Insurers of trade receivables should verify whether their outsourcing of collections complies with KNF guidance | In Principle

Guidance from the Polish Financial Supervisory Authority of 25 March 2024 on certain aspects of outsourcing by insurers and reinsurers also covers collection proceedings related to performance of insurance contracts. Insurers offering trade credit for which collections are carried out by external providers must verify whether this outsourcing is compliant with the regulator’s position.

As companies’ payment situation deteriorates, insurance coverage for trade receivables grows in importance. These policies are vital especially for exporters. As the Polish Chamber of Insurance writes in its annual summary of 8 April 2024, in 2023 insurers provided coverage for commercial transactions worth PLN 911 billion. That’s over 29% of the value of the entire Polish economy in 2023. Insurers of accounts receivable paid out claims totalling PLN 384.5 million in 2023, 75% more than in 2022.

Trade receivables insurance (trade credit) is structured so that a key element is collection of receivables, usually performed by the insurer under a power of attorney from the insured. Therefore, for insurers offering such products, the new guidance from the Polish Financial Supervisory Authority (KNF) of 25 March 2024 on certain aspects of outsourcing by insurers and reinsurers is crucial because the KNF guidance also covers “conducting collection proceedings related to performance of insurance contracts.” Therefore, insurers offering trade credit for which collection activities are carried out by external service providers need to verify whether their outsourcing in this regard complies with the KNF guidance.

The essence of KNF’s position on outsourcing

In its position paper, the regulator summarised its review of outsourcing rules followed by entities in the insurance and reinsurance market. KNF took a look at how insurance companies classify functions that are part of their management system or core business. The analysis showed that their practice is inconsistent, prompting the regulator to issue guidance to ensure compliance with the requirements in the Insurance and Reinsurance Act, as well as EU provisions.

KNF formulated the criteria for evaluating functions that are part of the management system or activities considered “core” or otherwise “important” to the insurer. In determining which functions or activities should be deemed “core” or “important,” the insurer should first conduct a sort of “indispensability” test to assess whether it could provide services to insureds without ensuring performance of that function. In making this assessment, the insurer should also consider the impact of outsourcing on maintaining a stable management system, sound financial condition, and legal compliance.

KNF also identified several other, broader criteria that should be taken into account in compliance with the principle of proportionality. These include the type of activity being outsourced, the impact of potential disruptions in the outsourcing on the insurer’s eligibility to hold an operating licence, or the financial impact of outsourcing on the insurer.

In its guidance, KNF also raised the issue of supplier risk assessment. In addition to the most obvious risk that the contractor will not perform the contracted functions or activities (or will perform them improperly), the authority also identified other, less obvious types of risk:

• The risk of concentration of functions in the hands of a single supplier with a dominant market position, making it difficult to quickly replace that provider
• The risk of conflicts of interest arising during implementation of outsourcing.

Accordingly, insurers’ outsourcing policies should establish:

• Sources of potential conflicts of interest for the insurer
• Control mechanisms
• Rules for monitoring and reporting on conflicts of interest.

The most typical threats to impartiality or independence in the performance of outsourcing are capital ties between the insurer and its supplier, or contractual interconnections.

Outsourcing of core functions and other activities in insurance and reinsurance

KNF takes the view that all functions that are part of the management system (actuarial, risk management, compliance, and internal audit functions) are essential for insurance and reinsurance activity. In principle, occasional consulting on one of these functions will not constitute outsourcing, but if a supplier continuously or periodically performs the tasks of a given function, the insurer should consider classifying it as outsourcing.

Under its criteria, KNF indicated examples of activities insurers should consider potentially “core” or “important,” including:

• Assessment of risk under insurance contracts and insurance guarantees
• Claims adjustment
• Creation of insurance products
• Ensuring ongoing maintenance and support of information systems.

At the other extreme, according to KNF, examples of activities that in principle can be excluded from the list of core or important activities would be:

• Security of buildings and personnel
• Recruitment of employees
• Training
• Marketing.

In this guidance, the final issue raised by KNF is monitoring the nature of outsourced functions or activities. Insurers should conduct a periodic review of all outsourced functions or activities to determine whether they have become core or important. The need to revisit the classification of a particular function or activity may arise from changes in external circumstances or from changes in the insurer’s organisation or business profile.

Effective date of the KNF guidance

The KNF Office expressed the hope that insurers would review their existing outsourcing policies and contracts, and make any changes required to take into account the KNF guidance on outsourcing by insurers, by the following deadlines:

• 31 December 2024 for review and modification of outsourcing policies, as well as taking the guidance into account when concluding new outsourcing contracts
• 31 March 2025 with respect to existing outsourcing arrangements.

Legal basis

KNF pointed out that the legal basis insurance companies should rely on when selecting and evaluating outsourcing providers includes:

• EIOPA Guidelines on System of Governance and EIOPA Report no. 14/017
• Commission Delegated Regulation 2015/35
• Regulation (EU) 2022/2554 on digital operational resilience for the financial sector.

The position published by the Polish Financial Supervisory Authority provides guidance on how to properly comply with outsourcing requirements. This clarification from the regulator should help standardise insurers’ practice of outsourcing of collection of trade credit receivables.

Mateusz Kosiorowski, adwokat, Danuta Pajewska, attorney-at-law, Klaudiusz Mikołajczyk, Insurance practice, Wardyński & Partners