The Financial Conduct Authority (FCA) has published the second consultation paper on its proposals for the UK implementation of the Insurance Distribution Directive (Directive (EU) 2016/97 (IDD) (CP17/23). CP17/23 follows the earlier consultation, CP17/7.
In CP17/23 the FCA proposes to change various parts of its Handbook to reflect the obligations under IDD. The proposals are split between changes for life business and changes affecting both life and general business.
The changes relevant to life business include firms’ general obligations, information disclosure to customers, inducements, suitability and appropriateness.
Changes with an impact on both life and general insurance business cover conflicts of interest, product oversight and governance, organisational requirements relating to the protection of customers’ money and professional requirements relating to the good repute of employees.
The consultation closes on 20 October 2017.
The FCA’s general approach to implementing the IDD
The UK Government must implement the IDD into UK law by 23 February 2018. HM Treasury is consulting on changes required to implement the IDD in statute, for example by amending the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001. The FCA will also need to amend its Handbook.
The IDD will be supported by two directly applicable Level 2 regulations which put further flesh on the bones of the directive. Drafts of these regulations were published by the European Commission on 20 July 2017.
In CP17/16 the FCA states that it will take an intelligent copy out approach to implementing the IDD. This means broadly copying directive requirements into UK statute but in some areas exceeding requirements where necessary. The FCA will go beyond intelligent copy-out where they believe it is necessary to maintain levels of existing consumer protection or to ensure consistency across different financial products.
Specifically, the FCA proposes to extend regulation to:
- apply the IDD standards to a wider range of firms than is strictly required;
- maintain existing UK standards that go beyond IDD requirements;
- introduce standards that go beyond IDD in the interests of consistency with other consumer protection legislation (such as MiFID II); and
- apply the conflict of interest rules to all insurance products, not just Insurance-Based Investment Products (IBIPS).
Changes to conduct of business rules
The FCA proposes to move insurance conduct of business requirements out of Chapter 7 of the Conduct of Business Sourcebook (COBS) and to place insurance requirements alongside other COBS rules.
Information and product disclosure for IBIPs
The IDD introduces a number of new requirements for firms distributing IBIPS including an obligation to provide appropriate information, to provide adequate periodic reports to customers and keep a record of customer agreements. The IDD requires that appropriate information include, at least, all costs and charges, risk warnings and whether the firm will conduct specific periodic assessments of suitability. This information may be provided in a standardised format. Firms must keep a record of client agreements showing the rights and obligations agreed with customers. Periodic reports (likely to be annual) must include the costs and services undertaken on behalf of the customer.
As the IDD requirements are similar to measures in MIFID II, the FCA intends to introduce new IBIP disclosure requirements alongside MIFID counterparts.
The FCA is not proposing to require this information to be in any standardised format.
IBIPS: Inducements and remuneration
The IDD requires that the payment of a fee, commission or non-monetary benefit does not have a detrimental impact on the quality of the service provided to the IBIP customer and does not impair compliance with the duty to act honestly fairly, and professionally in customers’ best interest. The IDD also allows Member States freedom to impose stricter rules on remuneration and inducements than are contained in the directive.
The existing FCA requirements on inducements in COBS 2.3 apply to designated investment business. A new chapter COBS 2.3A containing MIFID II inducement rules will be in place from 3 January 2018. The FCA proposes to apply these rules to IBIPS while the existing COBS 2.3 rules will apply for other life products. The FCA will continue to apply its Retail Distribution Review rules on adviser charges.
Where the IDD differs to MIFID II provisions, the FCA proposes to include both requirements. Specifically, the IDD requires that the payment of inducements from a third party must not have a detrimental impact on the quality of service, whereas MIFID II requires that inducements must be designed to enhance the quality of the service – similar, but different standards. The FCA plans to require that firms meet the MIFID requirements as these are expected to deliver better consumer outcomes, while also retaining the IDD rule in order to implement the directive into UK law.
