FCA Consultation Papers on IDD
The Insurance Distribution Directive was passed by the EU on 20 January 2016. It replaces the Insurance Mediation Directive (“IMD”) and aims to enhance consumer protection when buying insurance (including general insurance, life insurance) and insurance-based investment products (“IBIP”s) and to support competition between insurance distributors. These changes largely arise as a result of the requirements of the Markets in Financial Instruments Directive II (“MiFIDII”). We now have the second consultation paper from the FCA on how this major change in sales and distribution of insurance products within the EU is going to be passed into UK legislation. CP17/23 also includes proposals in relation to product oversight and governance, and professional and organisational requirements, but we do not cover those here.
CP17/23 has an end date of 20 October 2017 for consultation responses. However the IDD is required to go into UK law by 23 February 2018, which does not allow much time from the end of the consultation period for the UK to get its rules right. Yet again, the FCA and PRA are behind the curve in putting this directive (which has been discussed with the industry and national supervisors for some years) into a UK context. CP17/33 has also been issued with an end date of 25 November for consultation responses. This is the third consultation paper from the FCA on the topic.
UK firms are already subject to many of the Directive’s requirements, through the FCA’s Conduct of Business Sourcebook (“COBS”) regime and the UK’s ‘gold plating’ of the IMD and the Retail Distribution Review, but changes will still be needed to ensure regulatory compliance. The FCA is intending to “gold plate” the directive in the areas where existing UK rules are at a higher standard than the IDD.
Key elements of the Directive
The Directive brings in a number of concepts:
1. Providers and distributors must act in their client’s best interests. The FCA are extending this to apply to all sales including sales to professional clients and eligible counterparties.
2. Communications must be fair, clear and not misleading. Marketing materials must be clearly identified as such.
3. Remuneration of employees cannot be set in such a way as to create a conflict of interest with acting in the client’s best interests.
4. The nature and basis of remuneration of intermediaries must be disclosed.
5. For all sales, including non-advised sales, firms must identify the needs and demands of the customer on the basis of information obtained from the customer. All sales must be consistent with the needs and demands of the customer.
6. Where advice is provided, a personalised recommendation must be provided that shows the product meets all the suitability tests to meet the demands and needs of the customer. If the suitability of that product relative to others in the market is considered, then a sufficiently large number of competing products must be considered.
7. If a product is complex and advice is not provided, the product provider may need to capture enough information to ensure the product is appropriate for the client. Firms will need to decide if their products meet the test for not being complex.
8. Ancillary sales of insurance products must be optional and not forced on the client.
9. Disclosure needs to be provided free of charge on paper form if requested by the client.
The FCA is proposing changes to COBS 2, COBS 4, COBS 6, COBS 7 COBS 8 and COBS 16.
Information and Product Disclosure
Amendments are proposed to COBS 2.2 to implement most of the appropriate information requirements. Most of the changes will be extending MiFID requirements already in place for life insurance to apply to IBIPs as well.
Key Features Documents are not required from 1 January 2018 and the principal disclosure document will now be the Key Information Document for a Packaged Retail and Insurance-based Investment Products (“PRIIP”s). Therefore, we believe firms will need to create a new secondary document that acts as disclosure under the Directive and also includes any Solvency II required disclosures not covered by the Key Information Document (“KID”). Risk warnings and other explanations can be included.
The pre-sale information required from the intermediary includes:
• identity and address of the intermediary,
• whether intermediary provides advice,
• how to register complaints,
• where the intermediary is registered and
• whether the intermediary is representing the customer or the insurer.
For the insurer:
• the identity and address of the insurer,
• whether it provides advice and
• how to register complaints.
For general insurance, a new document is required, which is in a standard format with a layout specified by EIOPA. The Insurance Product Information Document drawn up by the insurer has the following sections:
• name of insurer,
• name of insurance,
• description of the insurance,
• what is covered,
• what is not covered,
• restrictions on cover,
• geographical coverage,
• the obligations of the insured,
• the amounts and duration of the premium payments,
• when the cover starts and finishes and
• how the client cancels the insurance.
