Last month Lloyd’s issued its eagerly awaited report on the implementation of the Insurance Distribution Directive (IDD) in the Lloyd’s Market. The report is not extensive and is worth a read if you are doing retail and SME business in that market whether as a Managing Agent or a coverholder.
In this article we will look at some of the key findings and provide commentary designed to help firms identify what they need to do now. In some cases we will do this by reference to our previous articles which provide considerable advice for firms needing help.
Lloyd’s focused on Managing Agents writing business for UK customers through UK coverholders and selected four firms to help with the diagnostic stage on the basis that those firms had the largest books of such business.
Importantly though, the IDD does not just apply to UK customers or UK coverholders and any firm which has a need to improve its approach as a result of the report will need to ensure that they take account of their non-UK business as appropriate particularly their EU business to which the IDD will continue to apply, regardless of Brexit.
The report highlights a number of good practices, areas where some firms will need to improve their approach and areas where Lloyd’s intends to improve its own controls through upgrades to processes such as the new DUA processes and to its approach, for example, in the form of amendments to Minimum Standards 9 “Customers”. Lloyd’s also recognised two areas which they considered to be key priorities: manufacturer identification and the product approval process.
Lloyd’s identified that Managing Agents were inconsistent in their approach to determining who was the manufacturer for each product they underwrote. This is in line with what we have seen across the London insurance market. The key importance of identification is that so much of the product governance approach is dependent on who is the manufacturer. If, as in many cases particularly where the product is distributed under a Binding Authority, there are two or more manufacturers an agreement needs to be in place setting out who is responsible for which aspects of product governance and distribution.
Who is a manufacturer is determined by PROD 1.1.4 as the firm who creates, develops, designs or underwrites a product.
Lloyd’s were very clear that in their view a Managing Agent will always be a manufacturer on the basis that, even if they have delegated underwriting to a coverholder, they are still underwriting the policy as the capacity provider. Firms in Lloyd’s and the market generally should take note of this view and look again at their approach. The UK market in particular is likely to be susceptible to an inconsistent approach, having concluded that a coverholder is “underwriting the risk”.
This is also likely to drive a much wider review of the approach to product governance for insurers as they will need to ensure that they have agreements in place with their co-manufacturers.
The question of whether a coverholder is also a manufacturer is dependent on the facts but in many cases this will be so because of the practice, particularly with MGAs, of coverholders developing their own products – a key element in determining who might be manufacturer.
One issue raised by Lloyd’s was that the Managing Agents had different approaches as to who made the decision as to whether the firm was a manufacturer and/or whether the coverholder was also a manufacturer. It appeared that in some cases it might be the underwriter, the compliance function or the DUA team. Lloyd’s recommendation was that this inconsistency should be mitigated by having a written internal procedure with supporting guidance regardless of who made the decision. This is a very good recommendation which we hope many firms will adopt to improve the consistency of approach. For efficiency we might add that it would be simpler if the underwriting team is given authority to make the decision. Every time a decision has to be handed off to a second person there are inefficiencies which can slow down the business flow unnecessarily.
Manufacturer status drives responsibility for a number of items including the development of the IPID to be delivered to the customer by the distributor. Again, the practice in the industry is often for the coverholder or MGA to prepare this and Lloyd’s now expect to see the Lloyd’s Managing Agent engage in this process where perhaps they had not been as they did not consider themselves to be the manufacturer.
We have written extensively on this topic at (and after) the time of implementation of the IDD. Our articles have provided pithy advice on what is required and how to implement an appropriate product governance framework. Of particular interest to readers might be “IDD: Been There And Bought The Postcard?” and “Insurance Distribution Directive Deep Dive 1: Product Governance”.
The following is commentary on Lloyd’s approach in their report much of which we have covered in our articles with clear intuition of expected areas where firms would need to be intelligent and diligent in their approach.
1. Product Approval
Lloyd’s appeared to find no issues with the Product Approval approach being taken by the Managing Agents which were involved in the diagnostics undertaken by Lloyd’s. However, they took the opportunity to remind all Managing Agents that the product approval process must take account of the entire distribution chain and consider the value to the customer of the product through that distribution chain. This will not present too much difficulty for the UK business being written by Lloyd’s Managing Agents as generally the distribution chains will not be too long but there remains a reasonable amount of work for the market to ensure it has all the information it requires for EU business being underwritten by EU coverholders where it may not be clear at this point how many brokers there are in the chain before it reaches the EU coverholder.
