Directive 159: The full impact of Directive 159 will only be known over time!

Directive 159 became effective on 12 April this year. The only exception was that existing outsourced arrangements would have until 1 January 2013 to comply, as was the case with binder agreements under the new Binder Regulations.

Binder Regulations came into effect on 1 January 2012 with respect to new binder agreements, whereas all existing agreements were given until 1 January 2013 to comply. These regulations were passed as part of the Short Term Insurance Act and appeared to be independent legislation with respect to outsourcing binders.

The binder agreements authorise the binder holder to perform only those functions that are stipulated in the Binder Regulations, namely entering into, varying or renewing policies; determining premiums; determining policy benefits; binding the insurer on policy wordings; and settling claims.

The Regulations also state that all administration activities incidental to the performance of these functions should be covered in the binder agreement. This is where the interpretation of the Regulations becomes tricky, because the line between genuine outsourced administration and administration incidental to the binder functions can be a fine one.

For example: If the binder function outsourced to a binder holder is the settling of claims, then the actual binder function is the decision to pay the claim after having due regard to the policy conditions. What functions are then considered incidental to making this decision as opposed to outsourced administration?

It will be extremely difficult to determine whether activities such as the appointment of loss adjusters and assessors and administering the processing of the claims file count as "binder” or "outsourced administration” functions.

To add to the ambiguity, the current definition of intermediary services includes the processing and administration of claims. This type of activity could technically fall into one of the three agreements an insurer can have with an intermediary. Recoveries could either be a binder function or an outsourced administrative function too.

Another significant difference between the Binder Regulations and Directive 159 is sub-delegating the mandate or the function that has been outsourced. When Section 48A was amended in the Insurance Acts, it was clear that a binder holder could not sub-delegate binder functions, nor could they pay fees to another party as the function was not taken away.

Only the Insurer could delegate these functions directly. There was a concern among Underwriting Managers that they would not be able to pay fees to intermediaries whereas insurers would be able to reimburse them for performing binder functions.

Directive 159 allows the binder holder or third party to sub-outsource the insurance function that was delegated to them as well as pay a fee commensurate with that function to the third party (perhaps even an intermediary).

It therefore becomes critical to get right what is a binder function, what is administration incidental to those binder functions and what is outsourced administration in terms of Directive 159. One set of functions can be outsourced and remunerated by a non-insurer, the others cannot.

A further example of overlap and confusion will be the costs that an intermediary or third party spends in reconciliation of premium bordereaux and being involved in collections. According to the current definition of intermediary services, the collection and accounting for premiums are remunerated through commission. The old practice of charging the client a debit order fee cannot be maintained as the work in question is done on the insurer’s behalf.

In terms of Directive 159, the governance of the binder agreement and binder relationship is dealt with in the Binder Regulations, drafted specifically for that purpose. Directive 159 does however deal with outsourcing of insurance functions as a whole and imposes a framework within which to do this and so automatically also includes the outsourcing of binder functions.

How the outsourcing of Binder Regulations is to be handled with respect to Directive 159 is not entirely clear as the two regimes are not exactly the same. In terms of the Binder Regulations, the FSB must be notified when the binder relationship is brought to an end.

It does not state anywhere in the Regulations that the handing of a binder mandate needs to be notified to the Registrar. In terms of Directive 159, any outsourced function that would be defined as either a control, management or material function needs to be specifically advised to the Registrar prior to the agreement coming into place.

Directive 159 makes it clear that the binder agreement and its contents will be dealt with in terms of the Binder Regulations rather than what Directive 159 defines as being obligatory for the 159 agreement. If the outsource of binder function falls within the management, control or material function then it would fall within the strict requirement of notification laid down in Directive 159 as binders is still an outsourced function covered by Directive 159’s framework.

Another difficulty is that the Binder Regulations were gazetted prior to 12 April 2012. An interesting question is what the status would be of binder agreements entered into prior to 12 April but after 1 January 2012.

It appears that none of the Directive 159 conditions would be applicable until 1 January 2013. Also – what happens with high risk outsourced agreements agreed to prior to 12 April? Would these all have to be notified to the FSB after 1 January 2013, regardless of when these arrangements came about?

One of the most important elements of Directive 159 is that the insurer, in order to outsource any functions (including binder functions) must have a comprehensive outsourcing policy in place. This will take some time as the insurer will have to deal comprehensively with the rules under which it will bring on board outsourced parties, how such relationship will be governed and how they will be terminated.

Once Directive 159 is in place it appears no new outsourcing arrangements (including binder arrangements) can be put in place until this policy is in place. Insurers will have to put a well thought out policy in place as a matter of urgency. This requirement brings binder arrangements into play in terms of Directive 159, outside of the wording of the agreements.

Further difficulties with putting together such a policy is that the insurer must decide what it regards as management, control and material functions in terms of the risks that these functions bring to the business. It must also decide what functions it regards as being Directive 159 functions and which of the functions outsourced to third parties fall outside this regulation. There will be various different interpretations in this regard.

The Directive also states that fees to be paid for the performance of such services are to be reasonable and commensurate for such services. The definition is less clear than that used in the Binder Regulations, which state that the remuneration cannot be based on premium against claims but rather on the actual costs of the binder holder in carrying out the binder services including a reasonable rate of return.

Currently insurance administrators charge for services rendered in different ways. It will be interesting to see how insurers calculate the fees that they intend to pay for such outsourced services. Presumably the market will dictate… An important point is that the profitability of the scheme cannot be used as a yardstick.

Many administrative functions and insurance service providers will fall within Directive 159. An insurer that is liable to repair vehicles effectively outsources these repairs to panel beaters. Insurers outsource their roadside assistance products and very often outsource their obligation to provide car hire in the event of motor vehicle accidents too. The more one digs the greater the impact of Directive 159 becomes.