The FCA is considering whether to “level up” insurance conduct rules to those of MIFID II in relation to inducements (for example, requiring that firms undertake ongoing assessments to ensure that inducements enhance the quality of services to customers).
The IDD contains suitability requirements where the distributor has given a personal recommendation in relation to an IBIP. Existing FCA suitability rules are set out in COBS 9. The FCA proposes to integrate new rules for IBIPS alongside MIFID II rules in COBS 9A while existing rules in COBS 9 will apply for other life products. The demands and needs requirements for intermediaries will be extended to insurance undertakings. Record retention rules currently in COBS 9 will be moved into the Senior Management Arrangements, Systems and Controls Sourcebook (SYSC).
The FCA proposes to follow the derogation enabling a reduced information regime for professional clients, aligning the approach with that in MIFID II whereby knowledge and experience can be assumed in particular circumstances.
For non-advised sales of IBIPS, distributors must assess the knowledge and experience of the customer to determine whether an IBIP will be appropriate. The FCA proposes to introduce an IBIP-specific appropriateness test into COBS 10A, alongside MIFID II requirements. Record keeping requirements for both insurers and intermediaries will be introduced into SYSC.
The FCA proposes to integrate the IDD derogations to allow non-complex IBIPS to be sold as execution only sales.
Conflicts of interest
The IDD includes provisions designed to manage conflicts of interest in relation to sales of IBIPS. The FCA currently applies conflict of interest requirements in SYSC 10 to all intermediaries. These requirements are not restricted to sales of IBIPS. Insurers are also subject to high level conflict requirements (for example in SYSC). The FCA proposes to apply conflicts requirements to all types of distributors, not just to those selling IBIPS.
The FCA proposes to level-up to MIFID II conflict requirements to create a level playing field in terms of consumer protection so that insurance distributors are subject to similar conflicts rules to regardless of the type of investment product sold. Where IDD requirements go beyond those derived from MIFID II the FCA will copy these out into the Handbook. New conflicts requirements for insurers will be added to SYSC.
Product oversight and governance
The IDD requires firms maintain, operate and review a product approval process for all new products and for products which are being redesigned. The current Responsibilities of Product Providers and Distributors for the Fair Treatment of Customers (RPPD) in addition to the Principles for Businesses currently govern firms’ obligations in relation to product governance. As the RPPD is broadly similar in approach to the IDD product governance requirements the FCA does not expect firms to make significant changes to their current systems and controls.
MIFID II also introduces product governance requirements. These will be included in a new FCA Handbook, the Product Intervention and Product Governance sourcebook (PROD). IDD and MIFID II product governance requirements are broadly similar, although MIFID II requirements go beyond IDD in a number of areas such as requiring firms to assess product charging structures and value for money, development of a target market and distribution strategy, multi-firm product development and the type of information that manufacturers must provide to distributors.
The FCA is proposing to introduce an insurance chapter into PROD to implement IDD requirements. These new rules will replace the RPPD for firms within scope of PROD. The FCA will use the MIFID II definitions of “manufacturer” and “distributor”, adapting where necessary in the context of insurance so, for example, clarifying that distributing will include the activities of advising and proposing a contract of insurance. Additional details about the activities that will be included within manufacturing will be included within the IDD delegated regulation on product governance.
The FCA will apply the rules in PROD to all insurers and intermediaries that manufacture or distribute insurance products – with the result that PROD will apply to insurers whether or not they distribute products directly or not.
The IDD contains the same requirements to ensure the protection of client money as was contained in the Insurance Mediation Direction (2002/68/EC) although, notably, the IDD extends the requirements to reinsurance intermediaries. CASS 5 currently allows firms to apply client money rules to reinsurance contracts on an optional basis.
The FCA consulted upon changes to the client money regime in CP17/7 – specifically in relation to reinsurance mediation. Respondents were broadly in favour of the FCA proposals to make reinsurance distribution subject to CASS 5. A number of respondents raised concerns about restricting client money protection for reinsurance contracts to risk transfer.
