ASIC's guidance on the Design and Distribution Obligations (DDO)1 is broad ranging and principles based. The purpose of this article is not to summarise it as a whole, but rather to focus on the issues and questions that have been of specific interest to the insurance industry. So, let's start with the question that insurers have been grappling with since the first exposure draft legislation was released in 2017.
How granular should the Target Market Determination (TMD) be?
As anticipated, ASIC states in its Regulatory Guide that it will not be offering "definitive guidance on the content and form" of the TMD. In fact, it says very little about the level of granularity required to prepare that document; the reason given being the diverse and varied nature of financial products to which the TMD will apply.
What ASIC does do is to suggest that it may be useful to identify a "negative target market" as part of the TMD, which would set out details of those consumers for whom the product is clearly unsuitable. While not required by the Corporations Act, that is likely to be a sensible approach for many retail insurance products, where those are characterised by a generally broad target market, but with a need to exclude several small and specific classes of customers.
ASIC also provides some insurance-specific examples which offer a little further insight. It refers to Tyre & Rim insurance, which in some cases will not cover vehicles used for commercial purposes (for instance, as a taxi) or which are over a certain age. It also refers to Consumer Credit Insurance, which makes some employment types ineligible to claim on the unemployment component of cover and which offers a life insurance component that may not be needed by some customers. In each case, it should be relatively simple to identify the negative target market groups affected and to build that into the TMD.
These examples, though, offer little guidance on how much further a TMD should delve into the product's various exclusions, limitations and conditions. In many cases, those terms will affect the value of the product for certain groups of consumers or in certain circumstances. How far issuers should go in limiting the target market or setting Distribution Conditions to address those potential outcomes remains uncertain, and further guidance from ASIC on this would be valuable. In the absence of that, product issuers will have little choice but to take a cautious approach in setting the TMD around these terms.
What approach should be taken to setting the TMD?
For existing products, ASIC notes that issuers may already have a commercial or marketing "target market". It accepts that issuers may proceed by critically assessing that target market, rather than trying to build a new one up from data alone. This seems sensible, in that it would offer issuers a model target market against which the DDO requirements could be tested.
In carrying out that work, ASIC states that issuers should also develop a "Product Governance Framework". ASIC places a considerable focus on this framework in its Regulatory Guide, by which it is referring to all the "systems, processes, procedures and arrangements" put in place to comply with the DDO, as well as the key stages in product design, distribution, monitoring and review. ASIC expects issuers to have such a framework in place, for it to be robust and well-documented, and for it to include details of who is responsible for its elements, the timeframes involved and the record-keeping and reporting requirements. These requirements emphasise that the DDO is more than just another compliance requirement; it needs to be an integral part of the insurer's overall approach to product development and management.
It is worth noting too that, in setting the TMD, ASIC contemplates that some current products may not comply with the DDO legislation at all. This could be due to the risks involved with the product, its low value or that it is "inherently flawed". ASIC anticipates that such characteristics might render the product unlikely to be consistent with the objectives, financial situation and needs of "any" potential customers.
By way of example, ASIC refers to funeral insurance which, it notes, has had both a low loss ratio (observed by the Royal Commission to be between 25% and 33%) and the potential for a customer to pay more in premium than they would be entitled to receive on a claim. Accepting that some insurance products may have a justifiable need for lower loss ratios (for instance, because of long-term claims volatility) or low claims payments relative to premium (for instance, because of a high claims frequency), products which have these characteristics should be carefully reviewed as part of DDO preparations to determine whether there is a need for fundamental re-design or, in some cases, withdrawal.
How should the TMD be set for bundled products?
ASIC confirms that a separate TMD is required for each separate kind of cover or kind of asset covered in a bundled retail product2. It states that this should not prevent an issuer from continuing to offer a bundled product, though does not comment on how that is to be done in practice. Insurers may find that some bundled products, which include a diverse range of retail coverage sections, will produce a challenging range of target markets. While this would not prevent the product being retained in that form, the distribution arrangements needed would likely be quite complicated.
What is required in setting Distribution Conditions?
ASIC refers to the Distribution Conditions, needed to support the TMD, as being just one part of an issuer's overall "Distribution Strategy". That strategy is a broader concept, including the issuer's distribution method, its "Choice Architecture", the distribution channels to be used, the identity of the actual distributors, the controls to be put in place, the approach to supervision and its processes for managing conflicts of interest.
ASIC states that the issuer's full Distribution Strategy needs to be consistent with the TMD. While that may go further than the legal requirements relating to Distribution Conditions, it reflects the reality that a Distribution Strategy which is inconsistent with the target market is likely to lead to DDO breaches, irrespective of how good the Distribution Conditions.
For many insurers, a key part of the Distribution Strategy will be its Choice Architecture. By this, ASIC is referring to the "environment, noticed and unnoticed, that influences consumer decisions and actions". It includes sales processes, for instance how a website sales path is set up, but also design decisions regarding whether to bundle products, how to deal with complexity and where to put default settings.
