European Parliament approves Insurance Distribution Directive
The European Parliament has approved the text of the Insurance Distribution Directive (IDD). This is the first step in the formal legislative procedure towards adoption and implementation of the IDD into law. If the European Council approve the IDD without change, the new regime for insurance distribution is likely to be implemented in late 2017/early 2018.
What does the IDD seek to achieve?
The Insurance Mediation Directive (2002/92/EC), implemented in 2005, was intended to create a single market for the sale of insurance products. It quickly became apparent to the European Commission and others that the IMD was something of a failure and plans to revise the directive were underway by 2008. Described in the Commission’s consultation as dense, legalistic and jargon-ridden, the mediation directive fell short in terms of drafting quality and has resulted in a lack of harmonisation of regimes across Member States. In July 2012, the Commission published the first draft of a revised directive in the hope that an improved legislative architecture might boost sales of insurance products across EU borders.
What do you need to know about the text approved?
The IDD text approved contains the following elements:
The IDD is a minimum harmonisation directive that will be applied to insurance intermediaries and also to insurance (and reinsurance) undertakings who sell direct to their customers. Claims management, loss adjusting and expert claims appraising are not within scope.
Introducing no longer included
Insurance distribution includes advising on, proposing or carrying out work preparatory to a contract of insurance or assisting in the administration and performance of such contracts, in particular in the event of a claim. Notably, the activity of ‘introducing’ is not within the definition of insurance distribution (as it is under the current Insurance Mediation Directive). Accordingly, once in force there will no longer be any need for those merely introducing customers to brokers or insurers (or providing data on policyholders to insurers) to be registered.
Registration of all intermediaries
Intermediaries (i.e. those insurance distributors who are not insurers or reinsurers selling directly) are required to be registered with a competent authority in their Home Member State. Where a distributor is responsible for the activities of an intermediary (for example, an Appointed Representative) they will have responsibility to ensure that the intermediary meets the conditions for registration and for registering that intermediary with the relevant competent authority.
Overriding requirement to act ‘in customers’ best interests
The IDD requires that insurance distributors should always act ‘honestly, fairly and professionally in accordance with the best interests of its customers’. This requirement imposes a high standard upon all distributors (including direct sellers and those distributing to professional customers) to consider the interests of customers in their business. This could have potentially far reaching consequences as was seen in the application of Treating Customers Fairly by regulators in the UK. Furthermore, distributors are required to ensure that they do not remunerate or assess the performance of their employees in a way that conflicts with the duty to act in the best interests of customers.
The IDD also requires firms to operate and review a process for the approval of each insurance product they offer and to review any significant adaptations of existing products before they are marketed or distributed to customers. This process requires firms to identify target markets and ensure that risks to the target market are assessed and managed.
Conflict management requirements for investment products
The IDD introduces higher standards of disclosure and conflict management for Insurance-based Investment Products (IBIPs). These are products that offer a maturity or surrender value that is dependent on market fluctuations. Where organisational measures are insufficient to ensure, with reasonable confidence, that risks of damage to the customer cannot be prevented, the distributor is required to disclose the general nature and source of the conflict. The European Commission is given powers under the IDD to introduce delegated acts in order to define the steps that distributors might reasonably take in order to identify, prevent, manage and disclose conflicts and to establish criteria for determining the types of conflicts that may damage the interests of customers or potential customers. The inclusion of conflicts measures and supporting delegated acts reflects similar requirements in the Markets in Financial Instruments Directive (MiFID). In addition, insurance distributors will be subject to the requirement in the measures being developed for packaged retail investment and insurance-based investment products (PRIIPs) to provide customers with a key information document (or ‘KID’). Non-investment products must be accompanied by an insurance product information document (or ‘PID’).
Enhanced professional requirements
Those persons carrying out insurance or reinsurance distribution will be required to meet certain competency requirements and comply with obligations for continuing professional development, taking into account the nature of the products being sold and the type of distributor (i.e. taking into account the variances between tied agents, commercial brokers and IFAs). These include requirements for continuing professional development.
Disclosure and transparency
Before the conclusion of an insurance contract, intermediaries are required to provide details about themselves and must describe to their customer the nature of their remuneration and whether the contract will work on the basis of a fee or commission (or other type of arrangement). The IDD excludes these obligations where the distribution relates to large risks, reinsurance or for professional customers. Insurance undertakings will be required to disclose the nature of the remuneration received by employees in relation to the contract sold (i.e. bonus payments). The IDD enables Member States to restrict the payment of commission as has been done in the UK under the Retail Distribution Review rules (in operation since December 31, 2012).
Online selling and aggregators
The IDD recognises the use of websites in distribution and in particular includes aggregator sites within scope. In addition, the IDD recognises that pre-contractual information can be provided to customers via a website where addressed personally to the customer.
When a product is offered with another service or as part of a package, the distributor must inform the customer whether it is possible to buy the different components separately and if so they must provide an adequate description of the different components as well as separate evidence of costs and charges.
What firms should do next?
The IDD is relevant to all firms that sell directly to customers (whether consumer or commercial). Firms in many highly regulated markets such as the UK are likely to have less to do in terms of adaptation to meet the new IDD requirements, however the new regime will have an impact on professional requirements, the management of incentives and conflicts and the scope of product governance requirements. Furthermore, the IDD introduces more stringent sanctions for breach of its requirements: a maximum penalty of at least €5 million or up to five per cent of total annual turnover or twice the amount of profits gained from the breach (and for a natural person, a penalty of at least €700,000 or twice the amount gained from the breach).
When is the IDD likely to be implemented?
If the European Council approves the text, the IDD will be published in the Official Journal of the European Union. Member States must then implement the IDD within two years.