A tiger with teeth? User-pays model lays foundations for tougher regulator
Even before the release of its response to the Financial System Inquiry (FSI) on December 7, 2015, the Australian Federal Government announced its support for a ‘user-pays’ industry funding model for the Australian regulator, the Australian Securities and Investments Commission (ASIC). A consultation paper on the funding model was released for stakeholder comment in late August and remains open for comment. In light of other recommendations of the FSI that will see a significant increase in the enforcement and intervention powers that ASIC will hold, and a corresponding drain on resources, an industry funding model always appeared to be a necessary cornerstone for the proposed regulatory changes.
The new funding model will require the biggest users of ASIC’s resources to pay up to $220 million of the $260 million that ASIC draws from the Federal Budget each year. Contributions will be raised by an annual levy calculated by reference to market capitalisation and an assessment of each sector’s risk to investors, and the areas of investigation and enforcement on which ASIC intends to focus. The fees are likely to initially comprise $53 million for banks and listed companies, and $91 million for investment banks, stockbrokers, insurers, and the superannuation and financial planning industries. If introduced, the levy will be phased in over the next three financial years.
The Government is expected to complete its capability review of ASIC and its consultation on the industry funding model by the end of this year.
So what does this mean for the insurance sector in Australia? The answer is that a sustainable funding model for the regulator is likely to provide ASIC with the resources it will require, in order to effectively wield the additional enforcement powers it will have at its disposal. By disconnecting funding from the Federal Budget, ASIC will obtain a transparent and consistent funding base and be somewhat unburdened from politicising the cost of its administration. Any need to rein in public spending will not impact on the regulator going forward.
One of the key recommendations of the FSI is the introduction of product governance obligations, and related product intervention powers for ASIC. In its recent response to the FSI, the Government has thrown its support behind these proposals. The Government said that following extensive stakeholder consultation, it will introduce legislation to make issuers and distributors of financial products accountable for their offerings and will develop a new ASIC product intervention power, which could be used to modify products, or if necessary, remove harmful products from the marketplace.
ASIC has also made it clear that it intends to focus on organisational culture, and considers that firms and directors could potentially face civil action if firm culture leads to poor consumer outcomes.
A regulator that seeks to intervene early in the product lifecycle, or closely monitor the culture of financial institutions in Australia, will need to maintain close oversight of the market. If it intends to use the product intervention powers it is expected to receive in coming years, it will need to be proactive, rather than reactive. For that end, it is likely to require significant additional resources to be effective.
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.
UK Government proposes to roll out the senior managers regime to all FSMA authorised firms (including insurance intermediaries); certification extended to all firms as part of the package
The UK Government has decided to introduce a statutory duty on senior managers in all firms to take reasonable steps to prevent regulatory breaches in their areas of responsibility. The move announced by HM Treasury will extend the certification regime introduced in banks to other financial services firms authorised under the Financial Services and Markets Act 2000 (FSMA).
The certification regime will apply to individuals who are not carrying out senior management functions (including SIMFs) but whose roles have been deemed capable of causing significant harm to the firm or its customers by the regulators. Most current approved persons below SIMF level are expected to become ‘certified persons’. Some roles in firms where prior regulatory approval is not currently required may also be required to become certified persons. The regime requires firms themselves to assess the fitness and propriety of persons performing other key roles, and to formally certify this at least annually. The proposals for certification closely resembles the key function holder regime under Solvency II.
The measures would be introduced under the Bank of England and Financial Services Bill 2015-16 which was published on the UK Parliament website on October 15. The first reading of the Bill took place on October 14. A second reading took place on October 26, 2015.
Further detail on the application of the changes to insurers and intermediaries is expected. It is expected that the Bill will come into force in 2018.
Italian Supreme Court hands down judgment on suspension of time limitation on insurance claims
Italian insurance contract law provides that notice of a claim for damages by a third party to a liability insurer or notice of commencement of court action by a third party will suspend any limitation period specified under the insurance contract until the rights of the damaged party have become enforceable or become time-barred.
A recent decision by Italy’s highest court, the Italian Supreme Court (Corte di Cassazione) confirms that in relation to insurance claims, the contractual limitation period is suspended when the insurer is notified of a request for indemnity by the damaged party or by a third party and not only when such notification is made by the insured.
FSB announce updated list of G-SIIs
In 2013, the Financial Stability Board (FSB), in consultation with the International Association of Insurance Supervisors (IAIS) and national supervisory authorities, published the first list of global systemically important insurers (G-SIIs). The methodology applied to identify the list of G-SIIs has been developed by the IAIS. The identification of G-SIIs and the application of specific measures (including a higher loss absorbency requirement) to those identified as G-SIIs, seeks to address systemic and moral hazard risks association with systemically important financial institutions (SIFIs).
The list of G-SIIs is published annually. The list of systemically important reinsurers has yet to be published.
