By way of follow up to our earlier briefing on the Insurance Distribution Directive (IDD), the FCA has now published its latest proposals (CP17/23) setting out changes to UK rules required to comply with the IDD (the Consultation Paper). The Consultation Paper follows the FCA’s earlier consultation paper, (CP17/7) with further proposals on how the FCA plans to implement the IDD in the UK.
The IDD replaces the Insurance Mediation Directive (IMD) and aims to enhance consumer protection when buying insurance (including general insurance, life insurance and insurance-based investment products) and to support competition between insurance distributors by creating a level playing field. Please see our comprehensive briefing on the IDD for further background information and the FCA’s earlier proposals.
The Consultation Paper seeks views on proposals relating to:
1. Changes to the FCA’s rules to implement the IDD requirements for life insurance business, including information provision requirements, and additional requirements related to the distribution of insurance-based investment products (IBIPs):
a. firms’ general obligations (Chapter 4);
b. information disclosure to customers (Chapter 5);
c. inducements (Chapter 6);
d. suitability (Chapter 7); and
e. appropriateness (Chapter 8).
2. Changes to the FCA’s rules to implement requirements in the IDD that apply to life and non-investment insurance business, including product oversight and governance, and professional and organisational requirements provisions:
a. conflicts of interest (Chapter 9);
b. product oversight and governance (Chapter 10);
c. organisational requirements relating to the protection of customers’ money (Chapter 11); and
d. professional requirements relating to the good repute of employees of insurance distributors (Chapter 12).
3. Additional Handbook changes relating only to non-investment insurance business including product information (Chapter 13).
4. Consequential amendments to other parts of the Handbook (Chapter 14).
This bulletin will consider some of the key proposed changes.
Conduct of business requirements for life business
Conduct of business requirements for life insurance firms
Chapter V of the IDD contains conduct of business rules that apply to all types of insurance business. Currently, many of the conduct of business rules from the IMD are implemented in COBS 7. The FCA is proposing to move away from this structure where it has similar requirements within the Handbook and, instead, implement these IDD conduct rules alongside other related COBS rules. The FCA’s intention is to improve the ease of reference for firms that distribute both products covered by MiFID and those covered by the IDD.
Information and product disclosure
The IDD introduces a range of new requirements for firms distributing IBIPs including providing appropriate information, providing adequate periodic reports to customers and keeping a record of customer agreements. As set out in our earlier briefing, the IDD requires:
appropriate information to be provided to the customer including, at least, all costs and charges, risk warnings and whether the firm will conduct periodic assessments of suitability. This information may be provided in a standardised format to customers, and the obligation applies in addition to the general requirements of the IDD;
firms to establish and keep a record of a document that includes the rights and obligations agreed with customers and any other relevant terms of service. These are usually referred to as client agreements; and
that adequate reports on the firm’s service are provided to customers in a durable medium. These periodic reports must include, where applicable, the costs associated with the transactions and services undertaken on behalf of the customer.
The FCA proposes to implement the new IBIP disclosure requirements alongside their MiFID II counterparts in the Handbook and, in some cases, relocate current standards in order to consolidate rules into one location. The FCA also proposes to retain its existing rules for non-IBIP life business and make the necessary amendments to implement the IDD minimum requirements.
The proposed new amendments to COBS will apply in relation to all customers purchasing or receiving advice on an IBIP, including professional clients and eligible counterparties (ECPs). In line with the approach taken in MiFID II PS 17/14, the FCA is not proposing to prescribe a standardised format for these disclosures at the current time. The FCA states that it continues to encourage firms to consider its Smarter Consumer Communications initiative when updating their disclosure documents and ensure information is presented in a way that reflects the needs of their target customers.
Under the IDD, in relation to the distribution of an IBIP only, firms must ensure that the payment of any fee, commission or non-monetary benefit by any person except the customer or a person acting on behalf of the customer (a) does not have a detrimental impact on the quality of the service provided and (b) does not impair compliance with the duty to act honestly fairly and professionally in the best interests of customers. Member states are also empowered by the IDD to limit or prohibit fees, commissions or other monetary and non-monetary benefits paid to insurance distributors and to impose stricter requirements on distributors in respect of certain specific matters covered in Article 29 than those in the IDD.
