Out-Law Guide | 09 Dec 2010 | 11:50 am | 10 min. read
The European Commission has begun a review of the Insurance Mediation Directive (IMD) that is likely to result in insurance intermediaries – and insurers making direct sales - having to comply with new rules on disclosure and managing conflicts of interest.
The IMD has been part of the regulatory landscape since January 2005. But the Commission is concerned that its minimum harmonisation regime has led to a patchwork of national regulations, with some member states "gold plating" the requirements and others implementing the bare minimum.
In a consultation paper published on 26th November 2010, the Commission asks for views on how a revised directive – IMD2 – could address what it identifies as the key problems arising from the current IMD: lack of transparency and conflicts of interest.
"Consumers often have insufficient understanding of the risks, costs and features of insurance products," the paper states. "Sellers of these products can be subject to significant conflicts of interest, for instance when their remuneration and inducements are higher for selling some insurance products as compared with others."
"Insurance intermediaries should be obliged to act honestly, professionally and in line with the interests of their customers. Another objective of the revision of the IMD should be to establish a more robust EU disclosure framework which should lead to a higher degree of harmonisation."
Bruno Geiringer, a life insurance specialist at Pinsent Masons, the law firm behind OUT-LAW.COM said:
"The consultation suggests the Commission is thinking of some potentially significant changes that will affect life and general insurers as well as insurance intermediaries. Given the short consultation period, there is not much time to respond. The market needs to get seriously involved in IMD2 now."
The Commission has since extended the period for responses by one month - from 31st January to 28th February 2011.
The current IMD exempts insurance undertakings and their employees from its scope. The Commission believes this means policyholders buying cover directly from insurers may receive less information and protection than if they bought via an intermediary. Bringing direct sales within IMD2 would help ensure a level playing field between direct and intermediated sales.
The paper, therefore, asks for comment on the extent to which current IMD requirements should also apply to insurers and their employees. It also asks whether websites that just provide information about insurance should be within its scope and how the line between this type of service and insurance intermediation could be drawn more clearly.
In addition, the Commission would like to see sales of insurance products by distance marketing (online, email, phone, fax or regular mail) brought within scope, taking into account the provisions already set out in the Distance Marketing of Financial Services Directive.
Another suggested change for IMD2 is to introduce conduct of business and conflicts of interest rules regarding the distribution of investments packaged as life insurance policies.
The Commission is carrying out a parallel consultation on the regulation of Packaged Retail Investment Products (PRIPs) covering (among other issues) pre-contractual disclosures and sales practices. But it suggests that rules on "insurance PRIPs" (investments packaged as life insurance products) should be included in IMD2.
The new Directive would, therefore, consist of two parts: one dealing with sales of non-PRIPs insurance and the other with sales of insurance PRIPs.
The Commission is concerned that the quality of information given to consumers varies significantly depending on the insurance product and the regulatory requirements imposed by the member state concerned.
"In general," the consultation paper comments, "information is dense, legalistic, full of jargon, and difficult to digest."
Current information requirements are set out in Article 12 of the IMD. Article 12(1) sets out the information to be provided by the intermediary as to its status and whether it gives advice based on a fair analysis of the market or whether it is under an obligation to conduct business with one or a limited number of insurers. Article 12(2) explains what is meant by a fair analysis.
Under 12(3), the insurance intermediary must specify the consumer's demands and needs and the underlying reason for the advice it gives on any insurance product.
None of these requirements, however, apply to the insurance of large risks or to reinsurance (12(4)). Large risks include transport (aircraft, ships, rail and goods in transit) and other risks where the policyholder carries on a business over a certain size.
Article 12(5) enables member states to introduce stricter information requirements as long as they comply with European law.
In the consultation paper, the Commission says its preferred option would be for similar information requirements to apply to direct sales of insurance, taking into account the differences between direct and intermediated sales. It asks whether the current exemption for large risks and reinsurance should continue and whether member states should still be allowed to introduce stricter information requirements.
