The Insurance Distribution Directive (IDD) will repeal the Insurance Mediation Directive (IMD) and must be transposed by 23 February 2018. With less than a year to go until the implementation deadline, the government and the FCA have issued consultation papers on the transposition of the IDD into UK domestic law.
In this article, Juanita Morrison and Emma Radmore look at the proposed changes to UK law and regulation.
How will the IDD be implemented in the UK?
The IMD came into force on 14 January 2005 and was transposed into UK law by virtue of the FSA's (as it then was) rules and amendments to the Financial Services and Markets Act 2000 (FSMA) and the FSMA (Regulated Activities) Order 2001 (RAO). The government envisages that the transposition of the IDD will take effect in a similar way.
The IDD applies to persons who conduct insurance distribution activities, including (re)insurers who sell directly to customers, (re)insurance intermediaries and ancillary intermediaries. This means the IDD will cover the sale of insurance products directly by an insurer, whereas the IMD applied only to intermediaries. In the UK, the government does not anticipate that this will have a significant impact as it chose to apply the IMD to insurers as well as insurance intermediaries, so UK law has been super-equivalent to the IMD in this respect. Additionally, the IDD includes in its definition of 'insurance distribution' the activities of insurance companies and price comparison websites, but these activities are already subject to regulation in the UK.
As with the IMD, the IDD is a minimum harmonising directive. This means the directive sets the minimum standards required and Member States are then free to add further requirements for their respective territory. In the consultation papers the government and FCA seek views on the minimum standards and the additional requirements proposed to implement the IDD.
HM Treasury's consultation paper remarks that during the period of Brexit negotiations and while the UK remains a full member of the EU, the government will continue to apply EU legislation. The government intends to transpose and implement the IDD to schedule, and by 23 February 2018.
For products sold as part of a package or add-ons by firms whose main business is other than the distribution of insurance products, Article 72B of the RAO currently provides an exclusion known as the "connected contracts" exclusion. Where a "provider" (that is, a person who supplies non-motor goods or travel-related services in the course of a business which does not otherwise consist of regulated activities) carries out insurance mediation activities in relation to a contract which is complementary to the provider's service and meets all of a number of set criteria, then the provider does not require authorisation under FSMA to carry out these activities. Common examples are retailers who sell insurance cover on white goods that they supply. Because of the limitations of the exclusion (in particular that it does not apply if the contract covers liability risks), it is safe to rely on it only in narrow circumstances.
The government's preference is to exclude life insurance and liability risk products from the connected contracts exclusion as it did when the IMD was implemented. The basis for the continued regulation of such products is that the government considers these products to be complex and could lead to significant consumer detriment if mis-sold.
One way in which the IDD provides greater flexibility for firms is in respect of providing information. The mere provision of data and information on potential policyholders to insurers and insurance intermediaries (and vice-versa) is removed from the IDD's definition of regulated insurance distribution activities (provided the firm does not take further steps to assist in the conclusion of the contract). The government does not consider that the de-regulation of such firms whose activities are limited in this way would cause detriment to consumers. However, the government is not inclined to legislate for a broader exemption for introducers. It believes that some firms acting as introducers do more than providing information and broadening the exemption could result in more firms becoming involved in the conclusion of the contract without regulation. So its proposal is to exclude from the scope of regulation only this limited information provision, but to maintain all wider introducer activities within scope.
When an EEA firm operates in the UK on a freedom of services basis it is the responsibility of the EEA firm's home state regulator to ensure the firm is compliant with the IDD. Alternatively, if an EEA firm operates on a freedom of establishment basis the IDD permits the responsibility for compliance to be split between the home state regulator and the PRA or the FCA as appropriate. In both instances the IDD permits the host state to intervene and the government proposes amendments to FSMA to enable the PRA or (more likely) FCA as the appropriate host state regulator to intervene in the event of a breach in specified circumstances.
Article 7 of the IDD permits the appropriate UK regulator to enter into an agreement with that firm's home state regulator to act as if it were the home state regulator where the insurance distributor's primary place of business is in the UK. The government is seeking to effect this by way of amendments to FSMA and for the appropriate regulator to publish any article 7 agreement it enters into. However, given the novelty of the provision it is unclear how often it will be used.
What are the FCA's proposals?
The FCA has published two consultations on IDD implementation. The FCA's first consultation covered the application of IDD, including the change in terminology from 'insurance mediation' to 'insurance distribution' in the FCA Handbook, the professional and organisational requirements, complaints handling and out-of-court redress, changes to the insurance conduct of business (ICOBS) rules and the regulatory regime for an ancillary insurance intermediary (AII).