2. Target Market
The IDD and FCA rules require identification of a product’s target market (and those for whom the product is not suitable) and regular checking that products are only being distributed to that market. There was evidence that identification of the target markets were not sufficiently granular, possibly because the Lloyd’s minimum standards did not match the FCA requirements for granularity. This is key not only as an element of product oversight but also as it is important for Manufacturers to be able to explain to the distributors who the product is suitable for (or not).
Our experience in the market has been that Insurers and MGAs have been relying on the Product Summary and/or IPID as an explanation of the product’s suitability when distributing products. The FCA and Lloyd’s expectation is for a higher level of advice to distributors. Insurers and other manufacturers, once they have identified their target market, should ensure that they explain to those distributing their products such as MGAs but also producing brokers for whom the product is suitable and for whom the product is not suitable in line with the assessment of whom they have developed the product for as a target market.
This may seem to be partially at odds with the traditional concept that a producing broker represents the insured and thus bears the responsibility of ensuring that they are buying the right product for their client but that is the impact of the product governance requirements. It is also in line with the concept that an insurer as well as any agent acting on their behalf such as a coverholder or MGA is required to act in the best interests of the insured. These recently developed philosophies are designed to ensure that products are right for the people who are buying them and it is now the responsibility of all firms (and in many cases individuals) in the distribution chain to ensure that products are designed for a specific target customer and only sold to that target market.
One way of evidencing that an MGA or Insurer has taken appropriate steps to get the product to the correct target market is to ensure all producing brokers have literature which sets out with appropriate granularity who the product has been developed for and who it is not suitable for.
This material should not only set out who the product was and was not designed for but also the preferred distribution strategy.
Insurers and MGAs also then need to ensure that they receive the MI to evidence that the product is getting to the correct market and performing as expected.
3. Product Testing
Lloyd’s identified that there was insufficient testing of products taking place. Our experience indicates that this is the reality across the market. It seems odd to us that this is the case. Most new products do not suddenly gain a significant growth path immediately, but they grow over a period of time. That being the case there is no reason for the first 3 to 6 months of sales after approval (or perhaps temporary approval) being considered to be a market test of the product. Assuming that the product performs as expected sales can continue and if the product requires adjustment for any reason that can be done before final approval for ongoing sales. This is in line with what generally happens within the market when a new product is released but it seems that the review and secondary approval is not taking place. It may mean a second stage in the process but provided the product performs as expected in the first 3 to 6 months this should not be too burdensome.
4. Best Interests Rule
This new rule is one which has a very wide ranging impact for insurers, MGAs and brokers and we have published articles about it numerous times, most recently in connection with the FCA work on value chains and GI pricing but also earlier at the time of implementation of the IDD:
- The FCA’s Latest Warning: Value, Pricing, the GI Distribution Chain and the Customers’ Best Interest Rule
- Insurance Distribution Directive Deep Dive 3: Customers’ Best Interests
Lloyd’s has picked this work and made a clear statement that Managing Agents need to do more, at least with reference to remuneration and the costs within the distribution chain in order to determine value to the customer. Having mentioned it as an element of the product approval process they highlighted their concerns in more detail. The report stated:
“….we would expect as a matter of good practice managing agents to properly assess the value of products provided to their target market including by investigating and reviewing the roles performed and the value provided by each party in the distribution chain together with the associated costs, fees and remuneration.”
This is a virtual paraphrase of the FCA expectations which we highlighted in the article on the FCA’s approach to value pricing in the distribution chain and the best interests rule. Clearly there is more work to be done in this area but the issue, not just within the UK is how to achieve what the FCA and Lloyd’s expects given the length of some of the distribution chains. There is also the question of how an insurer or MGA obtains the information it is expected to have about the services being offered by each link in the distribution chain and whether or not it is appropriate for an insurer or MGA as manufacturer of a product to be qualitatively assessing a broker which is representing the insured in the transaction.
