The Insurance Distribution Directive (IDD), which applies from 1 October 2018, introduces a regime for the selling of insurance-based investment products (IBIPs). Under the IDD, customers' profiles, including their demands and needs, must be determined, and suitability or appropriateness must be assessed for every IBIP sale (much like what MiFID II requires in the investment sector).
The "suitability" of an IBIP must be assessed in cases where the distributor provides advice to the customers. (If the insurer does not provide advice, then it must assess "appropriateness" instead). Depending on the nature of the advice provided, the distributor has to determine the extent of the information to be collected from the customer. The suitability assessment is then built on three points:
- the financial situation of the customer, including his/her ability to bear losses
- the customer's investment objectives, including his/her risk tolerance
- the customer's knowledge and experience in the product's investment field
For all three of these points, the IDD offers guidance on what must be included:
- the source and extent of the customer's regular income and assets, including liquid assets, investments, real property, and regular financial commitments
- the period that the customer wants to hold the investment for, his/her preferences on risk-taking, his/her risk profile, and his/her reasons for investing
- the customer's familiarity with the type of service, transaction, IBIP, or financial instrument; the nature, number, value, frequency, and transaction period of the IBIP or financial instrument; his/her education level and profession (including former professions, if relevant)
If any of this information is missing, then the distributor may not provide any advice to the customer. Similarly, if all the required information is provided but none of the products are suitable for the customer, then no advice can be given.
Only if the data is gathered and a product deemed suitable can the distributor provide advice. The outcome of the assessment is to be a suitability statement given on a "durable medium" that outlines the advice and describes how the product suits the customer's profile.
Should a periodic assessment of the suitability be performed by the distributor, the suitable character of the recommended product has to be reviewed at least annually. However, it may be necessary to increase review frequency depending on the characteristics of the customer's profile and on the nature of the recommended IBIPs (i.e. product complexity).
In cases where the contract is concluded through means of distance communication, the distributor is allowed to deliver the suitability statement after the conclusion of the contract, if two conditions are met:
- The customer has consented to receiving the suitability statement after the conclusion of the contract.
- The customer has been given the option to delay the conclusion of the contract until after receipt of the suitability statement.
In addition, the European Commission will amend the IDD in the coming months to oblige distributors to collect the customer's sustainability preferences (e.g. for green investments) as part of its suitability assessment.
The "appropriateness" of an IBIP must be assessed if the distributor does not plan to issue any advice. Only one criterion is necessary to determine appropriateness: the customer's knowledge and experience in the product's investment field, from which it should be determinable how well he/she can understand the risk involved.
If the customer fails to provide this information, or if he/she lacks knowledge and experience for the IBIP in question, then the distributor must issue a warning stating that the IBIP is not appropriate for the customer.
However, Member States may allow the appropriateness test to go unperformed if four conditions are met:
- The sale contract contains MiFID II non-complex financial instruments or it contains non-complex IBIPs.
- The idea to buy the IBIP is initiated by the customer.
- The customer is made aware that the test is being skipped, and that he/she therefore will not benefit from its protection.
- There are no conflicts of interest.
Regarding the first of the above conditions, the IDD refers to the MiFID II criteria for complex financial instrument and provides its own criteria for non-complex IBIPs as well. An IBIP is considered non-complex if it:
- has a contractually guaranteed minimum maturity value, which is at least the amount paid by the customer after costs are deducted
- does not have a contractual clause that allows the insurance company to materially alter its nature, risk, or pay-out profile
- can be surrendered, or otherwise released, at a value that is known to the customer
- does not explicitly or implicitly include any charges that, in cases of its being surrendered or released, cause unreasonable detriment to the customer because these charges are disproportionate to what it costs the insurance company
- does not in any other way incorporate a structure that makes it difficult for the customer to understand the risks involved
EIOPA has additionally issued guidelines on IBIPs that incorporate a structure which makes it difficult for the customer to understand the risks involved.
Before the IDD's implementation date later this year, distributors need to prepare their methods for gathering the required information and assessing it. Such a method will undoubtedly take the form of a questionnaire, of some type, with a system for scoring customers and pairing them with suitable or appropriate IBIPs. Distributors must also set their procedures for the suitability and appropriateness tests, which probably cross with existing mechanisms they have in place.
As you may have noticed, the IDD regime is similar in its details, and nearly the same in its spirit, to the MiFID II regime. It will herald an era of better customer protection for customers.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.