International focus

Australia

Back to the drawing board as design and distribution laws pass Parliament

The Treasury Laws Amendment (Design and Distribution Obligations and Product Intervention Powers) Act 2019 passed Parliament last week and received royal assent shortly after. It introduces design and distribution obligations into the Corporations Act 2001 (Cth), requiring financial services entities to consider the design of their retail financial products and the way they are distributed. The amendments to the Corporations Act 2001 (Cth) also give the Australian Securities and Investments Commission (ASIC) power to intervene in situations where there may be significant consumer detriment. The reforms were first proposed in 2014 by the Financial System Inquiry as a way to address the perceived ineffectiveness of giving lengthy disclosure documents to retail clients, and closely mirrored regulatory reform introduced in the United Kingdom in 2013.

The first draft of the legislation was first read in Parliament in September 2018 and initially applied to retail financial products requiring disclosure under the Corporations Act 2001 (Cth). We wrote about the proposed reforms in the Australian Insurance Law Bulletin (see vol 33 no 10). Following the release of the Royal Commission’s Final Report, the legislation was expanded to:

• cover financial products regulated under the Australian Securities and Investments Commission Act 2001 (Cth) – this has the effect of extending the obligations to credit products and warranty products, by way of example;
• include a private cause of action where an entity fails to make a target market determination; and
• give ASIC standing to seek compensation on behalf of affected consumers who are not parties to the legal proceedings.

What are design and distribution obligations?

The design and distribution obligations will take effect from April 5, 2021. From this date, financial products can only be distributed to retail clients if the product issuer, who is also responsible for preparing the product disclosure statement, has made a target market determination under section 994B. Section 994B(3) lists some exemptions from this general requirement and also enables further exemptions to be specified by regulation.

The objective of the target market determination is to ensure that when the product is sold to retail clients, the retail client would likely be in the target market and the product would be consistent with the retail client’s likely objectives, financial situation and needs.  Under section 994E, the person who makes the target market determination must take reasonable steps to ensure the retail product distribution conduct is consistent with the determination. This will undoubtedly add compliance costs for the product issuer who needs to oversee distribution by intermediaries, and significantly blurs the traditional distinction between the legal obligations of product issuers and distributors, even where both separately hold AFS licenses.

What should insurers do?

Although ASIC’s product intervention power is already in force, the design and distribution obligations will only apply from April 5, 2021. ASIC has not yet released regulatory guidance on the new provisions.

During the transition period, insurers should undertake a review of affected retail products and distribution channels, and prepare target market determinations ahead of time. These will inform what changes will need to be made to products and their distribution methods. Prompt action should be taken where the review identifies a retail product that may result in significant consumer detriment. Sales practices, incentive arrangements (e.g. front line commissions) and third party distribution arrangements are all likely to be impacted by the changes. Close attention needs to be given to the full product lifecycle and distribution arrangements to enable compliance with these obligations. Insurers should also consider how they will comply with the new record-keeping and reporting obligations.

United Kingdom

Ogden rate announcement falls short of insurers’ expectations

On July 15, 2019, the Ministry of Justice announced changes to the Ogden rate in England and Wales. An increase in the rate from -0.75 percent to -0.25 percent fell short of insurers’ expectations who were hoping for a much greater discount, prompting warnings that premiums may rise as a result. The new rate came into use on August 5, 2019.
Insurers have argued that this is inadequate and will breach the principle of 100 percent insurance, as it will result in over-compensated claimants. The decision is likely to cost the insurance industry millions of pounds. Shares in some UK motor insurers fell after the change was announced.

What is the Ogden rate?

Set by the UK government, the Ogden rate is used with the Ogden tables to help courts work out the size of the lump sum payments for complex personal injury liability claims. The discount is applied to a lump sum to reflect how much interest the victim of an accident would earn if the compensation was prudently invested. The higher the discount, the less the insurer must pay up front. 

In the commercial market, there will be two key results:

• increase in premiums – with insurers being required to pay out more than anticipated in the event of a serious accident, the inevitable effect will be a potential increase in premiums; and
• difficulty in getting cover – for industries at particularly high risk, the capacity to insure these risks in the market may decrease, making it harder to get cover.

The Ogden rate was previously set at 2.5 percent until 2017 when it dropped to -0.75 percent which had a huge economic impact on insurers. The new rate, although higher at -0.25 percent, is not what insurers had anticipated.

On October 1, 2019,  the Government Actuary determined that the discount rate in Scotland should remain at -0.75 percent. In Northern Ireland the discounted rate remains 2.5 percent because this matter is reserved to the Northern Irish assembly, which has not met since January 2017.

European Union

EIOPA issues recommendations to European National Competent Authorities to minimize risks to policyholders in the event of a no-deal Brexit

The European Insurance and Occupational Pensions Authority (EIOPA) issued nine recommendations to the National Competent Authorities (NCAs) with responsibility for the supervision of insurance undertakings and insurance intermediaries in European Union (EU) Member States.

The recommendations provide the NCAs with guidance on EIOPA’s expectations in relation to the treatment of UK authorized insurance undertakings and intermediaries that cover risks in their jurisdiction after the UK leaves the EU. The recommendations will only apply if the UK leaves the EU without a withdrawal agreement in place (a no-deal Brexit). In the event of a no-deal Brexit, the UK will become a ‘third country’. Insurance undertakings and intermediaries will lose the benefits of access to the EU Single Market and will cease to be authorized to write new business, pay existing claims or undertake insurance distribution activities.