In addition, the paper asks whether a definition of "advice" is needed and, if so, whether a definition similar to the one in the Markets in Financial Instruments Directive (MiFID) would be appropriate. MiFID defines investment advice as the provision of personal recommendations to a client either on the client's request or at the firm's initiative in respect of one or more transactions relating to financial instruments.
Article 12 of IMD touches on conflict of interest issues, in that the intermediary has to provide information on whether it partially owns or is partially owned by an insurance company and whether it is a tied agent a multi-tied agent or will base its advice on the fair analysis of the market.
But there are no specific rules about managing conflicts of interest. Nor are there any provisions on remuneration and remuneration disclosure.
The consultation paper suggests that, as regards non-PRIPs insurance sales, "it could be important to introduce more transparency on the way insurance intermediaries are remunerated as well as on the mechanisms in place to ensure the effective management of conflicts of interest."
One option would be to use MiFID as a starting point for a new set of high level principles.
Under MiFID, member states must require firms to take "all reasonable steps to identify conflicts of interest between themselves, including their managers, employees and tied agents, or any person directly or indirectly linked to them by control and their clients or between one client and another that arise in the course of providing any investment and ancillary services, or combinations thereof".
Where steps taken to manage conflicts of interest are not sufficient "to ensure with reasonable confidence that risk of damage to client interests will be prevented," the firm must clearly disclose the general nature and/or sources of the conflict before carrying out any business for the client.
In the UK, insurance intermediaries have been subject to MiFID-style conflict of interest rules since April 2009 under the systems and controls (SYSC) section of the FSA's Handbook (see: Systems and controls changes for insurance intermediaries).
The Commission's proposals would, however, impose conflicts of interest rules on insurers making direct sales. The paper asks how these principles could be reconciled "for all participants involved in the selling of insurance products".
The Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS) in its advice to the Commission on IMD2 recommended that both intermediaries and insurers should comply with high level principles on conflicts of interest, but suggested that only insurance intermediaries would have meet more detailed requirements set at European and national level.
Part and parcel of the conflict issue is the thorny problem of remuneration disclosure.
In its 2007 report on the business insurance sector, the Commission raised concerns about conflicts of interest arising, not only from the dual role played by many brokers in advising the insured and providing services to the insurer, but in the way they are remunerated.
In particular, it highlighted contingent commission arrangements (where the intermediary earns additional commission if it brings business to a particular insurer) because of the potential conflict between the intermediary's commercial interests and the objectivity of the advice it provides to the client. It promised to revisit the issue in its IMD review.
It seems very likely, therefore, that IMD2 will include remuneration disclosure in some form, but whether it will be compulsory (rather than at the customer's request) and whether it will apply to all types of insurance and insurance customer is not yet clear. The paper merely states that "requirements regarding a disclosure of remuneration could be introduced" but gives no further details.
Respondents are asked how the transparency of remuneration could be improved "for all participants involved in insurance selling", what conditions should apply to remuneration disclosure and what types of remuneration should be covered.
CEIOPS is against mandatory remuneration disclosure. In its advice to the Commission of 10th November, its members preferred the option of an "on request" regime where the information would be provided if the customer asked for it. They thought this should be a minimum requirement, so that member states could introduce stricter conditions at national level.
The majority of CEIOPS members also considered such disclosure need not be made in connection with large risks or reinsurance.
In the UK, the Insurance Conduct of Business Sourcebook (ICOBS) currently operates an "on request" regime, but only for commercial insurance. The insurance intermediary is required to disclose commission (including contingent commission) to a commercial customer if the customer requests it. This is backed up by FSA-approved industry guidance under which commercial customers are reminded about their right to request this information and firms have procedures in place to provide it (see Insurance broker remuneration: law and regulation).
