Out-Law Analysis

EIOPA issues guidance on integrating sustainability preferences in the IDD suitability assessment

Earlier this year, the European Commission published updated regulations on how to integrate sustainability factors into the product oversight and governance (POG) requirements for insurance undertakings and distributors.

The new regulations, which follow the Solvency and Insurance Distribution Directive (IDD) reviews, also set out how to integrate sustainability factors into the rules on conduct of business and investment advice for insurance-based investment products (IBIPs).

The POG regulation and its amendments affect both manufacturers and distributors of products, but the provisions concerning the integration of durability factors in the suitability process were addressed to insurers and insurance intermediaries advising on IBIPs. With very little notice, the European Insurance and Occupational Pensions Authority (EIOPA) has published new guidance (30 pages / 1.27MB PDF) to promote better understanding of how the Commission’s regulations should be implemented.

EIOPA has made clear that its guidance is not binding and does not prevent national competent authorities from taking a stricter approach to promote consumer protection. Here is a closer look at EIOPA’s practical suggestions.

Customer understanding of ‘sustainability preferences’

When explaining the term ‘sustainability preferences’ to customers, insurers and insurance intermediaries should distinguish between the three different types that are listed in the glossary of the EIOPA guidelines.

The three sustainability preferences are:

  • an IBIP for which the customer determines that a minimum proportion should be invested in ‘environmentally sustainable investments’ as defined under the EU Taxonomy.
  • an IBIP for which the customer determines that a minimum proportion should be invested in ‘sustainable investments’ as defined under the Sustainable Finance Disclosure Regulation (SFDR).
  • an IBIP that considers ‘principal adverse impacts’ (PAI) on sustainability factors where qualitative or quantitative elements demonstrating that consideration are determined by the customer.

The EIOPA guidance says insurance distributors should explain what the different sustainability aspects mean, while avoiding technical language and introducing other terms or definitions. They can also use explanatory notes included by the EU legislator in the margins of the compulsory SFDR template and present the information in ‘layers’ – providing brief explanations in the sustainability preference questionnaire submitted to the customer and more granular information if it is requested.

All insurance distributors selling IBIPs should be able to assess a customer’s sustainability preferences and know who among them sells IBIPs that promote environmental or social characteristics or that have a sustainable investment objective.

Collecting sustainability preferences information

After explaining to the customer what the preferences are and how they can be taken into account when structuring a contract, insurance distributors must then collect sustainability preferences information from customers as part of the suitability assessment.

Information on sustainability preferences may be collected as the last element within the collection of information on investment objectives without, however, preventing the customer from spontaneously expressing his or her sustainability preferences at an earlier stage of the assessment. If the customer has any sustainability preferences, the insurer or the insurance intermediary should ask which of the three options they prefer: environmentally sustainable investments; sustainable investments; or PAI. If a customer shows several preferences, it is also possible to offer them a combination of all three.

The distributor should then carry out a ‘deeper’ investigation, obtaining sufficiently granular information to allow them to match with the IBIPs’ features. For environmentally sustainable investments, distributors should explain that, from January 2023, there will be two key performance indicators (KPIs) used to assess the alignment with the taxonomy regulation. They should then as which KPI the customer prefers for their underling investments. KPI 1 shows the extent to which the IBIP is aligned with taxonomy based on all of its underling investments; while KPI 2 shows the extent to which the IBIP is aligned with taxonomy based on all of its underling investment except government bonds.

For sustainable investments, distributors should ask whether the customer wants their sustainability preferences to have a focus on a particular ESG criteria, a combination of them, or whether they do not have a preference. Similarly, for PAI, distributors should investigate whether the customer is more sensitive to the environmental or social criteria of ESG, and, in the latter case, try to obtain their preferences on human rights, anti-corruption or anti-bribery matters using simple ‘yes or no’ questions.

Taking action once the information is obtained

Once a customer’s preferences are clear, the insurance distributor should then obtain information on the minimum percentage of investments considered “sustainable” under the SFDR and of investments aligned with the taxonomy regulation – even identifying minimum proportions by standardised percentages. The distributor should also work out which PAI should be considered, including quantitative or qualitative criteria. For multi-option products (MOPs), distributors should ask whether all underlying options should consider PAI of investment decisions on sustainability factors, or only a proportion, including at least one underlying option.

