What the Insurance Distribution Directive means for firms

Implementation of the EU's Insurance Distribution Directive (IDD) had been delayed, but the new rules began to apply on 1 October. Amongst other things, the rules on insurance distribution now apply to a broader range of firms than before, and they face new disclosure obligations, oversight and governance rules, and parameters around cross selling.

It is vital that insurers and insurance intermediaries familiarise themselves with their new duties.

The Insurance Distribution Directive (IDD) is a new European Directive that entered into force on 1 October and which regulates the distribution of insurance products in the EU. Repealing and replacing the Insurance Mediation Directive (IMD), the IDD raises the level of minimum standards of insurance distribution in EU Member States and extends the scope of regulation to include insurers as well as insurance intermediaries.

The IDD grants domestic regulators the opportunity to apply more stringent standards. The FCA has chosen to 'gold-plate' some IDD obligations, including levelling up its requirements to those contained in the Markets in Financial Instruments Directive (MiFID II), which came into force in January 2018.

The IDD had been due to be implemented by 23 February 2018, but the implementation date was pushed back by the European Parliament in March to 1 October following pressure from the insurance industry and financial services regulators. Ahead of this, in January 2018 the FCA announced a formal transition period during which firms could implement new IDD rules similar in purpose to current rules and providing at least the same level of customer protection.

Wider Context

The introduction of the IDD is part of a broader project by the EU to revise the way in which financial services are regulated.

In particular, MiFID II is the EU's most ambitious piece of regulatory reform in the financial services industry to date and various obligations contained in the IDD have been designed to ensure a level of consistency with it. The FCA's Senior Managers and Certification Regime for insurers will change the way individuals working within FCA-regulated entities are monitored and comes into force on 10 December 2018.

The UK's exit from the EU may create knock-on effects to the way in which insurers and insurance intermediaries are regulated domestically, however the IDD (as transposed by the FCA) will continue to apply in full whilst the UK remains in the EU. 

Legislation and regulation

The IDD regime is detailed across five EU documents:

• the IDD itself
• a Delegated Regulation on Product Oversight and Governance Requirements (POG Regulation),
• a Delegated Regulation on Insurance-based Investment Products (IBIP),
• an Implementing Regulation on Insurance Product Information Documents (IPID), and
• supporting guidelines on IBIPs produced by the European Insurance and Occupational Pensions Authority (EIOPA).

At UK level, the primary legislation and regulation for the IDD is set out in the Insurance Distribution (Regulated Activities and Miscellaneous Amendments) Order 2018 and the Insurance Distribution Directive Instrument 2018 (FCA 2018/25).

Issues for UK firms

Following the lengthy lead-in time, the IDD now applies to UK insurance distributors. We cover below five keys issues for general insurance firms.

Scope

Where the IMD applies to the regulation of insurance intermediaries, the IDD applies to the wider regulation of insurance 'distributors' which will include:

• all sellers of insurance products, including insurance undertakings that sell directly to customers;
• firms who are not insurers and whose activities include advising on, proposing, concluding, carrying out other work prior to the conclusion of a contract of insurance or assisting in the administration and performance of contracts of insurance - intermediaries;
• ancillary insurance intermediaries.

The IDD introduces a new exemption for the mere provision of information to a relevant insurer or intermediary about a potential policyholder, or the provision of information to a potential policyholder about a contract of insurance or a relevant insurer. This exemption has been transposed by HM Treasury into Article 33B of The Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (RAO).

New guidance has been added into the FCA Handbook that Article 33B only will cover "those situations where a person provides existing information they hold on potential policyholders (for example their name and contact details) but does not extend to information they obtain from other means such as pre-purchase questioning".

This wording suggests that activities falling under this exemption will be limited in nature and provide only a slight extension to existing exclusions such as the provision of information on an incidental basis (Article 72C RAO) and arrangements enabling parties to communicate (Article 27 RAO). 

