcing standards
The good news for FAnews readers is that the folk at law firm Bowmans have already published a summary of the potential impact of the latest regulatory instrument. “The Joint Standard sets out the regulatory requirements regarding the outsourcing of material functions by licensed insurers,” they wrote. “It replaces Prudential Standard GOI 5 [and] provides a more comprehensive regulatory framework governing outsourcing by insurers from both a prudential and market conduct perspective”. Put another way, this 12-pager ensures that the prudential and market conduct supervisory functions around insurer outsourcing are uniformly applied.
The new law applies to all domestic insurers, micro-insurers and reinsurers licensed under the Insurance Act; but excludes Lloyd’s and branches of foreign reinsurers. It looks certain to keep insurers’ compliance and legal teams busy. Bowmans writes, “The Joint Standard introduces enhanced due diligence and performance management processes and policies which insurers are required to implement; insurers will also be required to consider their outsourcing arrangements in terms of credit and conduct risks”. The following is a summary of new requirements under the Joint Standard, ‘borrowed’ in part from the Bowmans’ report on same.
First and foremost, before entering an outsource arrangement, an insurer must “undertake appropriate due diligence for every activity or function that it intends to outsource in order to identify and manage all risks introduced by the outsourcing arrangement”. The regulatory authorities want insurers to carefully weigh up the cost, benefit and potential risk to its insurance business and only enter into outsourcing arrangements “where there is evidence that the benefits outweigh the costs and potential risks”.
Risk-focussed review of outsource arrangements
Second, before entering an outsource arrangement, an insurer must “consider where the service provider has multiple outsourcing arrangements with other insurers whether these multiple outsourcing arrangements are likely to increase the risks for the insurer, as set out in the Joint Standard”. The third point highlighted by the legal specialist was that “an insurer may not enter into or maintain an outsourcing arrangement where the key persons of that service provider do not meet the fit and proper requirements relating to competence and integrity, as provided for in Prudential Standard GOI 4 which deals with the fitness and propriety of key persons of insurers”.
The usual list of compliance-related hints and tips followed. Per the Bowmans communication, an insurer must notify both the FSCA and PA on any material outsourcing arrangements at least 30 days prior to entering into same. “The notification must include certain information and be accompanied by a confirmation that the outsourcing arrangement is compliant with the insurer’s outsourcing policy and within the risk appetite set by the board of directors of the insurer,” Bowmans writes. The joint regulators must also be notified when an outsourcing agreement is terminated, alongside specific requested information, within seven days of the date of termination.
Two-years for full implementation
There are a handful of tasks that should keep the compliance gurus at local insurers awake for the next year or two. They have 24-months from the implementation of the Joint Standard to ensure than any pre-dated outsourcing arrangements are fully compliant with the new standard. Compliance with the Joint Standard is also indicated upon the renewal or renegotiation of any pre-dated outsourcing arrangement; so, this writer guesses if you renegotiate a standard between today and 1 December this year, you will have to ensure compliance.
Insurers will also have six months from its implementation to comply with the various terms and conditions set out in Joint Standard, until which time they must comply with Prudential Standard GOI 5 as if it has not been repealed.
As a parting thought, your writer wondered how the new joint standard clashed with the binder framework. The only reference to binders appears in section 5.7 of the standard dealing with remuneration paid in respect of outsourcing. Per paragraph (b) this payment may “not result in any function or activity in respect of which commission or a binder fee is payable being remunerated again”.
Writer’s thoughts:
It looks reasonably safe to say that South Africa’s short-term insurance brokers will be unaffected by Joint Standard 1 of 2024. Do you agree, or have you already heard rumblings from your insurance partners that your binder or outsource arrangements are up for review? Please comment below, interact with us on X at @fanews_online or email us your thoughts editor@fanews.co.za.
