We are sure you already know that the implementation of the Insurance Distribution Directive (IDD) has been delayed until later this year, and, like us, have welcomed that.
The European Parliament’s ECON Committee recently adopted two Resolutions asking the Commission to delay the application date of the IDD from 23 February to 1 October 2018. It further waived its scrutiny rights under the Delegated Regulations on product oversight and governance and insurance-based investment products, to “allow sufficient time for the industry to implement the necessary technical and organisational changes”. Normal procedure is that for Delegated Regulations there is a specific “scrutiny period”, and by waiving its rights to scrutiny for the Delegated Regulations on product oversight and governance (insurance-based investment products), the ECON Committee has in effect given the industry extra time to take in the current position without any further imminent changes to take account of.
In this article on the IDD we are focussing on the issues surrounding complex and non-complex products. We will be providing further guidance on other areas of the IDD in a separate article (see section below ‘What else does the IDD involve?’ for more information).
Further background on the IDD implementation delay
To give a little more background to the proposal to delay the application date of the IDD to 1 October 2018, the FCA announced that the European Commission proposed a delay to the application date of the IDD, and the proposal is currently under consideration by the European Parliament and European Council. In order to provide certainty for the industry, HM Treasury announced that the government will delay transposing the IDD into UK law until the outcome of this proposal has been confirmed. Once the IDD is transposed into UK law the FCA will make its final rules – these were published in near-final form on 19 January 2018, and as the FCA said in Policy Statement PS18/1 ("Insurance Distribution Directive implementation – Feedback and near-final rules for CP17/23, CO17/32, CP17/33, CP 17/39 and near-final rules for CP17/07"), they do not expect to make any changes to the near-final rules. Firms will be required to comply with the FCA’s final rules from whatever date is ultimately agreed at European level as the application date of the Directive – under the current proposal from the Commission, this date would be 1 October 2018.
FCA will be putting in place a formal transition period so that firms may adopt some or all of the new IDD requirements earlier than the implementation date if they are ready to do so.
Many industry bodies strongly advocated for a delay over the past months, for example, the ABI Conduct Regulation Committee earlier this year, who were in communication directly with key MEPs and other EU and UK stakeholders. We understand that Insurance Europe lobbied for a delay as well.
Complex and non-complex products
The proposed new EU regulatory regime includes new requirements on the sale and distribution of insurance-based investment contracts, with particular regard to those firms selling with-profits on an execution-only basis.
The proposed changes to “execution only” sales require contracts that are sold that way to be classified as either “complex” or “non-complex”. If they are non-complex then there is no change to the current rules on how they may be sold. If, however, they are considered to be “complex” then the insurer must EITHER:
- Change the product so that it becomes non-complex; OR
- Ensure that the insurer undertakes an “appropriateness test” on the individual buying the policy to ensure that the policy is appropriate for their needs and their level of investment knowledge. This must happen before the policy is bought and would typically form part of the online sales process.
There is no guidance on what questions an insurer should ask as part of the appropriateness test but the questions should be relevant to the particular product. For example, for simple/non-complex products, the questions could be along the lines of:
- Do you understand that the past investment performance of this investment is not a guide to its future investment performance?
- Are you comfortable with the level of risk of this investment and the fact that, although higher risk investments could mean higher returns, there is no guarantee of this and you may get back less than you invested?
- Do you understand the charges associated with the investment?
- Have you read and agreed to the Terms and Conditions of the investment?
For more complex products, additional questions such as the following could be appropriate:
- Have you traded in the above-selected investments previously?
- Do you understand that investments in securities and derivatives, in general, are subject to market risks that may cause their prices to fluctuate over time?
- How many times have you traded in these investments in the last 12 months?
- How many months have you been investing on an execution-only basis without advice?
- Do you understand that there may be penalties for early redemption?
If the insurer considers that the product may not be appropriate, or if the insurer is not able to obtain sufficient information to establish appropriateness, then the insurer must warn the customer of that fact (and this may be done in a standardised format). The sale may still continue subject to the warning being given.
There are no explicit rules on what product types are considered complex or non-complex. However, the FCA recently made a pointed note to refer to page 5 of the updated guidelines from EIOPA dealing with this issue. These state:
“As stated in the explanatory text to the consultation paper, EIOPA does not consider that mechanisms such as profit sharing should automatically result in a product being deemed complex. The drafting of the Guidelines was intended to capture cases where the effects of these mechanisms can be difficult for the customer to understand.”
“Based on the comments received, EIOPA recognises that the drafting may have been too broad in some cases and has made some amendments to both the Guidelines and the explanatory text in order to avoid inadvertently capturing certain contractual structures that are used in traditional life insurance policies, such as the payment of discretionary benefits. In particular, the overarching provision regarding the existence of ‘complex mechanisms that determine the maturity or surrender value or payout upon death’ has been replaced by the requirement that the effects of these mechanisms need to be assessed. The changes also take into account where specific consumer protection rules are laid down in national law.”
Our interpretation of this is that the main criterion to use when assessing whether a product is complex or non-complex is whether the product incorporates a structure which makes it difficult for the customer to understand the risks involved. This is set out primarily at point 1.1 in the EIOPA guidelines (EIOPA-17/651 | 4 October 2017 | "Guidelines under the Insurance Distribution Directive on Insurance-based investment products that incorporate a structure which makes it difficult for the customer to understand the risks involved").
Thus, if it is judged that the customer cannot readily understand the risks, then the product is classed as complex.
Our suggested decision-making process in this matter is that you should ensure you have assessed all contractual structures/features/cost structures (see points 1.5 to 1.17/1.18 of the guidelines) and decided whether you consider the customer should be able to understand them. If you think they are readily understandable, then using these criteria you can class the product as non-complex. This decision-making process should be clearly documented, ie what you have looked at and why you consider the customer should understand the particular features/issues (or otherwise).
Also, see further EIOPA guidelines (EIOPA-BoS-17/204 | 11 October 2017 | "Final Report on Guidelines under the Insurance Distribution Directive on Insurance-based investment products that incorporate a structure which makes it difficult for the customer to understand the risks involved") which you may find useful to give you a steer on which features to assess to establish the degree of complexity. In particular, refer to pages 1-13.
With reference to unit-linked and simple with-profits products, our view is that these should be regarded as non-complex, assuming that there is nothing complex about the charging structure eg tiered fund charges. And as long as the policy values go up and down in line with the value of the funds then that also helps. It is difficult to be definitive without seeing the details of the products, but if the product is simple and transparent then it will probably classify as a non-complex product.
What else does the IDD involve?
We will be issuing further guidance on the following topics, which are also captured within the IDD:
- Additional knowledge and competency requirements for distributors, plus professional, organisational and prudential requirements (including professional indemnity cover).
- Product oversight and governance requirements.
- The Insurance Product Information Document (IPID) for non-life products.
- Disclosure requirements in relation to insurance-based investment products.
- Pre-contract disclosures.
- Remuneration disclosure requirements.
- Conduct of business general principles including acting in customers’ best interests.
- Conflicts of interest.
- Customer demands and needs requirements.
- Complaints handling and out of court redress.
How we can help you
We are in the process of finalising the details of an “IDD readiness audit” which we will be offering to clients in good time in the run-up to the implementation date. If you think you might be interested in this, please contact us.
To be notified by email about future articles by OAC you can subscribe to our newsletters.
For more information
Senior Regulatory Compliance Consultant
< Back to News & insight