Bermuda granted full equivalency under Solvency II; Japan temporary equivalency under articles 172 and 227
Bermuda has been granted full equivalence by the European Commission under Articles 172, 227 and 260 of Solvency II. Japan has been granted temporary equivalence under Article 172 and provisional equivalence under Article 227.
Amendments being proposed to modernise insurance law in China
On 14 October 2015, the Legislative Affairs Office of the State Council of the People’s Republic of China (PRC) published draft amendments (Draft Amendments) to the PRC Insurance Law for public consultation. Following the minor changes to the PRC Insurance Law in late 2014 and early 2015 respectively, these Draft Amendments are being seen as offering significant changes to insurance law in the PRC.
The proposed major changes being put forward can be summarised as follows:
- expanding the business scope of life insurance companies to include annuity business (both corporate annuities and occupational annuities)
- permitting insurance funds to invest in equity products, insurance asset management products, and derivative products if invested for risk management purposes only
- abolishing the limitation on the amount of premiums being retained by a property and casualty insurance company, which under the current regime is up to 4 times of the sum of the paid-in capital amount and the reserve amount of such companies
- redefining the deposit fund of an insurance company as the ‘capital deposit fund’ which may only be withdrawn by insurers for the purpose of meeting debts during liquidation. The amount of the capital deposit fund has been decreased from 20 per cent to 10 per cent of the registered capital of insurance companies (with RMB 200 million as the maximum)
- incorporating the ‘Solvency II’ regime into the Draft Amendments, in particular the mechanism for classification of capital, evaluation techniques, the capital replenishment mechanism and establishing risk-based capital requirements
- authorising the China Insurance Regulatory Commission (CIRC) to take action (e.g. limiting shareholders’ rights, requiring shareholders to sell shares, limiting the business of insurance companies) against insurance companies whose corporate governance structure does not meet statutory requirements
- authorising CIRC to, when necessary, require shareholders or de facto controllers of insurers and insurance intermediaries to cooperate in investigations conducted by CIRC
- strictly prohibiting investors which cannot meet the statutory qualification requirements (such as net asset value and profitability requirements etc.) imposed on the direct shareholder(s) of an insurance company from indirectly making investments in such insurance company
- increasing the protection of policyholders, insureds and beneficiaries;
- increasing legal liabilities for breaching requirements
- authorising CIRC to issue regulations regarding reinsurance and internet based insurance
- incorporating a regulatory regime for insurance loss adjustors
- incorporating a new chapter in the Draft Amendments to regulate the insurance industry association and other insurance related market organisations (such as China Association of Actuaries, Insurance Asset Management Association of China, and Insurance Intermediary Association).
In short, these Draft Amendments have shown the government’s resolution to streamline administration in order to give play to the role of market. This is particularly reflected on the liberalisation of business operation of insurance companies (such as expansion of business scope, elimination of self-retained premiums etc.). However, on the other hand, these Draft Amendments also intensify and strengthen the sanctions and punishments so as to caution the breaching activities and entities.
Update on ASEAN / AEC commitments
As the deadline for the establishment of ASEAN Economic Community (AEC) draws near (31 December 2015), it is anticipated that there will be more actions undertaken by the Singapore government that will showcase the potential of AEC and more initiatives from the Monetary of Singapore as part of its fulfilment of AEC/ASEAN commitments.
ASEAN stands for the Association of Southeast Asian Nationals. Its goal is closer regional economic integration among its 10 member states namely, Brunei, Cambodia, Indonesia, Myanmar, the Philippines, Singapore, Thailand and Vietnam.
A recent achievement of AEC/ ASEAN was announced on 4 September 2015 with the issuance of a handbook concerning the multi-jurisdictional offering of equity or plain debt securities. This handbook provides detailed guidance on the operational aspects relating to the implementation of the Streamlined Review Framework for the ASEAN Common Prospectus, including criteria for ASEAN issuers. Under this Framework, issuers wishing to offer a multi-jurisdictional offering of equity or plain debt securities within ASEAN can issue one prospectus based on the ASEAN Disclosure Standards and benefit from a streamlined review process resulting in a shorter time-to-market with commitments by the authorities to complete the review process within four months from the date of submission. This will enable the issuer to have faster access to capital across the ASEAN region. With Singapore, Malaysia and Thailand being its current three signatory jurisdictions, it is anticipated that more member states will join in due course.
For the Financial Services Sector, under free flow of services, the commitments are to substantially remove restrictions for the Insurance, Banking and Capital Market sub-sectors with the intended liberalisation of Singapore’s direct non-life insurance, reinsurance and retrocession, insurance intermediation and services auxiliary to insurance sub-sectors. Despite ongoing concerns over the launch timing, many industry watchers remain optimistic on the progress of AEC which will most likely result in increased competition and provide the most benefits to multinationals based out of developed and established jurisdictions like Singapore.