The Insurance Distribution Directive (“IDD”) will supersede the current Insurance Mediation Directive (Directive 2002/92/EC) (“IMD”). In preparing the IDD, the European Commission intended to enhance the regulation of insurance sales and address concerns over a patchwork of national regulations that emerged as a result of IMD gold plating.
As one of the Commission’s aims for IDD is to level out regulatory standards across the EU, it is perhaps surprising that IDD is itself a minimum harmonisation directive. As a consequence, firms and customers will continue to be faced with different regulatory requirements and protections between the Member States in which the distributor is active. In this article, we discuss the provisions of IDD and the consequences to be expected for the UK and German insurance distribution markets.
Given that the UK gold plated IMD to some degree, many of the incoming provisions in IDDshould not significantly alter existing sales practices or governance. The same is true for the German insurance mediation rules, although the German legislator has so far intentionally not covered the roles of group insurance policy holders or the classification of insurance comparison sites; both aspects are currently left to be ruled on by the German courts. In these respects, IDD might bring about significant changes at least in Germany. However, in both jurisdictions firms should note key provisions regarding disclosure of commissions, bundling of products and professional standards requirements and should identify any divergence between their current approach and the requirements in IDD.
This article is based on the final text of IDD adopted by the European Council on 14 December 2015. The IDD will come into force 20 days after its publication in the Official Journal and Member States will have two years from that date to transpose it into national law. At the time of writing, the IDD is still awaiting publication in the Official Journal but it is likely that the transposition date will be January or February 2018.
IDD applies to any person carrying on the activity of “distributing insurance”. Significantly, it now governs the activity of distribution whether carried out directly by an insurer or through an intermediary.
Within the scope of “distribution”, IDD recognises and applies its rules to three types of distributors (collectively known as “insurance distributors”):
- Insurance intermediaries, i.e. persons that pursue the activity of insurance distribution for remuneration and who are not ancillary insurance intermediaries.
- Ancillary insurance intermediaries, i.e. persons that pursue the activity of insurance distribution for remuneration but whose principal professional activity is not insurance distribution and who only distribute insurance products that are complementary to their goods or services.
- Insurance undertakings (this is a key shift from IMD which only covered intermediary sales).
The new terminology of “insurance distribution” encompasses much of the same activities as “mediation” under IMD, including advice, preparatory work for the conclusion of a contact of insurance, concluding contracts of insurance and assisting in the administration and performance of such contracts. Interestingly, simply “introducing” is no longer within scope.
The definition of “insurance distribution” also clarifies that insurance comparison sites are subject to IDD, unless they do not receive any remuneration or offer the opportunity to (directly or indirectly) conclude via a website or other media an insurance contract (for example websites managed by public authorities or consumers’ associations which do not aim to conclude any contract but merely compare insurance products available on the market). This is no doubt to align regulatory treatment across Europe. While comparison sites are generally treated as regulated insurance mediation in the UK, this legal question has so far been left unregulated by the German legislator and has not been answered in case law.
The exemption for connected contracts of insurance is retained in a modified form. It now applies to “ancillary insurance intermediaries” (see above) who carry out distribution activities if:
- the insurance complements the good or service supplied by the provider;
- the insurance covers:
- risk of breakdown, loss of, or damage to, the good or non-use of the service; or
- damage to, or loss of, baggage and other risks linked to travel booked with that provider; and
- the premium does not exceed:
- in the event the insurance is complementary to a service and the duration of that service does not exceed 3 months, €200; or
- in any other event, €600.
Potentially more ancillary distributors can benefit from this exemption given that the premium threshold has increased to €600 and the 5 year limit on the duration of the policy has been removed. However, it is worth noting that the UK implemented the connected contract exemption more restrictively than the original wording in IMD and may choose to do so again. In Germany, the connected contract exemption gold plated IMD, so it can be expected that the German legislator will do the same with the amended connected contract exemption that is now contained in IDD.
Activities which do not constitute “insurance distribution” under IDD include:
- the provision of information on an incidental basis in the context of another professional activity;
- the professional management of claims on behalf of an insurance or reinsurance undertaking, and loss adjusting and expert appraisal of claims;
- the mere provision of information about potential policy holders to intermediaries or insurance undertakings, where the provider does not take any additional steps to assist in the conclusion of an insurance or reinsurance contract; and
- the mere provision of information about intermediaries or insurance undertakings to potential policy holders, where the provider does not take any additional steps to assist in the conclusion of an insurance or reinsurance contract.