Disclosure obligations

The IDD imposes a wider range of disclosure obligations on firms including: 

• distributors must confirm whether they are acting as an insurer or an intermediary;
• intermediaries must state whether they are acting on behalf of the customer or the insurer;
• where intermediaries are contractually obliged to conduct business with one (or more) insurers, they are now under a pro-active duty to provide the customer with the name of the insurer(s). (Previously, intermediaries simply were obliged to inform customers that they have the right to request the name of such insurer);
• intermediaries must disclose the "nature and basis", or type and origin, of the remuneration that they receive in relation to the contract of insurance in question; and
• insurers are required to disclose the "basis" of the remuneration paid to their employees.

These new disclosure obligations have required firms to make substantial amends to their customer-facing documentation and sales scripts.

Demands and needs statements

Under the IMD intermediaries had to simply specify, on the basis of information provided by the customer, the demands and needs of that customer. Under the IDD, distributors are now required to specify customers' demands and needs based upon information obtained from them. They must also ensure that the insurance policy proposed or recommended is consistent with those demands and needs. These new obligations will require distributors to be more active when assessing demands and needs with customers prior to the insurance being sold.

Where no personal recommendation is being made to the customer, the FCA has made it clear that only high level information is required for non-advised sales, such as the type/amount of driving performed under a motor insurance policy and levels of cover/excess. Firms therefore should be careful not to stray inadvertently into advising their customers.

Firms who provide personal recommendations to customers also must provide a personalised explanation of why a particular insurance policy would best meet the customer's demands and needs.

Cross-selling obligations

The IDD introduces new rules which apply when insurance products are sold alongside non-insurance products. These rules apply differently depending upon whether the insurance product is the 'primary' or the 'ancillary' product.

Where the insurance is the primary product in the package, distributors must inform customers whether it is possible to purchase each component separately. If so, the customer must be provided with appropriate information on these different components; a description of how the interaction between the different components modifies the risk or the insurance coverage, and evidence of separate costs and charges for each component. 

Where the insurance is the ancillary product, distributors will need to ensure that the non-insurance elements are available to be purchased by customers on the same terms, but without the insurance.

Product design and manufacture obligations

The IDD and the POG Regulation contain new requirements relating to the manufacture, oversight and governance of insurance products, which are relevant for both manufacturers and distributors of insurance products.

These rules require manufacturers to specify a target market for each product; maintain, operate and review a 'proportionate and appropriate' product approval process which ensures that customers' interests are taken into consideration throughout the life cycle of the product; and review the insurance product and distribution strategy to ensure that they are consistent with the target market. These new rules apply only to products developed or significantly amended after 1st October 2018 and supplement, but do not entirely replace, existing guidelines contained in the Handbook (RPPD).

The POG rules require a greater degree of formality when an insurer and intermediary are regarded as 'co-manufacturers'. While an insurer may always be a 'manufacturer', intermediaries only may be regarded as 'co-manufacturers' when they have a decision-making role in designing and developing an insurance product. It is not always clear when an intermediary is acting as a 'co-manufacturer'; which requires a holistic analysis taking into account the specific circumstances of the individual case.

EIOPA guidance states that an intermediary cannot qualify as a 'manufacturer' simply by performing activities such as tendering for insurance undertakings to cover specific risks; claims handling; the ability to discount commission; or tailoring contracts for individual customers.

Conversely, an intermediary can qualify as a 'manufacturer' when it autonomously determines the main elements of an insurance product or provides the coverage and sets the level of premium payable by the customer. An intermediary also can qualify as a "manufacturer" when it can autonomously change significant elements of an existing product such as the coverage, premium, costs, risks or target market.

Where 'co-manufacturing' occurs, the insurer and intermediary must enter into a written agreement which specifies how they will collaborate to comply with manufacturers' product oversight and governance requirements. These agreements will enable regulators to supervise co-manufacturing partnerships more effectively, by providing clarity to the apportionment of each party's respective role. Insurers also will benefit from this apportionment of responsibility as, without such agreement, they may be held responsible for every aspect of the product approval process.

Under the new IDD / POG rules, distributors who do not 'manufacture' insurance products must now pay closer attention to whether their distribution arrangements have the potential to cause customer detriment, as well as ensuring that they are suitable for the objects, interests and characteristics of the target market. A greater degree of co-operation with manufacturers is required, as distributors must promptly inform the manufacturer when the insurance product no longer is aligned to the target market. Upon request they must also provide the manufacturer with management information on sales activities, such as reviews of the distribution strategies for the insurance product.