What are the PRA’s expectations on outsourcing the actuarial function?
Prudential Regulation Authority (PRA) Supervisory Statement SS2/21 on outsourcing and third party risk management gives firms plenty to think about.
In this article we outline some aspects firms should consider when outsourcing their actuarial function, including having appropriate back-up arrangements and exit plans. And we discuss whether similar principles might be extended to internal actuarial departments.
Outsourcing of the actuarial function
In SS2/21 the PRA makes clear it considers outsourcing of a key function, such as the actuarial function (AF), a “material” outsourcing arrangement. Firms that outsource the AF, or are thinking of doing so, need to take action to comply with the PRA’s material outsourcing requirements.
In particular, firms need to think about whether they should have exit plans and a back-up provider in place to ensure continuance of service if the provider is unable to deliver the service, either for a period of time or indefinitely.
What back-up arrangements are required?
A controlled exit from an actuarial outsourcing agreement should not give rise to major issues. Providers accept that there may be circumstances for change and will help facilitate an orderly handover. Continuity risks primarily arise from unexpected and, hopefully, rare events - such as insolvency of the provider.
Appropriate back-up arrangements will depend on a number of factors, including the significance of the firm, (PRA Category 1 and 2 firms would be expected to have robust arrangements), the complexity of the firm’s business and the ownership of/access to models used by the AF.
For less complex insurers appropriate back-up arrangements may be the simple identification of alternative providers that would be willing to perform the service and could do so at short notice.
Others may need to take additional steps, such as engaging with a back-up provider to ensure the reins can be taken over in a timely manner if something untoward did happen to the incumbent. The extent of such engagement should, again, take complexity into account. For example, firms will need to agree the terms of any back-up arrangements and decide whether any back-up provider should have regular interactions and be kept abreast of developments.
Actuarial models are key. While models for a simple business may be developed and tested in a matter of days, it takes much longer to develop appropriate models for a complex business.
In a stressed hand-over for more complex businesses, the back-up provider will need either to have already developed the necessary models or have access to copies of the models used by the incumbent. Otherwise there could be an unacceptable break in service.
This means that even if a firm chooses not to engage with a back-up provider directly, it should ensure that it has, or can get, access to the current provider’s models and appropriate user documentation and can share these with a back-up provider in the event that the incumbent provider is unable to deliver the service.
In stressed circumstances a “gentleman’s agreement” that models will be shared may not be enough. Firms should discuss ownership of models with their service provider and, at the very least, should press for up to date copies of models and documentation to either be shared or held under an escrow agreement.
Additional considerations include the modelling software/platform used and whether there are barriers to others using that software. After all, there’s little point having a copy of a model following the failure of a service provider if the ability to run or change it is somehow dependent upon the continued existence of the service provider.
What about in-house services?
Before looking at other actions firms may need to take when outsourcing their AF, it’s worth thinking about whether the themes discussed above apply equally to in-house teams, particularly if the team is small or if reliance is placed on a few key personnel.
Taking into account regulatory initiatives on operational resilience, firms need to ask themselves what they would do if the unthinkable happened and those staff are not available, either for a period or indefinitely. If the answer is unknown or unclear we suggest they might want to consider putting a back-up option in place!
". . . firms need to ask themselves what they would do if the unthinkable happened and those staff are not available, either for a period or indefinitely."
Similar to back-up arrangements for outsourcing, there are a range of options that firms might contemplate in terms of the interaction between the firm and the back-up service provider. Firms need to identify what needs to be in place to ensure the back-up service provider can hit the ground running if there is an issue. It’s also important to remember that there is no “one size fits all” solution.
However, the approach to back-up arrangements for an internal department should not simply mirror what might be put in place as back-up for an outsourced operation.
Here, given that there is no competition between the current and back-up providers, there is a much greater opportunity for the firm and back-up provider to work in partnership. If implemented well, a valuable relationship should develop that provides benefits for the firm, even if the back-up option is never invoked. For example, one benefit might be the back-up provider performing independent review of reports and approaches as part of being kept informed of developments.
What other actions are required?
Returning to outsourcing, while the PRA’s requirements on exit planning and back-up arrangements may be an area to which firms have historically paid limited attention, the Supervisory Statement is a reminder that firms need to have appropriate contractual arrangements in place and carry out robust due diligence for material outsourcing.
As a minimum, firms that outsource their AF should ensure that contracts reflect the PRA’s expectations on written agreements as set out in Chapter 6 of the Supervisory Statement. While these expectations are broadly aligned with typical contractual clauses and current regulatory requirements, the PRA presses for coverage of topics that currently may not be addressed by all, such as the aforementioned exit planning.
There is a clear message from the PRA that firms should carry out rigorous due diligence to ensure the service provider is not only able to carry out the work, but is also financially sound. Before outsourcing, a firm must understand and be comfortable with the level and type of service it expects to receive, and how that service will be provided. It must also be confident that the service provider will be able to fulfil its obligations over the term of the agreement. These views should be confirmed periodically.
How can we help?
Barnett Waddingham provides outsourced Chief Actuary and actuarial function services to a range of insurance firms and has extensive experience in delivering bespoke solutions. We would be happy to discuss your outsourcing requirements and back-up arrangements with you. For more information, please get in touch with John Hoskin or your usual Barnett Waddingham contact.
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