There is no equivalent rule in ICOBS on disclosure to consumers. But as from 31st December 2010, when the Retail Distribution Review (RDR) rules come into effect, firms selling pure protection products associated with investment advice will need to take reasonable steps to ensure the consumer understands how the firm is paid and, if applicable, that the firm will receive commission in addition to the adviser charge (see: The RDR and pure protection products).
At European level, the Federation of European Risk Management Associations and the European Federation of Insurance Intermediaries recently approved a "transparency protocol" that incorporates an "on request" disclosure regime for commercial customers. The protocol is, however, only intended to provide a framework for member associations and is not legally binding.
Using existing rules in MiFID as a benchmark, the consultation paper outlines the main principles the Commission believes should apply to insurance PRIPs in IMD2.
Under these proposals, the person selling an insurance PRIP would be responsible for providing pre-contractual information. In the context of a direct sale, this would be the product originator; in an indirect sale, it would be the intermediary.
Insurers or intermediaries selling or giving advice on insurance PRIPs would have to act honestly, fairly and professionally in accordance with the best interest of their clients. For tied agents, the responsibility to act in the client's best interests would remain with the insurance undertaking.
When giving investment advice, an insurer or intermediary should obtain the necessary information about the client's financial situation, his relevant knowledge and experience and investment objective to enable the firm to recommend suitable products.
For non-advised sales, the paper suggest member states should ensure that the intermediary or insurer asks for information about the client's knowledge and experience in the relevant field to assess whether the product is appropriate. If, on the basis of this information, the insurer or intermediary considers the product is not appropriate, the Commission proposes that the insurer or intermediary should warn the client.
On the remuneration issue, the consultation paper proposes that insurers and intermediaries selling insurance PRIPs "would need to ensure that the client receives information as regards the remuneration for the sellers". What information is not specified, although the paper says the difference between the premium paid and the actual invested part of the premium must be made clear.
The paper adds: "Remuneration structures should not be such that they materially impact on the ability of the intermediary to act in the best interest of the client and should be structured in a way that effectively avoids or managers any conflicts of interest that may arise."
As with the non-PRIPs insurance proposals, conflicts of interest rules for insurance PRIPs would be based in their MIFID equivalent. Member states would be required to ensure that insurance intermediaries and insurers take all reasonable steps to identify conflicts of interest. Where these steps cannot ensure "with reasonable confidence" that the risk of damage to client interests will be prevented, the intermediary and insurer would be required to disclose the conflict before carrying out any business for the client.
Although the current IMD includes provisions enabling insurance intermediaries to carry on business in more than one member state, the notification provisions it imposed have proved cumbersome.
The Commission sees IMD2 as an opportunity to improve and modernise the cross-border regime and asks for comments about how best to do this, including whether to include a definition of "freedom of establishment" to provide greater clarity.
The Commission also thinks it would be appropriate to establish basic common principles for professional requirements for all sellers of insurance products. One option would be require member states to ensure that all persons responsible for insurance distribution and sales demonstrate a level of knowledge and ability necessary for the performance of these duties.
The paper suggests IMD2 should include a "mutual recognition" clause, so that member states would recognise professional qualifications gained in other member states.
The consultation is open until 28th February 2011. The Commission hopes to present a revised text to the Council of the European Union and the European Parliament early next year.
Commenting on the consultation, Bruno Geiringer said the proposals gave the industry a lot to think about within a fairly tight timetable.
"Life companies already preparing for a post-RDR world will have to take into account the potential impact, particularly if they are engaged in direct sales. On the general insurance side, the suggestion that the changes might involve some form of commission disclosure will be a big concern for brokers.
"With one eye on the PRIPs consultation, the UK regulator needs to lobby the Commission hard and effectively to avoid duplication and ensure that recent changes to improve clarity as a result of RDR are not wasted," Geiringer added.
"I hope that the break-up of the FSA and the major changes to the UK regulatory landscape will not cloud the need for focus and care at this time."
Contact: Bruno Geiringer ([email protected] / 020 7418 7306)