As ASIC stated in its recent report on disclosure, "choice can never be framed neutrally – 'any way a choice is presented will influence how the decision-maker chooses'"3. In the context of insurance, ASIC's point here is that the processes by which customers decide on limits, excesses, optional cover and the like should assist them to make decisions that produce good customer outcomes and avoid bad ones. Where the potential exists for that not to be the case, insurers will need to consider whether the target market may be impacted. While that could be addressed through additional Distribution Conditions, it may in some cases be simpler to first review the Choice Architecture itself.
As to the Distribution Conditions themselves, ASIC refers to the use of knock-out questions, data and additional customer questions to help limit distribution to those reasonably likely to be in the target market. It also points to the importance of issuers using their own past experience with the product to identify relevant risks. Careful regard should therefore be had to known issues with the existing distribution of insurance products and to make sure that those have been demonstrably addressed.
How should excesses and Optional Cover be treated?
In a similar vein, ASIC states that, for products that are customisable at the point of sale, issuers will need to consider whether the target market will vary depending on the differing forms of product available. For insurers, this will involve a consideration, at least, of whether the excesses and optional cover available to customers affect the TMD and therefore require additional Distribution Conditions. As an example, ASIC notes that "incremental changes" to excesses and the addition of specified personal items to home contents insurance may not change the target market. While this offers some comfort, it is likely that some levels of excess or forms of optional cover (for instance, regarding flood cover) would impact the TMD.
How should distributors meet their obligations?
ASIC emphasises the need for distributors to meet their own obligations under DDO and, most importantly, to take "reasonable steps that will, or are likely to" result in distribution of the product being consistent with the TMD. ASIC accepts that these may be "shaped" by the issuer, but that in most circumstances, merely complying with the issuer's Distribution Conditions will not be sufficient. Distributors must give their own consideration to the steps and controls that need to be put in place. As with other aspects of DDO, this calls for early communication between insurers and their distributors to make sure that an appropriate alignment is achieved.
How should insurance renewals be treated?
Insurers have been particularly concerned about how the DDO requirements are to be met in relation to insurance renewals, given the practical challenges involved in obtaining further information from customers in that context. ASIC's guidance signals at least the possibility that insurers could meet those requirements without having to contact insureds.
ASIC states that insurers will need to "take reasonable steps to ensure that the renewal process results in outcomes that are consistent with" the TMD. That, it says, will involve the consideration of a range of factors, including the insurer's own assessment of the events which could lead to the customer's objectives, situation or needs changing and the likelihood of those events occurring, and relevant data in the insurer's hands. Insurers will then need to determine whether the data they hold is sufficient to meet their obligations or whether more data is needed from customers in order to adequately inform its analysis.
As to the method of obtaining more information, ASIC does not comment on the proposition that insurers might present a set of statements to customers on renewal and ask them to advise of any inaccuracies. Having regard to ASIC's general approach on this subject, though, it seems that approach may be viable, particularly given the challenges involved in pursuing alternatives. However, that approach is more likely to meet the "reasonable steps" standard if the statements presented to customers have a sound basis, are sufficiently highlighted to them and the customer is offered a simple mechanism for correction.
How should Review Triggers be set?
In relation to the setting of Review Triggers that would reasonably suggest that the TMD is no longer appropriate, ASIC suggests that insurers focus on available data, such as product claim ratios, denied and withdrawn claims, penetration rates, cancellation rates, average claim times and complaint trends. The challenge with this approach is that, while some of this data is likely to be useful as a "red flag", it is unlikely in most cases to be determinative that the TMD is no longer appropriate without further investigation. In our view, the Review Triggers themselves will need to be the substantive outcomes of those investigations.
What is a 'significant dealing'?
Issuers are required to notify ASIC of a "significant dealing" in a financial product that is not consistent with the TMD. ASIC states that, in determining whether this threshold has been met, regard should be had to the proportion of customers purchasing the product who are not in the target market, the actual or potential harm to those customers, and the nature and extent of the inconsistency of distribution with the TMD. While ASIC does not rule out other considerations, these factors are likely to offer useful guidance to insurers in determining whether a significant dealing has occurred and could be applied in a similar manner to the criteria for determining significant breaches under section 912D of the Corporations Act.
When are submissions due?
ASIC has asked for submissions on its Consultation Paper and draft Regulatory Guide by 11 March 2020, with a view to finalisation of the Regulatory Guide sometime later in 2020.
ASIC states that it expects to have a "constructive" relationship with industry during the implementation of DDO. It recognises that DDO is a new form of regulation and that, just as the approach taken by issuers and distributors may develop over time, its own approach to administration is also likely to evolve. Those comments should provide some encouragement to insurance industry participants that, provided an earnest approach is taken to compliance with the new requirements, there will be goodwill applied in building and improving arrangements as experience is gained.
A link to ASIC's Consultation Paper and Regulatory Guide can be found here: https://asic.gov.au/regulatory-resources/find-a-document/consultation-papers/cp-325-product-design-and-distribution-obligations/