Whatever the appropriateness in the view of the market based on years of trading and relationships with the distributors it cannot be clearer that the FCA and Lloyd’s expect the analysis to be undertaken by the manufacturers including the Managing Agent. Importantly, it is our view that this is not an element of product oversight that can be delegated to a co-manufacturer. The key reason for that is that the co-manufacturer, if a coverholder/MGA, will be one of the links in the chain which the Managing Agent must qualitatively assess.
This appears to be confirmed by Lloyd’s as the report goes on to make the point that a Managing Agent must look, no doubt as a part of its due diligence process when considering whether to grant a binder, at the approach to remuneration of staff adopted by the MGA/coverholder. We think, that if the insurer has or is considering granting numerous or consecutive binders, the Managing Agent will need to look at the question of remuneration by product/binder so the due diligence done on the coverholder initially may not be sufficient. The simple reason for this is that each binder usually relates to a single or mixed but connected products and for each such product there may be a different sales team or a different overall distribution approach and therefore the analysis needs to be based on the product as it is the value to the customer of each individual product (or group of connected products) which is important.
It is clear from the Lloyd’s report that this is the approach they are taking when combined with both their earlier diagnostic work resulting in the report on Acquisition Costs Managing Agents’ Governance and Controls published in February 2019 and the ongoing diagnostic work currently underway on fair value of consumer products.
5. Other IDD Areas
Lloyd’s also took the opportunity of the report to comment on the need for Managing Agents to ensure quality controls existed around Good Repute, Training and Competence, Disclosure Requirements and Demands and Needs all of which have had upgrades in the IDD. In many cases they noted that Managing Agents were meeting expectations and commented on areas where improvements could be made even though the prime responsibility sat with the distributor. There was a reminder that the Demands and Needs statement was a key part of ensuring that the product was being delivered to the right target market and that Managing Agents should ensure they engage in the process of defining demands and needs. There was a broad reminder throughout that the Managing Agents have a responsibility to ensure that the coverholders/MGAs were meeting expectations and regulatory requirements as well as having the appropriate resources to meet their own requirements for the services they provided to the Managing Agents.
Interestingly there was a focus on Ancillary Insurance Intermediaries (AII). These intermediaries are considered by many to represent a higher level of risk and are therefore outside of many firms’ risk appetites as a distributor. However, it appears that some firms have either not undertaken sufficient assessment of their distributors or had not consciously concluded whether to deal with AIIs. Lloyd’s expectation is that they should do so as they should appropriately categorise all distributors because of how the FCA rules apply differently to each category. In the case of AIIs Lloyd’s would like the Managing Agents to identify whether they are within risk appetite and if so ensure they are appropriately dealt with within the risk framework, no doubt receiving additional controls representing an appropriate response to the additional risk which they present to the Managing Agents.
The section in the report on AIIs neatly segways into the following section where Lloyd’s discusses the need for Managing Agents to have adopted a risk based and active approach to management of their coverholders and distribution chains with appropriate due diligence and monitoring/auditing being at the heart of that active risk management approach. Lloyd’s have helpfully highlighted some of the factors which Managing Agents may wish to take into account in developing their approach but none of these are new to the market so merely serve as gentle reminders of what Managing Agents should be doing, if they are not already.
The report highlights that Managing Agents have identified the key areas of the IDD but some within the limited cohort have done better than others in some areas while there remains overall further work to be done. The suspicion and general understanding is that within the market there are pockets of good work but further work is required and in many cases inconsistencies which have crept in should now be avoided given the clarity offered by Lloyd’s from this report.
As with most thematic diagnostic work by regulators the report also represents a warning to the market. You have been advised what the expectations are and there is no longer an excuse if your approach and controls are not what is expected.
A tool commonly being used by Lloyd’s is to limit underwriting authority of a Managing Agent if the controls over a book of business or area of the business are not satisfactory. This is an opportunity for Managing Agents to review controls and ensure they are what they should be so as to avoid any potential consequences of this nature.
For coverholders and/or MGAs it represents an indication as to why further oversight may be coming their way and why they are going to need to look more closely at the distribution chain beneath them. They will also need to spend more time working with their capacity providers to ensure that both, as co-manufacturers, have real clarity over the division of responsibilities for product governance and oversight. Having a brief statement of responsibilities will not be enough, particularly if it does not match either regulatory expectations or what is happening in practice as between the firms.