IDD requires employees of insurance intermediaries and insurance undertakings to be of good repute (as a minimum, they must have a clean criminal record and not have been declared bankrupt) and to have continuing professional training and development based on at least 15 hours of professional development per year, taking into account the nature of the products sold, the type of distributor, the role they perform and the activity carried out. This may be demonstrated by obtaining a certificate.
Information requirements and conflicts of interest
Distributors are subject to an overarching duty to act honestly, fairly and professionally in the best interests of their customers. More specifically (but excluding distribution activities in relation to the insurance of large risks), IDD imposes the following requirements on firms:
Distributors cannot remunerate or assess the performance of their employees in a way that conflicts with their duty to act in the customer’s best interests. The IDD wording precludes any remuneration arrangement that could incentivise the sale of a particular product to a customer when a different product would better meet the customer’s needs.
Information about the firm:
There are obligations on both the intermediary and the insurer to provide information about themselves in good time before the conclusion of an insurance contract. Such information includes details about the firm, the basis of its service, complaints procedures and in the case of an intermediary, on behalf of whom the intermediary is acting.
Transparency and disclosure:
Intermediaries are also required to disclose:
- any 10% or more direct or indirect links to an insurer;
- the nature of the intermediary’s remuneration (i.e. commission or fee based); and
- whether it has entered into exclusive distribution agreements with insurers.
The significant change for the UK will be that existing FCA rules only require the disclosure of commission to commercial customers on request (notwithstanding other legal and fiduciary duties to disclose conflicts of interest) whereas the incoming rules now apply to all customer types. In Germany, the rules on disclosure of commission will have to be amended significantly.
To provide a level playing field, direct sales by insurance undertakings must also disclose the nature of any remuneration received by employees of the insurance undertaking in relation to that insurance contract.
Member States are also entitled but not obliged to impose limitations or prohibitions on the receipt of fees, commission or non-monetary benefits received by distributors from third parties. Clearly, commissions are a standard feature of insurance distribution models and it will be interesting to see whether the FCA or the German legislator use this invitation to impose stricter controls on distributors given its similar activity in the retail investment space (for example in the UK; the Retail Distribution Review, which already applies to life insurance products).
Insurance intermediaries must disclose whether or not they provide advice on the basis of a “fair and personal analysis” and if not, they must provide the names of the insurers with whom they do or may conduct business. Advice is given on the basis of a fair and personal analysis when it involves an analysis of a sufficiently large number of insurance contracts available on the market to enable the firm to make a personal recommendation in accordance with professional criteria.
If advice is provided, customers must be provided with a personalised recommendation. Whether advisory or not, all distributors must provide the customer with a statement of demands and needs and objective information about the insurance in a comprehensible form (see below).
As regards insurance intermediaries, these provisions are consistent with the existing requirements in IMD and FCA rules, as well as with German insurance intermediary regulation.
Product Information Document:
In respect of non-investment insurance contracts (for investment-based insurance contracts, firms should refer to PRIIPs Regulation (Regulation 1286/2014)), IDD requires a standardised insurance product information document (“PID”) to be provided to the customer before the conclusion of the insurance contract, on paper or another durable medium (although note the Information Conditions of Article 23). IDD prescribes the information that must be provided, and future EIOPA technical standards will establish a template PID to use. This approach is similar to the requirements of the PRIIPS Regulation allowing firms to standardise their approach to a certain extent across life and non-life business.
The product manufacturer is responsible for producing the PID and the distributor for distributing it. Such firms will therefore need to review their documentation suite in light of IDDrequirements.
Insurance-based investment products
IDD imposes additional requirements on the distribution of insurance-based investment products by insurers and insurance intermediaries:
- Such firms are required to maintain and operate effective arrangements to manage conflicts of interests and when the conflict cannot be prevented, it must be disclosed in good time before conclusion of the insurance contract (delegated acts will provide greater detail on firms’ obligations).
- In addition to the pre-contract information mentioned above, the firm must provide the customer with risk warnings regarding the product/investment strategy proposed, (where advice is given) whether the firm will provide the customer with a periodic assessment of suitability and detailed information about costs and related charges associated with both the product, and the method of distribution (i.e. the cost of investment advice given and any third party payments) and their effect on the investment return.