Taking the responses into consideration, the FCA proposes to make the application of CASS 5 mandatory for reinsurance mediation. Firms will therefore be able to choose between risk transfer and segregation as they are currently able to on an optional basis.
The IDD imposes good repute requirements on natural persons working in insurance and reinsurance undertakings and insurance and reinsurance intermediaries. This requirement extends to people with management responsibility for insurance and reinsurance distribution. The IDD requires that ancillary insurance intermediaries (AIIs) ensure that persons responsible for distribution should be of good repute. The IDD requires that insurance and reinsurance undertakings establish, maintain and keep appropriate records to demonstrate their compliance with good repute requirements.
The FCA already requires that persons directly involved in a firm’s insurance mediation activity meet good repute requirements. These rules will be retained with some adaptations to bring requirements in line with the IDD. The current rules in the Prudential Sourcebook for Mortgage and Home Finance Firms, and Insuance Intermediaries (MIPRU) will be moved into SYSC. The requirements will be applied to all firms with permission to conduct insurance mediation (excluding connected travel insurance providers, who will not be subject to good repute rules).
The FCA will introduce a good repute requirement for all AIIs in scope of the IDD. IDD record keeping requirements will be included in SYSC.
Additional FCA Handbook changes
The IDD requires that firms provide objective and relevant information about an insurance product prior to the conclusion of the contract. Information should be presented in a comprehensible form in order to allow the customer buying insurance to make an informed decision. The Handbook currently requires that firms provide their customers with appropriate information (which the FCA believes is clarified by the IDD requirements).
Existing requirements in relation to pre-contractual customer information can be found in Chapter 6 of the Insurance Conduct of Business Sourcebook (ICOBS). The FCA is proposing to retain the requirements in ICOBS with some additions to IDD obligations, for example the requirement for the product manufacturer to draw up the Insurance Product Information Document (IPID) and the requirement to provide product information in a durable medium.
New guidance will be included in ICOBS to recommend that firms consider their product governance arrangements when producing and providing product information to customers. This will include guidance that firms should consider providing a short summary of the policy – including the information set out in the IPID requirements – to commercial customers. The FCA is seeking to improve product information for all customers, and specifically mentions small and medium sized enterprise customers that purchase more complex insurance products.
In particular all firms are reminded of the following principles when producing customer information:
- product information should be developed in line with the Smarter Customer Communications initiative;
- consider the information needs of customers including when product information would be most useful in the sales journey;
- review and make any improvements required to the product governance process to ensure that it meets the customers’ best interest requirement;
- provide information in a targeted and balanced fashion to ensure it has relevance for customers;
- ensure that product information is honest and fair about the limitations of the product itself; and
- design product information to reflect the cumulative effects of package sales where relevant.
The IDD introduces a requirement to provide customers with a highly standardised IPID. As a final template has yet to be published by the European Commission, the FCA has based its approach on the draft EIOPA Implementing Technical Standard for the IPID.
The FCA proposes to:
- introduce a rule requiring an IPID to be provided to consumers before purchasing a general insurance product (this does not extend to pure protection products for which the current policy summary document will continue to apply);
- retain the requirements to provide complaints processes and access to compensation for payment protection policyholders;
- reproduce the IPID delegated regulation in the Handbook once it has been adopted; and
- introduce new guidance to clarify that other pre-contractual disclosures may be required in addition to those contained in the IPID (for example, existing FCA requirements applied to sales of GAP insurance).
The FCA is not proposing to extend the requirement for an IPID to commercial customers. The FCA believes that firms providing commercial cover should be given greater flexibility in terms of the information they provide to customers.
The FCA has also provided a list of frequently asked questions in relation to the IPID, based on discussions with stakeholders in earlier consultations.
View: FCA publishes second consultation on implementing the IDD