THE INSURANCE DISTRIBUTION DIRECTIVE
After a long reform process initiated in 2009, the final text of the Insurance Distribution Directive (IDD) was finally agreed at European level just before Christmas. The IDD is the recast of the Insurance Mediation Directive (known as IMD I) and will come into force on 22 February 2016. Member States have until 22 February 2018 to implement it into their national laws, at which point IMD I will be repealed. As with IMD I, the IDD will regulate the point of sale of insurance products but it will introduce significant changes, as set out below.
Why the IDD?
Back in 2005 when it was implemented, IMD I introduced a new harmonised regime for insurance "intermediaries" (persons involved in the sale or administration of an insurance contract) across Europe. Amongst other things, it required pre-sale information to be given to customers and it set minimum standards covering matters such as fitness and propriety, training and competence, prudential requirements and complaints handling.
One of the purposes of harmonising these requirements was to create a single market for the sale of insurance product across the EU. However, a review by the European Commission identified a number of issues with IMD I (listed in our previous briefing), including the fact that it had been implemented inconsistently by the Member States, leading to fragmentation of the market. The IDD aims to address these issues and to lead to better harmonization of insurance distribution across the EU. It may therefore be surprising that the IDD only provides for minimum harmonization. This can probably be explained by the fact that the distribution channels for insurance operate very differently from one EU Member State to the other.
Unlike IMD I, the IDD empowers the European Commission to adopt "level 2" delegated acts in the areas of (i) product oversight and governance, (ii) conflicts of interest, (iii) conditions under which inducements can be paid or received, (iv) assessment of suitability and appropriateness, and (v) reporting to customers. No such acts have been adopted to date but early in January the European Insurance and Occupational Pensions Authority (EIOPA) launched an online survey to prepare for the European Commission's call for advice on the IDD delegated acts.
In addition, EIOPA is due to produce technical standards with the European Commission and publish "level 3" guidelines. The technical standards will address purely technical issues (e.g. standardised format for customer information). The guidelines, whilst not binding, will aim to ensure more consistency in how the relevant IDD principles are implemented. On 30 October 2015, EIOPA published consultation paper (EIOPA-CP-15/008) proposing preparatory guidelines on product oversight and governance arrangements (POG Guidelines). EIOPA states that the POG Guidelines aim to support national regulators as they prepare for the implementation of the IDD and to encourage more convergence across the EU.
One of the issues identified by the European Commission was the relatively narrow scope of IMD I, given that traditional intermediaries are not the only people who sell insurance. The IDD therefore has a much wider scope since, as the name indicates, it now covers different modes of distribution. Unlike the IMD I, the IDD covers direct sales by insurers and reinsurers, and it confirms that insurance intermediaries include internet distributors, such as price comparison websites. The purpose of this is made very clear in the Preamble, which states that:
“consumers should benefit from the same level of protection despite the differences between distribution channels”.
Another important change is that the IDD extends to any person whose activities consist of assisting in the administration and performance of insurance contracts, including where such person is acting on behalf of the insurer. Note that however, the management of claims for an insurer on a professional basis, loss adjusting and expert appraisal of claims have been carved out of the extended scope.
The IDD has retained the exemptions set out in IMD I, with small changes. Thus it does not cover the sale of insurance which is complementary to specific goods or services (breakdown, travel, etc) where the premium is below a specific threshold (€600 per annum or €200 of up to three months cover). IDD also retains the exclusion for "ancillary insurance intermediaries" who pursue the insurance distribution activity on a secondary basis alongside their main professional activity (this latter exclusion however does not apply to credit institutions or investment firms).
Conflicts of Interest and Remuneration
The issue of insurance brokers remuneration and conflicts of interest has been contentious for a number of years. The European Commission looked into this as far back as 2007, when it published the report of its competition inquiry on the business insurance sector (see our briefing). The report concluded that the issue would be addressed in the redraft of IMD I.
It is not surprising therefore that the first proposed re-draft, then known as "IMD II" included extensive remuneration disclosure requirements, including details of contingent fee arrangements. The difficulty, however, is that this is an area where practices and customer expectations vary enormously from one Member State to another and therefore it was difficult to find common ground. The IDD now only requires disclosure of the nature of the remuneration (e.g. fee, commission or other) and the method of calculation. In the case of a direct sale by an insurer, the nature of the remuneration received by the employee in relation to the insurance contract must be disclosed.
In addition, the IDD requires Members States to ensure that insurance distributors avoid conflicts of interest when setting their remuneration and it empowers the European Commission to produce delegated acts on this specific issue.
Cross selling, which is the practice of selling different products together, was also a controversial topic, especially given recent mis-selling scandals such as the one in the UK concerning Payment Protection Insurance (PPI). The initial draft of IMD II went as far as imposing a ban on tying practices (although it allowed the bundling of different products that were available separately). The position in the final form of the IDD is as follows:
- If insurance is the main product, tying is allowed as long as the customer is informed whether the components can be bought separately, at what price, and how coverage varies depending on whether or not the products are tied.
- If insurance is the ancillary product, the insurance distributor must offer customers the possibility of buying the other component separately. However this does not apply when insurance is ancillary to some specific products covered by the Markets in Financial Instruments Directive (MiFID, 2014/65/EU), the Mortgage Credit Directive (Directive 2014/17/EU) and the Payment Accounts Directive (2014/92/EU).
This is one of the areas where EIOPA is empowered to develop level 3 guidelines.
The IDD introduces new requirements on insurer and intermediaries to operate an approval and review process for each insurance product they manufacture. In doing so they must specify their target market for that product, identify the risks being covered and they are then under a duty to distribute only to that target market. As previously noted, EIOPA has already consulted on proposed POG Guidelines.
The above paragraphs only describe the most significant changes brought about by the new directive. The IDD further refines the IMD I regime in a number of other ways, for instance by creating a clearer procedure for cross-border activities which may lead to passporting rights being used more often by the industry, by imposing additional disclosure requirements for those settling insurance-based investment products (consistent with the MiFID II regime) and by setting out new requirements as regards continuing professional development.
Finally, in the chapter on "information requirements and conduct of business rules", the Article 17 of IDD provides that:
Member States shall ensure that, when carrying out insurance distribution, insurance distributors always act honestly, fairly and professionally in accordance with the best interests of their customers.
The exact scope of the Article 17 requirement is unclear and goes beyond the FCA's existing Principles for Business, which include the requirement for a firm to "pay due regard to the interests of its customers and treat them fairly". Interpreted strictly, this could have a potentially far reaching effect, so it will be interesting to see how this requirement is implemented in the UK.