For life insurance and IBIPs, new disclosure is required explaining the policy, what is covered and how does it work in simple language as well as the Solvency II type information. Some of this can be provided by a KID under PRIIPs so any new document is an addition.
Regular updates are required at least annually for IBIPs. This should include things like charges and values.
For the distributor providing advice, there has to be updated information on whether the product is still suitable for the client every year.
Suitability and appropriateness
The suitability requirement appears similar to best interest advice for the client.
All sales of insurance contracts are proposed to require capturing the client’s needs and their demands from an insurance policy. This applies even on non-advised sales and on non IBIPs (ie pure protection contracts).
Appropriateness is a new concept and applies only to IBIPs. If no advice is given and the product is complex, the provider has to obtain sufficient information to show that the customer can understand the product and that the product is appropriate to his needs. If the product is non-complex, the customer has to be warned that no assessment has been carried out.
The draft delegated act specifies the tests for appropriateness based on whether the product meets the needs and demands test and the insurer needs to gain the following information on the customer:
1. the types of transactions, IBIPs or financial instrument that they are familiar with;
2. the nature, value and frequency of the customer’s transactions in IBIPs or financial transactions and the period over which they have been carried out;
3. the level of education, profession or relevant former profession of the customer or potential customer. Article 30(3) of the Directive states that a non-complex product can be either:
(1) one which only provides investment exposure to the financial instruments deemed non-complex under MiFID II and does not incorporate a structure which makes it difficult for the customer to understand the risks involved, or
(2) other non-complex insurance-based investments.
The financial instruments deemed non-complex under MiFID II as used in definition (1) are:
• money market instruments,
• shares in UCITS,
• structured deposits (if easy to understand), or
• other non-complex financial instruments.
The draft delegated act from EIOPA and CP17/33 defines a non-complex product under (2) above as satisfying all of the following:
1. it includes a contractually guaranteed minimum maturity value which is at least the amount paid by the customer after deduction of legitimate costs;
2. it does not incorporate a clause, condition or trigger that allows the insurance undertaking to materially alter the nature, risk, or pay-out profile of the IBIP.
3. it provides options to surrender or otherwise realise the IBIP at a value that is available to the customer;
4. it does not include any explicit or implicit surrender charges which are disproportionate and cause unreasonable detriment to the customer.
5. it does not have a structure which makes it difficult for the customer to understand the risks involved.
The FCA defines a non-complex IBIP as one that is directly linked to one or more of:
• money market instruments,
• shares in UCITS,
• structured deposits (if easy to understand),
• other non-complex IBIPs.
Therefore, unit-linked products can be deemed to be non-complex and EIOPA is providing an additional category of non-complex products. For EIOPA, with-profits would be simple if it meets the other criteria. Our belief is that accumulating with profits products with the sum assured near to or equal to 100% of premiums paid and a guarantee that MVR will not apply at certain dates, would easily comply with EIOPA’s definition. Conventional with-profits would appear to be complex and only some products are likely to meet EIOPA’s proposed definition.
There is no need to review appropriateness on an ongoing basis but the information used to assess it needs to be kept.
The suitability test applies only when advice is given and is a much harder test. COBS 9 currently contains suitability test rules that apply to all life policies including IBIPs. The FCA proposes retaining these rules for non-IBIPs and applying the suitability test in the EIOPA draft delegated act to IBIPs. This test considers whether:
• a product meets all customer’s investment objectives including risk tolerance, and
• a product meets a customer’s financial situation including ability to bear losses, and
• the customer understands the product and has the necessary knowledge and experience in the investment field relevant to the product.
The adviser will need to do the normal work around full fact finds that we have become used to in the UK. If the advisor has indicated that periodic assessments of suitability will be provided, then this should be at least annually. Frequency would be higher based on risk tolerance and nature of the IBIP.
The draft delegated act defines the additional non-complex IBIPs as including with-profits if it meets certain conditions. The FCA confirms that unit-linked insurances with no gearing would also be non-complex.
Firms also need to go through their point of sale documents and replace the Key Features with one or more documents that integrate properly with the KID.