Where minimum requirements of IDD go beyond the FCA's current rules, the FCA will include such requirements in its new rules. However, the FCA is not proposing to change the existing UK provisions which go beyond the IDD's minimum requirements.
The IDD introduces AIIs as a new category of firm. To satisfy the definition of an AII a firm must meet the following conditions:
- its principal professional activity is other than insurance distribution
- it only distributes insurance products that are complementary to another good or service
- it does not offer life assurance or liability risks unless the cover compliments the good or service that the intermediary provides as its primary professional activity.
The IDD does not require the direct regulation of AIIs whose insurance distribution activities are limited to products which meet particular criteria.
The UK’s connected contracts exclusion is narrower than the IDD, as it includes motor warranties and connected travel within regulation. As discussed above, the Treasury has consulted on whether any changes are required to the connected contracts exclusion in light of the IDD.
The FCA is proposing to create three categories of AII:
- "in-scope AIIs": these are firms who are within IDD scope and other firms who are within the UK regulatory perimeter, but may be outside the IDD
- "connected travel insurance (CTI) providers": these are firms whose primary business is to make travel arrangements for customers, but who distribute insurance that is complementary to those services
- "out-of-scope AIIs": these are firms, such as white goods and furniture retailers who fall outside the UK regulatory perimeter because of the connected contracts exclusion as currently drafted.
Where insurers and intermediaries use out-of-scope AIIs, for AIIs who are outside of the UK's regulatory perimeter, the FCA proposes to place an obligation on the authorised firm under ICOBS to ensure that customers are provided with information on its identity, address and complaints procedure. So in-scope AIIs and CTI providers will in principle be subject to all FCA requirements (except that the CTI providers need not comply with the conflicts and transparency disclosures), whereas out-of-scope AIIs need only comply with the overarching principles, pre-contract disclosure and complaints and redress requirements.
FCA's proposal for insurers' and intermediaries' staff knowledge and competence requirements includes the following:
- Minimum 15 hours of continuing professional development for those directly involved in insurance distribution, including product or sales managers but not employees in roles such as HR, facilities management or IT. The FCA proposes to issue guidance on the format and content of CPD. It notes firms subject to its TC sourcebook will already be subject to higher CPD requirements. It will not require employees to hold any particular qualification unless TC already requires them to do so
- Firms must maintain records of employee competence. Under the IDD the minimum-record keeping requirements only apply to insurance and reinsurance undertakings, but the FCA proposes to extend the requirement to include intermediaries and AIIs. The FCA does not anticipate that this will result in significant additional costs and expects it will result in consumer protection benefits
- The requirements will apply to insurers and reinsurers as well as to intermediaries, so the FCA will go beyond the IDD in this respect, as it does for firms subject to TC. However, the knowledge and competence requirements will apply only to those employees involved in insurance distribution, and can be modulated to apply in a proportionate manner to, for example, call centre operatives.
The FCA currently requires intermediaries to hold higher minimum aggregate PII cover than the IDD minimum and also sets conditions on excess levels and specific terms within the cover. It proposes to amend all requirements to require the IDD minimum, but to keep its existing super-equivalent requirements.
The IDD requires (re)insurers and intermediaries to use only authorised or exempt intermediaries for insurance distribution services. Insofar as current rules do not expressly reflect this, they will need to do so.
The FCA will apply the IDD's overarching principles to all intermediaries carrying out insurance distribution activities regardless of whether or not they have direct customer contact. The FCA will give effect to these by:
- amending the current ICOBS rules on communications and financial promotions to require that all marketing communications be clearly identifiable as such;
- a new rule requiring insurance distributors to act honestly, fairly and professionally in the best interests of their customers; and
- a new rule in SYSC to prohibit remuneration and performance management practices that would conflict with the customer’s best interests rule.
ICOBS 4 - to incorporate the IDD requirements in respect of pre-contacts disclosure
Conflicts of interest and transparency
The FCA proposes to amend ICOBS 4 to align with the following IDD requirements:
- intermediaries must disclose if they have 10% or more voting rights or capital in an insurer, or vice versa. (Currently the requirement is “more than 10%”);
- intermediaries must disclose if they give advice based on “a fair and personal” analysis of the market; and
- where an intermediary is contractually bound to place business with a specific insurer or insurers it must provide the names of these insurers. (Currently this information need only be supplied on request by the customer).
Disclosure of firms' remuneration arrangements
The FCA proposes to amend ICOBS 4 to incorporate the following IDD requirements in respect of remuneration disclosure:
- intermediaries must disclose the nature and basis of remuneration received in relation to the insurance contract being proposed (eg bonuses for hitting a sales target where the specific contract sold will count directly towards that target)
- insurers must likewise disclose the nature of remuneration paid to their employee and the amount of fee where remuneration is in the form of a fee paid by a customer.
