1. Financial firms frequently decide to outsource aspects of their operations to other parties, Related or not. Outsourcing can bring significant benefits to a firm in terms of efficiency, cost reduction and risk management. However, both the process of implementing outsourcing arrangements and the outsourcing relationship itself may expose a firm to additional risk. It is therefore important that firms take care to supervise the conduct of activities that are outsourced. GEN 3.3.32(1) requires an Authorised Person to inform the Regulator about any material outsourcing arrangement.
2. The activities of outsource contractors have the ability to undermine the risk management activities of Insurers. Insurers should take particular care if outsourcing activities such as underwriting and claims management, where inappropriate performance of the functions can expose the Insurer to serious financial loss, for example through acceptance of inappropriate insurance risks, mis-pricing, failure to obtain appropriate reinsurance cover, or failure to detect invalid claims. These considerations apply to such arrangements as binding authorities and other agencies appointed by Insurers.
3. In negotiating a contract with an outsource contractor or in assessing an existing agreement, an Insurer should give consideration to matters relevant to risk management, including the following:
a. setting and monitoring of authority limits and referral requirements;
b. the identification and assessment of performance targets;
c. procedures for evaluation of performance against targets;
d. provisions for remedial action;
e. reporting requirements imposed on the outsource contractors (including both content and frequency of reports);
f. the ability of the Insurer and its risk management functions (for example, internal auditors), and its external auditors, to obtain access to the outsource contractors and their records;
g. protection of intellectual property rights;
h. protection of customer and firm confidentiality;
i. the adequacy of any guarantees, indemnities or insurance cover that the outsource contractor agrees to put in place;
j. the ability of the outsource contractor to provide continuity of business; and
k. arrangements for change to the outsource contract or termination of the contract.
4. Insurers should take care to manage the risk that the sound and prudent management of the Insurer's business may be compromised by conflicting incentives in the outsource agreement. In particular, Insurers should consider whether the Remuneration structure creates any perverse incentives. For example, an outsource contractor with underwriting authority may have an incentive to accept poorer quality business if Remuneration is based on commission (especially if bonuses are given for volume) and Remuneration is not affected by the performance of the Contracts of Insurance accepted.
5. Intra-group outsourcing may be perceived as subject to lower risks than using outsource contractors from outside a Group. However it is not risk-free and an Insurer must still assess the associated risks and make appropriate arrangements for their management.