In the UK, the current inducements rules in COBS 2.3 apply to designated investment business which includes life policies. These are largely derived from MiFID I requirements. As part of the RDR, the FCA introduced new adviser charging rules in COBS 6 for the retail investment advice market. These rules were designed to remove the potential for adviser remuneration to distort the advice that consumers receive.
The FCA proposes to:
apply the high level inducement rule in COBS 2.3A to firms doing insurance distribution activities in relation to IBIPS, and within that section include new requirements as necessary to implement the Article 29(2) requirement (and for this business COBS 2.3 will be disapplied);
maintain the existing requirements in COBS 2.3 for other life policies without changes; and
continue to apply the RDR rules in COBS 6.
The FCA is also considering whether to ‘level up’ to MiFID II requirements. In some areas, the MiFID II delegated acts include additional detail compared to the IDD with regard to inducements. For example, MiFID II includes additional requirements relating to sales involving more than one distributor firm, record keeping and that firms must make ongoing assessments that inducements enhance the quality of services. The FCA’s current intention is to apply these requirements for IBIPs and the FCA is considering whether or not it is appropriate in relation to IBIPs to apply MiFID II delegated act requirements for inducements relating to investment research, which primarily relate to the use of dealing commission by portfolio managers and other investment firms carrying on MiFID II or third country business, in connection with receipt of investment research.
Our earlier briefing sets out the IDD suitability requirements. The current rules on suitability are set out in COBS 9 and apply to firms when giving a personal recommendation on all life policies, including IBIPs. These suitability rules also implement the IMD requirements related to the assessment of demands and needs for advised sales. Where a firm makes a personal recommendation to a professional client in relation to a life policy, then rules which implement requirements of the IMD also apply.
The FCA proposes integrating the IDD requirements for suitability into the new COBS 9A for IBIPs. The current suitability requirements in COBS 9 will continue to apply to other life policies.
As noted in our briefing, the FCA’s current rules for the appropriateness test are set out in COBS 10. However, these do not currently apply in relation to the sale of life policies, including IBIPs. The equivalent MiFID II requirements for appropriateness are contained in the new COBS 10A.
The FCA proposes integrating the IDD appropriateness requirements into the new COBS 10A and to apply these to IBIPs only. The associated record-keeping requirements, including a minimum retention period of five years, will be integrated into SYSC 9 for intermediaries and SYSC 3 for insurers in line with the FCA’s approach to suitability and MiFID II.
The FCA proposes to exercise the derogation to allow non-complex IBIPs to be sold under the execution-only process and integrate the IDD execution-only requirements into the new COBS 10A.
Conflicts of interest
The IDD has a set of provisions designed to stop conflicts of interests leading to consumer harm in the distribution of IBIPs. Articles 27 and 28 of the IDD focus on the need for effective organisational and administrative arrangements by insurance intermediaries and undertakings to avoid conflicts leading to consumer detriment in relation to IBIP distribution.
The FCA proposes to maintain the current approach in its rules of applying conflict of interest requirements to distributors of all types of insurance (including all life and general insurance business) rather than limiting the application to IBIP business only. The IDD requirements are broadly consistent with existing rules in SYSC 10, so the FCA notes that the impact on firms should be low, while maintaining existing consumer protections.
Product oversight and governance
The IDD product governance requirements are set out in our earlier briefing. The The Responsibilities of Providers and Distributors for the Fair Treatment of Customers (RPPD) covers broadly similar matters as the IDD provisions. Therefore, the FCA does not expect the introduction of the new provisions to require significant change for UK firms in practice. From a rule change perspective, the FCA proposes to introduce a new chapter to the PROD sourcebook to implement the provisions for insurance business. These new rules will replace broadly equivalent existing RPPD guidance for firms within scope of PROD.