The recommendations come at a time when a number of EU Member States have introduced measures to protect EU policyholders of UK policies in the event of a no-deal Brexit. So far the countries that have introduced such measures include France, Germany, Ireland and Luxembourg.

The recommendations include:

• Orderly run-off – NCAs should either introduce a legal mechanism to facilitate the orderly run-off of UK insurance business or should require that UK firms operating in their jurisdiction immediately take all necessary steps to become authorized. UK insurers should not write new contracts in EU jurisdictions unless authorized to do so.
• Authorization of third-country branches – UK insurers may seek authorization to carry out cross-border business through a branch in an EU Member State. NCAs must ensure that the conditions for branches are fulfilled but may apply the principle of proportionality on the basis that the UK was subject to Solvency II immediately before it left the EU.
• Portfolio transfers – NCAs should allow UK insurers to finalize portfolio transfers from the UK to an EU undertaking provided that the transfer was ‘initiated’ before Brexit. This, EIOPA suggests, is where the UK regulator has notified the NCA about the transfer and the insurer has paid the regulatory transaction fee and appointed an independent expert.
• Change in the habitual residence or establishment of the policyholder – Solvency II sets certain rules in respect of the ‘location of risk’ that determine where business is written. The recommendations state that where a life or non-life policy (not covering buildings, contents or vehicles) was concluded in the UK but the policyholder later moves with the result that they have a habitual residence in the EU, NCAs should consider that this contract was written in the UK and that the UK remains the state where the risk was placed.
• Distribution – UK intermediaries that wish to continue to distribute (re)insurance products to European policyholders should be registered within the EU. Note that this means UK firms cannot rely on the registration of EU producing brokers, as the requirement for registration will apply throughout the distribution chain where there is an EU policyholder or EU risk. Where intermediaries seek to establish branches in the EU, NCAs should ensure that any legal persons have sufficient corporate substance. The recommendations also state that where a UK intermediary is undertaking distribution activities in the EU, NCAs should ‘take into account that only the consistent and uniform application of the IDD can guarantee the same level of protection for consumers and ensure a level playing field in the Union’. This is clearly reminding authorities that their primary objective in looking at activities must be the protection of consumers.

The recommendations will only be applicable should the UK leave the EU without an agreement in place. However, EIOPA will expect NCAs to introduce measures to meet the above recommendations (or explain why they have not done so) and confirm the status of such measures within two months from publication (and translation) of the recommendations.

South Africa

Damages under insurance contract with reinstatement value conditions

Where an insurance policy included reinstatement value conditions and the insured had taken immediate steps to comply with the reinstatement conditions, the insured could rely on the clause as long as the insured was genuinely desirous of restarting the business but was unable to do so because of the insurer’s unjustifiable decision not to indemnify under the policy.

The proviso to the reinstatement value conditions that they are ‘without force or effect if the insured is unable or unwilling to replace or reinstate the property on the same or another site’ does not exclude an inability to replace or reinstate if money was not available because the insurer withheld the indemnity payment obligation.

The court granted judgment for the insured of the replacement value fixed by the experts in evidence. The court also awarded interest on the amount at the legal rate of 15.5 percent from September 2011 when the costs of reinstatement had been established.

The case is Watson v Renasa Insurance Company Limited.

Guidance on conducting insurance business in terms of section 5 of the Insurance Act

Section 5(1) of the Insurance Act 2017 prohibits any person from conducting insurance (including reinsurance) business in South Africa unless licensed under the Act. Under section 5(2), a foreign re/insurer will be regarded as conducting insurance business in South Africa if that foreign re/insurer, or another person on its behalf, directly acts in South Africa in respect of the foreign insurance business. The wording of section 5(2) is wide and includes intermediary services performed on behalf of the foreign re/insurer.

In April 2019, the Prudential Authority (PA) and Financial Sector Conduct Authority (FSCA) issued guidance on the application of section 5(1) and (2). The guidance is issued under section 141 of the Financial Sector Regulation Act 2017. The guidance is for information and is not binding; but it will help to understand the authorities’ attitude to enforcement of the Act.

The guidance confirms:

• Reverse solicitation (when a South African policyholder/insured seeks insurance from the foreign re/insurer) is permitted and does not amount to the foreign re/insurer conducting business in South Africa. The foreign re/insurer must have no presence in South Africa, and all financial services relating to the insurance policy must be dealt with offshore.
• A foreign re/insurer may not directly contact policyholders or potential policyholders or otherwise solicit business in South Africa.
• A foreign re/insurer may not indirectly conduct business in South Africa through agents, including intermediaries. The test is one of agency: is the person acting in South Africa on behalf of the foreign re/insurer when soliciting or placing business?

Attachment 1 to the guidance provides useful examples of direct and indirect conduct that will be regarded as conducting business in South Africa.

The guidance seeks to expand the scope of the deeming provision in section 5 so that a foreign re/insurer will be regarded as conducting business in South Africa if it ‘in any way… influenced’ the placing of business with it. This is overly broad, and goes beyond the test of agency referred to in section 5.

The PA or FSCA will engage with the foreign re/insurer in the first instance in regard to a suspected contravention of section 5. If not resolved, the authorities may pursue the matter further with the relevant foreign regulator or against relevant persons located in South Africa.