Having covered Product Governance in our first Insurance Distribution Directive (IDD) Deep Dive and Customer Information and IPIDs in our second Article this article, our third and final in the series, will focus on the new Customer Best Interests Rule and what it may mean for insurance businesses whether they be intermediaries, including MGA’s, or insurers.
What is the “Customers’ Best Interests” rule?
The rule appears to originate in Paragraph 46 of the preamble to the IDD which provides that:
“Member States [EU countries] should require that remuneration policies of insurance distributors [insurer and brokers, MGAs and others to whom the IDD applies] in relation to their employees or representatives do not impair their ability to act in accordance with the best interests of customers or prevent them from making a suitable recommendation or presenting information in a form that is fair, clear and not misleading.”.
Article 17 of the IDD dealing with general principles provides that:
“Member States shall ensure that, when carrying out insurance distribution, insurance distributors always act honestly, fairly and professionally in accordance with the best interests of their customers.”
Article 19 dealing with conflicts of interest and transparency then provides that:
“Member States shall ensure that insurance distributors are not remunerated or do not remunerate or assess the performance of their employees in a way that conflicts with their duty to act in accordance with the best interests of their customers”.
The contextual background therefore is that these words as they appear in the IID and which did not appear in the Insurance Mediation Directive (IMD) impose a new duty to act in accordance with the customers’ best interests.
The Financial Conduct Authority (FCA) in implementing the IDD has simply taken the language of the IDD in Article 17 and added it as a new Principle within its rule book. The relevant FCA Policy Statement (PS17/21) in paragraph 5.3 provides that the FCA will be amending ICOBs 2 to include a High-Level Rule which provides that insurance distributors will be required to “act honestly, fairly and professionally in accordance with the best interests of their customers”.
What is a “Best Interests” duty?
Under English law a duty of this nature is imposed on an agent who represents another person, the principal (in the insurance context most often a broker representing a policyholder or potential policyholder but also a coverholder representing an insurer) in negotiations with a third party (the insurer where representing the policyholder or the policyholder where representing the insurer).
The duty requires the agent to act diligently and use their skill to negotiate terms of a transaction on behalf of the principal to the principals’ advantage and to manage any potential conflicts of interest appropriately. It is a duty of trust and confidence placed in the agent.
Thus, an agent must not use their position of trust to profit secretly or to otherwise create an inappropriate benefit or gain for themselves (or others) without the knowledge and consent of their principal.
To whom will it apply?
The common law duty is wholly appropriate for an intermediary which acting as agent for the insured is arranging their insurances for them. To include the duty in legislation relating to the distribution of insurance is therefore no more that restating the law in so far as that restatement applies to distributors who are agents representing prospective policyholders.
There are however some anomalies when it comes to other insurance distributors. In particular, there is no general duty at law for an individual or company which is selling a product be it a car, washing machine or insurance policy to another company or an individual to act in the best interests of that purchaser. Nor is there any general duty to act in the best interests of a purchaser when acting as an agent of the vendor, such as a retailer who may be the agent of the manufacturer or in the case of insurance, an MGA with a binding authority authorising them to sell or distribute the products of an insurer on behalf of that insurer.
Historically, the legal difference between an agent representing an insurer such as a coverholder and an agent representing an insured when arranging a policy or seeking payment of a claim has been recognised in the regulatory environment by rules which made a distinction between the sale of a product or the provision of advice and/or a recommendation, the latter implying some greater duty of care.
In some ways the legal distinction left a lacuna for those who, not representing the insured, may have been less interested in ensuring that policyholders received an appropriate service or product than making a profit. This lacuna was partially filled by the FCA regulations on ‘Fair treatment of customers (generally referred to as TCF) and then further filled by the broader approach to Conduct Risk which brought in Product Governance, but the various requirements remained primarily imposed on the insurer and any broker representing an insured leaving those in the middle of any distribution chain relatively untouched. Further, where a product was being sold rather than arranged the duties and responsibilities (?) were quite light.