The product governance provisions will apply to all insurers and insurance intermediaries where those firms manufacture or distribute insurance products. This will include applying the requirements to all insurers, whether they distribute products directly or via intermediaries.
However, MiFID II is also introducing product governance requirements for MiFID business, which go further than the IDD in a number of areas. For example, they cover considerations for firms in assessing product charging structure and value for money, development of the target market and distribution strategy, multi-firm product development and information that manufacturers provide to distributors.
The IDD requirements recap those of the IMD (with an increased minimum financial capacity requirement) and extend requirements to reinsurance intermediaries. The current rules give intermediaries the option between risk transfer and segregation of customer accounts (through CASS 5). In addition, firms are permitted to apply the CASS 5 rules to reinsurance contracts on an optional basis. Current capital requirements are in force for insurance and mortgage intermediaries, based on 5% of commission rather than 4% of annual premiums.
The FCA does not propose to amend the current capital regime for insurance intermediaries or require a guarantee fund to be set up.
The FCA has given feedback on its proposed approach in its earlier consultation paper to make reinsurance distribution subject to CASS 5. The FCA notes that an ‘overwhelming majority of respondents (19 of 20) agreed with the approach’. The FCA agrees with feedback it has received that reinsurance distribution is not sufficiently different from insurance distribution to warrant narrowing the set of options for implementation. Therefore, the FCA proposes to change the application of CASS 5 to make it mandatory instead of optional, for reinsurance mediation in order to implement the IDD.
The IDD requirements are set out in our earlier briefing and the existing requirements are set out in the MIPRU sourcebook. The MIPRU requirements apply to all firms with permission to carry on insurance mediation activity under Part 4A of FSMA, other than connected travel providers. The FCA proposes to:
retain the good repute rules with some modifications to implement the IDD good repute requirements;
move the rules from MIPRU to SYSC so the relevant professional requirements are all in the same sourcebook;
maintain the application of the provisions, applying them to all firms with a Part 4A permission to carry on insurance mediation activity, other than connected travel providers, in order to minimise any potential regulatory distortion and ensure that customers continue to benefit from consistent consumer protection;
introduce a good repute requirement for in scope AIIs in relation to natural persons responsible for ancillary insurance distribution, in line with the minimum relevant requirement in the IDD;
transpose the relevant IDD record-keeping requirements into SYSC 23 and apply the requirement to all firms to which the good repute requirements apply, as it considers this an appropriate way to demonstrate compliance with the rules; and
retain the existing carve-out for connected travel providers from the good repute requirements.
Additional changes for general insurance business
Product information disclosure requirements
The IDD requires firms to provide customers with objective and relevant information about the product, prior to conclusion of the insurance contract. This information should be presented in a comprehensible form in order to allow the customer buying insurance to make an informed decision. ICOBS 6 currently requires firms to provide appropriate product information. In particular, the appropriate information rule, ICOBS 6.1.5R, requires firms to take reasonable steps to ensure a customer is given appropriate information about a policy in good time and in a comprehensible form so that the customer can make an informed decision. Firms distributing protection policies are also required to provide a policy summary consumers.
The current requirements are not changing substantially under the FCA’s proposals but FCA is clarifying its rules and will make some additions to the rules in ICOBS 6.1.5R and adding the new rule that the Insurance Product Information Document (IPID) must be drawn up by the product manufacturer. The IPID itself is similar to the current policy summary document set out in ICOBS 6 Annex 2. The policy summary contains mandated requirements for payment protection and pure protection policies. The FCA is proposing to introduce a new rule requiring an IPID to be provided to consumers in relation to general insurance contracts (that is, not including pure protection contracts) as set out in a new ICOBS 6.1.10.
The FCA is asking for comments on the Consultation Paper by 20 October 2017. The FCA will also be consulting on its remaining proposals for implementing the IDD in the next few months. The third consultation paper will address:
proposals to reflect the Level 2 delegated acts in the Handbook; and
any Handbook changes arising from the Treasury’s consultation on implementing the IDD, including any changes to the FCA’s regulatory processes and the Perimeter Guidance Manual (PERG).