The FCA intends to provide guidance in ICOBs on the meaning of 'nature' and 'basis' with the former relating to the type of remuneration and the latter relating to the source of remuneration. The consultation paper provides illustrative examples of statements that would not be compliant. The FCA's proposal concerns the effecting of the remuneration disclosure requirements under IDD. It does not propose to amend requirements relating to commission disclosure by intermediaries or impact any other obligations relevant to remuneration arising from general law.
The FCA is also proposing to amend the definition of 'durable medium, 'fee' and 'remuneration' in line with the IDD.
Means of communication to customers
The FCA proposes to incorporate the following IDD requirements into ICOBS 4:
- information may be provided on paper, a durable medium other than paper or a website (where it is not a durable medium and satisfies certain conditions). Where information is provided through a medium other than paper, the option to have the information on paper must be available and free of charge
- no provision for the information to be provided orally at the request of the customer
- telephone sales should comply with existing EU law in relation to distance marketing
- all the information required must be provided in a clear, accurate and comprehensible manner; in an official language of the Member State, and free of charge.
In terms of fees, FCA will amend its definition within the Glossary to align with the IDD definition.
Firms will need to (i) identify the customer's demands and needs, and match them to the available products, and (ii) state the customer's demands and needs to assist them in making an informed decision.
However, the FCA recognises the need for a clear distinction between advised and non- advised sales. It does not expect firms involved in non-advised retail sales to carry out a detailed investigation of the customer's circumstances, but the firm should identify the customer's demands and needs. The FCA offers illustrative examples in the consultation paper. For advised sales the FCA proposes a new requirement for firms which provide a personal recommendation to provide a personalised explanation as to why the proposed products best meet the customer's insurance demands and needs.
As discussed above, the IDD introduces new requirements where an insurance policy is sold in connection with, or alongside, other goods or services as part of a package or the same agreement. Where the insurance is ancillary to the main non-insurance product the customer must be able to buy the primary product without the insurance. In the FCA's view, 'ancillary' has a broad meaning and includes all instances where insurance is sold to complement other goods or services.
Where insurance is not the primary product, the IDD requires the insurance distributor to inform the customer whether it is possible to buy the different components separately and, if so, shall provide an adequate description of the different components of the agreement or package as well as separate evidence of the costs and charges of each component.
Article 14 of the IDD requires insurance and reinsurance distributors to have a process in place for customers and other eligible parties to register complaints and receive replies. This requirement applies to all types of insurance transaction, whether it involves a retail customer or a commercial customer, including reinsurance transactions. Article 15 requires each Member State to have in place effective Alternative Dispute Resolution (ADR) systems. The FCA will rely on the requirements of the DISP sourcebook to implement these requirements and does not propose to extend the scope of jurisdiction of the FOS wider than the current definition of eligible complaints to consider complaints from wider commercial customers, although it is considering more generally whether to extend FOS eligibility to larger SMEs than are currently covered. Additionally it will extend necessary requirements to all distributors when carrying out distribution activities.
The FCA proposes to introduce a requirement for EEA branches of UK (re)insurers and intermediaries to comply with an ADR entity in the EEA state in which they are established to resolve consumer disputes.
The consultation paper annexes a draft instrument with proposed changes to:
- The Glossary – in which there are many new definitions and several significant changes to existing definitions
- SYSC – creating and applying a new Chapter 19F.2 (IDD remuneration incentives) and 23 (rules and guidance on knowledge and competence in relation to insurance distribution activities)
- TC – a new chapter 4.2 and table
- MIPRU – to implement the requirements on good repute, PII requirements and use of intermediaries (and IPRU(INV) also in respect of relevant firms)
- ICOBS – changes to most chapters – particularly those discussed above, including the introduction of a new ICOBS 4.1A.1 on means of communication to customers and additions to 4.3 on remuneration disclosure, together with the significant amendments to ICOBS 5 discussed above and a new chapter 6A.3 on cross-selling; and
- DISP - in relation to requirements to treat complainants fairly.
The Treasury's first consultation closed on 22 May 2017. It plans to draft legislation implementing IDD later this year following a consideration of responses to the consultation.
The FCA published its second consultation paper on 24 July 2017. It covers the FCA's approach to product oversight and governance, changes to CASS 5, the new Insurance Product Information Document and the conduct of business requirements for life business including insurance-based investment products.
The FCA asks for responses to its second consultation by 20 October 2017 and it aims to publish rules in a Policy Statement in December 2017.