The IDD changes that approach by imposing the “Customers’ Best Interests” duty on all distributors in any distribution chain. An insurer selling a policy direct, a coverholder or MGA representing an insurer and selling a product either direct or via a retail broker and any retail broker as well as any others in the chain, are required to comply with the duty. This appears to be a paradigm change away from the legal position to one where, in order to continue to develop the confidence of customers in the insurance sector, everyone involved in the distribution of insurance products must look to make sure that the policyholders are receiving a product which is suitable to them. The shift is also supported by the introduction in the IDD of very specific requirements for product governance and demands and needs requirements which apply to all products being distributed. The distinction between a sold product and one where advice or a recommendation is made has been narrowed materially, potentially closing the lacuna.
How will it apply and what might its’ impact be?
This is a deeper question than it might at first appear because, if the duty being imposed by the new FCA Principal was the duty imposed by common law it would be wholly inappropriate for those not representing a prospective policyholder as insurers and their agents are not in a position of trust and confidence as regards the individuals and companies buying their products nor are other distributors in the chain.
So the real first question has to be “what is the duty which is being imposed?”
Unfortunately, there is no real answer to this question. It clearly cannot be the duty imposed on an agent representing a principle despite the identical language as that is not applicable to a number of the circumstances in which distributors are operating.
The FCA have provided no indication as to how the duty may operate in the consultation papers dealing with the IDD and this rule in particular. In addition, the FCA more recently issued important papers dealing with their Approach to Consumers and a related document discussing the potential to create a new duty of care. These documents provide in some detail the FCA approach to protecting consumers outlining all of the principles and rules which are relevant and the approach they will take to protecting consumers. TCF (including the 6 Outcomes and the Responsibilities of Providers and Distributors documents), customer information and transparency and conflicts of interest all play a significant role and receive quite a focus. There is also discussion of the duty which is already imposed by the Consumer Rights Act 2015. Discussion of the “Customers’ Best Interests” rule is limited to a mention of its existence and reference to it being possibly a tool for introducing any new Duty of Care in the discussion paper leaving doubt as to the application and importance of this new rule.
Perhaps the best way of looking at the new rule therefore is to place it solely within the context of the IDD itself. The Preamble to this EU Directive provides the background to the Directive. The expressed intention is to bring a consistent approach to regulation of the distribution of insurance products covering all forms of distribution and throughout any chains which will be applicable to all participants. The IDD upgrades the approach to Product Governance, Product and Status disclosure, the management of conflicts of interest with specific focus on remuneration of staff and distributors and extends the requirements for consideration of the customers’ demands and needs beyond advised sales.
Bearing this in mind, it is possible to adduce an intention that all those in the chain of distribution must be on the alert for instances, whether on individual risks or books of business, where the customer’s best interests are not being served properly either as a result of the product itself or the method of distribution. In practise what this means for insurance product distributors is that all of them now owe a duty to the policyholder or prospective policyholder to ensure that the product is appropriate for them. That means that where an insurer is the manufacturer of the product a broker or MGA will need to do some form of due diligence on the product governance process of the insurer to ensure that it has been thorough and to obtain satisfaction with the approach taken to be aware of the target market and distribution approach and thereby ensure their approach is in line with that intended by the insurer manufacturer. Conversely, if an MGA is the manufacturer the insurer will need to undertake an element of due diligence on the product governance work of the MGA to be comfortable that it has been thorough, and that distribution will mean that the product is being distributed to the target market.
Both insurers and intermediaries (including MGAs) will also need to be in receipt of appropriate conduct risk and other management information to gain comfort that the approach is working and the product performing as anticipated. Where indicia are available to anyone in the chain of distribution that action needs to be taken it will be the responsibility of each of those to whom such information is available to act to rectify any issue, systemic or otherwise.
The result therefore is that the new rule is no more than another high-level principle which, added to the other tools available to the FCA, has a broad application. At present it has no specific import or operation and there are no detailed rules to be followed in order to be compliant with it. It does however, tighten up the coverage of those caught by the rules and open the door to a broader duty of care and could be used for that purpose if the FCA so decides after completion of the current consultation process.
On that issue we would recommend that parties who are interested should ensure they review and respond to the current duty of care consultation. The deadline for doing so is 2nd November 2018.