- Such firms can only receive or pay fees, commissions or soft commissions from or to third parties in connection with the distribution of insurance-based investment products, if such payment does not have a detrimental impact on the service received by the customer and does not impair compliance with the duty to act in the customer’s best interest.
- Firms providing advice must carry out a suitability assessment, and non-advised sales must be subject to an appropriateness test.
Commission Delegated Acts and EIOPA Guidelines will provide greater clarity as to the relevant minimum IDD standards. Member States are also entitled but not required to introduce stricter standards regarding the distribution of insurance-based investment products including commissions, mandatory provision of advice and circumstances where a firm can describe their advice as independent (already a feature of the FCA’s RDR regime for retail customers).
In the UK, many of the themes above already apply to firms selling insurance-based investment products (because although MiFID 1 did not strictly apply to this asset class, theFCA felt they were analogous to MiFID financial instruments and extended many of MiFID’s provisions to them). Following on from the FCA’s DP15/3 and the delays in MiFID II implementation, it will be interesting to see whether the FCA decides to apply MiFID II standards (with IDD overlay if required) to distributors or simply implements IDD. In Germany, the market of insurance-based investment products is far less mature than the UK, so new regulation from the part of the German legislator as well as from BaFin may be expected.
In any event, firms will need to check that their operating procedures and practices are consistent with incoming regulatory requirements.
IDD requires that distributors that offer an insurance product together with an ancillary product or service (which is not insurance) must provide customers with an adequate description of the component parts of any package, the costs and charges of each component and any impact the package has on the risk profile or insurance coverage. The move towards transparency is consistent with other incoming EU regulation (for example, there are similar provisions in MiFID II) and existing FCA policy trends (for example, the FCA’s work on add-ons) as well as attention from German consumers associations, especially in respect of PPI products. However, the true impact will only become clearer once EIOPA’s guidelines on cross-selling are published. It will be important to get clarification on when an offer is to be seen as cross-selling under IDD, and if so, whether IDD rules would still apply in the case where goods or services are distributed with ancillary insurance.
In addition, when an insurance product is ancillary to any goods or services and packaged with them, the distributor must offer their customers an opportunity to purchase the component goods and services separately. There are exemptions for ancillary services which are investment services, certain credit agreements or payment accounts.
Group insurance contracts
Similarly to IMD, IDD does not contain specific regulation in respect of the so-called group insurance contract (being a very popular contractual concept used in the German insurance distribution market).
IDD neither expressly excludes nor includes the group policy holder in the definition of “insurance intermediary” or “insurance distributor”. However, in clause 49 of IDD it is clarified that, in the case of group insurance, “customer” should mean the representative of a group of members i.e. the group insurance policy holder who concludes an insurance contract on behalf of the group of members where the individual member cannot take an individual decision to join (such as a mandatory occupational pension arrangement). Further, the representative of a group of members shall, “promptly after enrolment of the member in the group insurance, provide, where relevant, the insurance product information document and the distributor’s conduct of business information”.
If the group policy holder was to be classified as an insurance distributor under IDD, then this specification of its information duties would be redundant, as in such case the group policy holder would be obliged to deliver the required information to the group members before concluding the group insurance contract. Accordingly, the group insurance policy holder should not be classified as “insurance intermediary” or “insurance distributor” but this will remain to be decided on a case by case basis for group insurance contracts.
It remains to be seen whether the German legislator will, nevertheless, implement specific national insurance distribution provisions regarding the group insurance policy holder; it may well decide to keep the current legal situation where the decision is left to the German courts.
Product governance and oversight
Insurers or intermediaries that manufacture insurance products must maintain, operate and review proportionate and appropriate product approval processes. In particular, these processes must identify target markets for each product, the risks for that target market and a map out of an appropriate distribution strategy. Insurance undertakings then have an obligation to monitor the product to ensure it remains consistent with its target market.
Details of the manufacturer’s product approval process and target market should be provided to distributors, who themselves have an obligation to obtain such information and to understand the characteristics of the product.
In the UK, the requirements under IDD should not mark a significant shift from the FCA’s current expectation that firms should have sound product governance processes to ensure Treating Customers Fairly outcomes (see the FCA’s Regulatory Guide, “The Responsibilities of Providers and Distributors for the Fair Treatment of Customers”). The same is true for BaFin which relies on the firm’s obligation to develop and distribute only such insurance products which are in compliance with the German Insurance Contract Act.
However, firms will need to consider their existing processes in the context of the detail in IDDand any subsequent delegated acts.