Perspectives

The Insurance Distribution Directive

Changing the way insurance is sold

By Stefan Lia

An introduction to insurance business in Malta

The insurance market provides consumers with a wide choice of policies depending on their needs. The range of products mean that it can be difficult for consumers to fully comprehend what they are purchasing, especially when it comes to long-term insurance products which may include an investment element.

On 22 February 2016, The Insurance Distribution Directive (IDD) was published in the Official Journal of the European Union, meaning that it should be transposed by February 2018. The focus of the IDD is on selling practices for insurance products and aims to establish a level playing field between participants in insurance sales, whilst ensuring that consumers are provided with the right information to take an informed decision on their insurance purchase. It also aims to bring the insurance industry in line with consumer protection rules recently adopted in other financial sectors.

The IDD updates the 2002 Insurance Mediation Directive which introduced a framework for regulating European insurance brokers, agents and other insurance distributors. Insurance distributers can vary from agents, brokers and insurance undertakings to travel agents and car rental companies who would be distributing specific insurance products as part of a wider product offering (rental vehicles, holidays etc.). For the first time, insurance undertakings will also fall within the scope of this directive.

Although the IDD is not as wide ranging, in terms of cost and requirements, as the recently implemented Solvency II which had capital requirements, governance and reporting within its scope, the IDD touches on areas which are directly related to insurance products including governance, conflicts of interest, suitability and competencies required. Below we consider each of these in turn. 

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Product oversight and governance

The main scope of the directive is to regulate what products are brought to market and how these are sold. Under article 25 of the IDD, insurance distributors are required to have in place an oversight and governance process for the approval of new products. The process must consider any significant changes to an existing product prior to distributing it to clients. The process must cover the product’s design, marketing and distribution strategy.

The aim of this provision is to protect consumers by ensuring that insurance products introduced meet the needs of the market targeted for distribution, thereby mitigating the potential for mis-selling. There also has to be ongoing monitoring of the products once they are launched in order to ensure that they continue to meet market requirements.

Conflicts of interest, inducements and transparency

Consumers do not usually understand the relationships between principals and agents within the insurance industry. They might also not appreciate the role different agents have and how these are remunerated. The IDD is very prescriptive in that it sets out the exact pre-contractual information that needs to be provided to consumers. Emphasis is on disclosing the nature of the remuneration received in relation to the insurance contract and any ongoing premiums and fees payable throughout the duration of the contract.

In addition, distributors are not allowed to remunerate or apply sales targets that could provide an incentive to recommend a certain policy when a different product could meet the consumer’s needs better. Consumers also need to be made aware how the entity or individual selling the product is being remunerated.

Distributors will also be required to maintain organisational and administrative arrangements with a view to taking all reasonable steps to prevent conflicts of interest from adversely affecting the interests of their customers. They also need to keep their clients informed on the arrangements and how these might affect them. 

Suitability, appropriateness and product information for consumers

For the first time, distributors will be subject to suitability and appropriateness requirements similar to those for investment services firms under MiFiD II. When providing advice, the distributor will be required to provide the consumer with a periodic assessment of the suitability of the insurance-based investment products recommended.

A Product Information Document ("PID") must be provided to all consumers. The documents must include standard information on the product, and must be provided at the pre-contractual stage. The requirement is applicable to both life and non-life products. The PID has to be “short, stand-alone, comprehensible, accurate and not misleading”.

When bundling products, firms will be required to disclose information on each component in the package (e.g. costs and charges) and customers must be able to purchase them separately. The rules will strengthen disclosure requirements and have business implications as firms will need to price components separately.

Professional competency requirements

The professional knowledge of those involved in product development, distribution and aftersales needs to match the level of complexity of their role as well as the nature, type and complexity of the product. For the first time, salespeople at distributors will be required to undergo a minimum of 15 hours of professional training or development per year.

Insurers should be putting the finishing touches to the implementation of Solvency II which brought with it a lot of “regulatory fatigue”. This new directive, often dubbed as "the MiFID of insurance", will again focus on governance and internal processes, similar to Pillar 2 under the Solvency II directive. Insurers who implemented Pillar 2 requirements properly should therefore be well set to include the new requirements within their framework.  

There are however new requirements under the IDD which both undertakings and intermediaries will need to assess, bearing in mind that EIOPA has only recently launched its consultation on the guidelines related to the directive.

In conclusion, insurers will have to analyse the operational and strategic impacts of the IDD on their current product offering, especially in terms of suitability and appropriateness of their products to their target market. In addition, they will need to look at their current business model when it comes to product distribution due to the new requirements specifically aimed at streamlining the insurance distribution process.

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