On October 30, 2015, the European Insurance and Occupational Pensions Authority (EIOPA) published a consultation paper (the Consultation Paper) on its revised proposal in respect of guidelines for product oversight and governance arrangements by insurers and insurance distributors (the Guidelines). The Consultation Paper, which is addressed to regulators as competent authorities, follows the widely commented on consultation during the period October 2014 to January 2015 on product oversight and governance arrangements for insurance undertakings only. In light of the agreement to the Insurance Distribution Directive (IDD) earlier in the year, the scope has now been extended to include insurance distributors.
Role of EIOPA
In recent years there has been an increasing shift towards the European Supervisory Authorities (ESAs) taking ownership of matters which have historically been determined by national markets. The creation of the ESAs responded to a call from the European Parliament for a move towards more integrated European supervision in order to harmonise regulation across the European Union to reflect the increasing integration of financial markets and, critically, place customer protection at the forefront of its objectives.
EIOPA, as the ESA for the insurance market, has designated consumer protection and conduct regulation part of its remit considers its mandate to include issuing guidelines in the light of Article 41(1) of Solvency II: ‘Member States shall require all insurance and reinsurance undertakings to have in place an effective system of governance which provides for sound and prudent management of the business’. This Consultation Paper is now the most recent instalment following the direction given by the Joint Committee of the ESAs in the Joint Position of the ESAs on Manufacturers’ Product and Oversight & Governance Processes published in November 2013.
It is clear that firms across the EU should expect increasing engagement from EIOPA on all areas of market activity; in a welcome speech at the 5th Annual Conference on 18 November 2015, the Chairman of EIOPA Gabriel Bernardino emphasised that the authority is ‘moving from regulation to supervision’ in order to create a ‘credible deterrence of market misconduct’.
Product governance in the UK
The Guidelines, which represent the developing move away from consumer protection measures at the point of sale (such as status disclosure and information about the product) towards a more intrusive and proactive regulatory approach which is designed to pre-empt (and protect against) areas of risk, follows in the footsteps of the approach adopted by the regulators in the UK.
Product governance has been an increasing area of concern for the Financial Services Authority and now the Financial Conduct Authority (FCA) as conduct regulator for a number of years. In a speech in 2010, the Financial Services Authority announced a strategy to review the ‘whole product life cycle, the product value chain, including upstream processes – product development and design – as well as downstream activities – marketing, distribution and post-sale handling’ and the FCA has continued to devote significant resources to this issue since it took over from the Financial Services Authority in April 2013.
There have been a number of thematic reviews in respect of the development of insurance products, which have involved detailed investigations into market practice and the consumer experience, and firms have been experiencing a high level of engagement in relation to all aspects of the product cycle including how the product is designed, how it operates and the means of distribution. In addition, the FCA has made it clear that intervention can be expected at any stage of the product life span if customer detriment is threatened.
Integration with the IDD
Product oversight and governance arrangements are also a key feature of the IDD: Article 21 of the IDD will introduce product oversight and governance arrangements for manufacturers and distributors of insurance products. Firms will be required 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.
However, as minimum harmonisation will not be achieved until the requirements of the IDD have been transposed (which is expected in 2017) EIOPA is concerned with the intervening period, and also notes that there is a possibility that Member States may have diverging views on how the new requirements of the IDD should be understood and applied in practice.
What are the Guidelines saying?
In summary, the Guidelines are intended to address the fact that consumers across Europe have been presented with products which did not meet their expectations, primarily due to inherent flaws in both the design of the product itself and the manner in which it was sold. As a headline point, the Guidelines require firms to take a much more robust and thorough approach to product testing which will include undertaking stress-tests which take into account changes in the financial strength of the firm as well as reviews of how policy terms and conditions may impact the target audience. In addition, the Guidelines introduce some key elements for the collaboration between manufacturers and distributors emphasising the importance of strengthening the exchange of product related information.
For insurers and intermediaries who manufacture products for sale to the market, EIOPA requires clear product governance and oversight arrangements to be established, with defined objectives, which address the particular nature, scale and complexity of relevant products. These oversight and governance policies should be reviewed regularly and include a frequent analysis of target market, the skills of the employees who design the products, and detailed product performance monitoring. EIOPA suggests that monitoring should include a review of the expected claims ratio as well as the claims payment policy, or causes of complaints in determining whether to revise the offering. This analysis would allow firms to assess whether certain products are good value to customers and indicate whether the customers are getting a fair deal. Firms would also have to take into account whether products overlap with coverage already provided to customers. Terms and conditions should be reviewed to see if they meet the needs of the target audience and reviewed to ensure that that audience understands the policy terms and limitations.
The Guidelines for insurers and intermediaries who manufacture products for sale to customers have now been established as follows:
- Establishment of product governance and oversight arrangements.
- Objectives of the product governance and oversight arrangements.
- Role of the manufacturer’s administrative, management or supervisory body.
- Review of product governance and oversight arrangements.
- Target market.
- Skills, knowledge and expertise of personnel involved in designing the products.
- Product testing.
- Product monitoring.
- Remedial action.
- Distribution channels.
- Outsourcing of the product design.
- Documentation of product governance and oversight arrangements.
For insurance distributors, the emphasis is ensuring that there are comprehensive systems and controls around the distribution of the products including ensuring that there are clearly defined processes around the flow of product information between the manufacturer of the product and the distributor.
The draft Guidelines for insurance distributors who distribute products to customers are as follows:
- Establishment of product distribution arrangements.
- Objectives of the product distribution arrangements.
- Role of management.
- Obtaining all necessary information on the target market from the manufacturer.
- Obtaining all other necessary information on the product from the manufacturer.
- Distribution strategy.
- Regular review of product distribution arrangements.
- Provision of sale information to the manufacturer.
Responses are due on the draft Guidelines for insurance distributors by 29 January 2016.
While EIOPA plans to revisit the preparatory Guidelines once the deadline for the transposition of the IDD has passed to assess whether any revision is necessary, it is likely that the content will remain broadly the same. As such, insurers and insurance distributors will need to place product governance and oversight at the forefront of strategy going forward.