If a customer does not have any sustainability preferences, they should be considered as “sustainability neutral” and the insurance distributor should recommend IBIPs both with and without sustainability-related features.

If the customer shows sustainability preferences but does not determine which of the options they prefer, EIOPA suggests putting policies and instructions in place for situation where the customer is not willing or able to make a choice. EIOPA has also advised distributors to record any sustainability preferences expressed by the customer in general terms, and suggested recommending an IBIP that matches as best as possible the customer’s preferences and recording the reasons justifying these recommendations.

Matching customer preferences with IBIPs’ sustainability features

EIOPA has made clear that insurance distributors must consider information disclosed prior to the conclusion of the contract and via the insurer’s website, bearing in mind the different disclosure obligations in force on 2 August 2022 and on 1 January 2023 – the effective date of the new taxonomy regulation. Insurers and insurance intermediaries can rank and group IBIPs by the proportion invested in economic activities that qualify as environmentally sustainable; the proportion of sustainable investments and the consideration of PAIs.

Insurance distributors should assess MOPs – with regards to the first two options – by checking whether the weighted average of minimum proportion of environmental or sustainable investments in an MOP’s underlying options chosen by the customer matches the minimum proportion expressed by the customer at the time when the advice is provided; or all the MOP’s underlying options selected should match the minimum proportion determined by the customer at the time when the advice is provided. When assessing MOPs with regards to the third option, PAI, distributors should simply consider the PAI preferences as determined by the customer.

Ensuring the suitability of an insurance-based investment product

In accordance with new IDD rules, an insurance distributor should not recommend IBIPs when their sustainability features do not match the customer’s sustainability preferences. If an insurance distributor does not have IBIPs whose characteristics match the customer’s sustainability preferences, they must refrain from advising – as they must in the absence of any other suitability criteria.

However, an important difference immediately leaps to the eye between the assessment of the ‘original suitability criteria’ and the assessment of the sustainability preferences. In the event of a mismatch between an IBIP and the original suitability criteria, the insurance distributor must either refrain from offering the insurance contract or switch to the ‘appropriateness’ test, as long as national rules allow it. Instead, “where no IBIPs meets the customer’s sustainability preferences, the customer can decide to adapt his or her sustainability preferences” and thus avoid giving up the advice on IBIP.

It is now easier to understand the purpose of EIOPA's preliminary recommendation to insurance distributors to adopt a neutral and unbiased approach throughout the suitability test, and to refrain from exerting pressure on the customer to adapt their sustainability preferences.

In the event that an insurer or an insurance intermediary does not have an IBIP that matches the customer’s initial sustainability preferences it should document this ‘mismatch’ in the suitability statement; inform the customer about the mismatch and explain the reasons; and make clear that the customer is free to adapt their sustainability preferences. If the customer decides to do so, the insurer should present IBIPs that are the closest fit for the new sustainability preferences and specify if these are available on the market or by the distributor providing advice.

Future challenges for insurance distributers

EIOPA’s efforts to simplify these complex sustainability issues is welcome, despite some legitimate misgivings over the highly instructive role they are required to play in the process. The EIOPA public consultation’s feedback statement, published together with EIOPA guidance earlier this summer, stressed that the stakeholders need simpler and more user-friendly documents to ensure they understand how to integrate the customer’s sustainability preferences into the suitability assessment under the IDD.

To limit the work to the insurance distributer, EIOPA pointed out that insurance distributors are not required to conduct the periodic assessment at the date of the application of new rules for the existing customers but they should use the next regular update of the existing suitability assessment to identify the customer’s individual sustainability preferences.

EIOPA has made clear that it is aware of the challenges insurers and insurance intermediaries face, given that the new rules are not yet finalised and they will come into force at different times. Because of this, EIOPA has suggested how insurers can take advantage of the data currently available, and has used colours and graphics to spur insurers and insurance intermediaries to make best efforts to ensure good data quality.

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