Insurance Distribution Directive has potential to be a game-changer of seismic proportions.
This week the FCA issued Consultation Paper 17/7 the first of two papers aimed at ensuring the UK is compliant with the EU requirements in the IDD by February 2018. The IDD was finalised by the EU in 2016.
The IDD gives rise to significant issues for the insurance industry and potentially creates game changing dynamics. There are two crucial issues and some minor changes which while adding cost are not significant for firms already looking to do what is right. These latter changes involve the introduction of compulsory training for employees of regulated firms who are involved in distribution and the introduction of EU requirements for managing complaints. No rocket science there then.
The first crucial issue is that Ancillary Insurance Intermediaries, such as car manufacturers and dealerships and travel agents selling insurance will now be caught in the regulatory web and though the web for them is thin the cost to comply will be an added burden. So there is a proportionate approach which should lead to better protection for the public.
More concerning, the IDD introduces new General Principles which are not dissimilar in approach to the FCA Principles and PRA Rules. Hidden within the first however, is a ticking time bomb. Distributors, and that includes intermediaries in the middle of a chain (wholesalers) and insurers will owe a duty to act in the best interests of their customers. This has the potential to be a game changer of seismic proportion leading the goalposts to be in another hemisphere. It should be noted that it applies not only to consumer insurance but to all insurance products.
An insurance policy is a contract. The customer pays its premium and the insurer agrees to pay them if a fortuitous event occurs causing loss to the insured. The terms are set out in the contract. If the event is not covered or one of the exclusions applies the insured does not get paid. However, there is a possibility that if an insured does not get paid they will now be able to make a claim against the insurance company for breach of the duty to act in their best interests. Two bites of one cherry.
A closer look at the duty is required as the new duty seems to transpose the insurance dynamic completely. Historically a duty to act in the best interests of customer (an insured) was a duty imposed on an agent (broker) acting for the insured when arranging insurance on their behalf. In insurance the key duty as between the two contracting parties (the insurer and the insured) has been for the insured to owe a duty to disclose to the insurer all material information the insurer may reasonably require in order to be able to underwrite the risk though this principle has been undermined in recent times as regards consumer insurance.
For some time now a person with a sufficiently close connection to another owes that other person a duty not to act in a manner which may lead to harm. Examples include road users owing a duty to each other and employers owing duties to their employees. This is a principle brought about to provide compensation when a person has acted without proper thought or care. They have acted negligently and are responsible for the damage caused by them to a third party. This is what happens to a manufacturer if they have made a product which injures a person who buys it.
However, this duty is couched in the terms of the duty owed by an agent who has been appointed to do something by someone, their principal. Here the agent is required to put its customers’ interests ahead of its own. The obligations include requiring the agent to be subject to the control of the principle and to act within the scope of their authority. These are not obligations that an insurer, not representing an insured, can generally fulfil. There is also the duty of an agent to act with due care and skill but this is in the context of standing in the shoes of their principle rather than being similar to the duty owed by a manufacturer to a buyer of its products which is what in reality an insurer and its customer are.
There is a question as to whether this duty will be enforceable by the customer of an insurer. The ability of a person to obtain compensation from another for a breach of a statutory duty is not clear cut but given the modern and international encroachment of the mass litigation culture there is a strong possibility that the courts will ultimately find favour with the argument.
Whether the courts do so or not insurers, brokers and wholesalers need to know how to defend themselves against the onslaught either from customers or the regulators. In recent years the regulators have focussed on the need for insurers to create product governance processes which ensure that products are designed for customers, tested and then sold to only those customers for whom the product is designed with subsequent feedback to ensure continual improvements if required. However the duty is interpreted insurers who want to ensure they can defend claims by customers are likely to need to establish that appropriate levels of care were used in the design, testing and distribution of their products. This will include ensuring that the sales staff are properly trained – and we are back to the current consultation paper.
What is missing from this first of two papers is the IDD requirement for Product Governance. Whatever the minimum requirements for product governance contained in the second FCA consultation paper, insurers, brokers and wholesalers now need to pay a lot of attention to ensuring that their product governance procedures are working and that the products are designed with the best interests of and sold only to the customers for whom they have been designed. Insurers, brokers and wholesalers need to ensure the process no longer leads to policies fit for purpose for one group of customers being sold to another group. Ultimately it may also lead to a homogenisation of products. Where products are sold on the web it is clear that the customer facing pages are going to need to be very specific about who the product has been designed for.
It could also lead to the death of the cheap and cheerful policy. The adage that you get what you pay for and even the age old principle that the buyer has some responsibility when buying a product, the buyer beware principle, seems to be gone now if it had not disappeared years ago. Insurers justified the sale of some cheaper and simpler products as being to reach customers who may otherwise not be able to afford cover. That approach must now be at risk. How, however does that sit with the natural inclination of buyers to pay a little as possible for similar, if not identical, products from vastly different manufacturers with vastly different underlying products and service standards. Could this be a restriction on competition and new entrants or just a leg up for those who spend more on marketing and brand?
Also at risk has to be the ability for an insurer to offer mass produced (volume) products for consumers which have very limited value but high levels of profit for an insurer. How can this be in the interests of the customer?
There are further issues to consider. How does an insurer price a policy for the eventuality that a customer or a number of customers who do not get their claims paid may now make a claim based on this duty? How do they reserve against these possible claims? There is no current experience on which to base reserving.
There are no answers to these questions at this point in time. The UK, at least until Brexit, is committed to complying with the requirements of the IDD. One suspects this will be a bit like taxes however – once introduced it will not go away. The goal posts have been shifted again though it may be some time before we see the full impact of trying to score goals where there are no posts or perhaps even no pitch.
