IMD to become IMD2

The review of the Insurance Mediation Directive,

its growing role in retail financial services distribution

1. Introduction

There appears to be something of a consensus amongst policy-makers and the financial industry that the insurance sector came out of the financial crisis reasonably well – with the notable exception of AIG. However, this has not meant that the insurance industry has escaped the raft of regulatory and political attention generated by the financial crisis at national, EU and global level.

The major regulatory change for insurers in the EU remains the implementation of Solvency II which will determine how much capital an insurer will need. In addition, the Directive calls upon the Commission to revise the existing Insurance Mediation Directive (IMD), taking into account the consequences of Solvency II for policyholders. The new “IMD 2” (1) will form an important part of the EU Commission’s attempts to create a single market in retail financial services. Any significant change or enforcement of IMD will have a serious impact on the manufacture and distribution of retail financial products

While receiving less coverage than Solvency II, the IMD “Review” represents a significant change to market practices of insurance companies (life and general), IFAs and manufacturers of competing products from other financial sectors. The IMD derives from the historic sectoral approach for financial regulation, introducing distinct regimes for banking, securities and insurance. The Commission recognises that competing products can originate from various providers where sectors can be blurred. It notes that insurance investment products compete with products from other sectors covered by securities (MiFID) regulation. This links the negotiations over IMD to both the MIFID review (2) and the PRIPs initiative (3).

The Commission is looking in detail at the retail market to see if there is a ‘level playing field’ between competing (or substitutable) products in terms of consumers’ best interests. In reality, the Commission (and some political stakeholders) are concerned that having different regimes creates a risk of arbitrage, where market participants structure products so as to minimise their regulatory obligations.

Because of these linkages the IMD review should be of interest to all providers, distributors and advisers of financial services, as it highlights current thinking of the Commission and national regulators on key, politically sensitive issues that have gained prominence since the financial crises. These include consumer protection, transparency, conflicts of interest, suitability of advice and disclosure of remuneration.

UK – Protecting the Retail Distribution Review (RDR)

The UK has sought to harmonise the impact of sectoral directives through the horizontal application of a common regulatory platform which covers conduct of business including inducements and conflicts of interest. This included extending standards set out in MiFID to other parts of the retail investment market.

As an early and vigorous adopter, the FSA (who were widely criticised for ‘gold-plating’ the implementation) will be seeking to exert significant influence with other parties based on its experience.

One area of significant concern is the degree to which the UK will be able to defend the detail of the Retail Distribution Review (RDR) in the face of both the IMD and MiFID reviews which could ‘trump’ key aspects (4).

2. Current thinking - a summary

Stakeholder involvement has progressed via advice given by EU regulators Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS, replaced by European Insurance and Occupational Pensions Authority - EIOPA), a public hearing (Dec 2010) and a general public consultation which closed on February 2011. We know the direction of travel of the debates involved in the development of the Directive but much technical detail still has to be decided. The proposal, due late 2011, will then be subject to full political scrutiny of the co-decision process where the European Parliament plays a leading role. All stakeholders will have to be active at this stage of a public debate which could prove highly critical of industry practices.

2.1 Scope

There is general agreement to retain the activity-based definition of insurance intermediation and not based on types of "professions" e.g. travel agents. ‘Introducing’ will be removed from the definition of ‘insurance intermediary.’

Reinsurance intermediaries should remain within the scope of the IMD and that the current exemption for large risks and reinsurance should continue.

The main impact will be extending the IMD to direct writers (i.e. direct sale of insurance products by insurance undertakings and their employees). However, it will have to take into consideration the specificities of each distribution channel. The UK has stated that it wants to ensure that the requirements on direct sales are proportionate; “given the different pressures experienced by direct sales, and the many different European legislative provisions which already govern their conduct (e.g., the Life and Non-Life Directives).”

Importantly, the scope would need to take into consideration the differences between investments packaged as life insurance policies (insurance PRIPs) and other categories of insurance products. The Commission is clear that it wants to use the IMD as an instrument for introducing (conduct of business) rules for insurance PRIPS.

Sales of insurance products by distance marketing (online, email, phone, fax or regular mail) should be brought within scope, taking into account the provisions already set out in the Distance Marketing of Financial Services Directive (5).

Debate has begun with regulators on how to treat newer additions to the financial landscape such as websites, and in particular aggregate or comparison websites. The position seems to be that if they just provide information about insurance – either to the customer or a registered insurance intermediary – they should fall outside its scope. But the line between this type of service and insurance intermediation could be drawn more clearly and discussion will continue. The UK position is that if the website provider allows the customer to search for insurance products on the basis of features and benefits or where a customer is able to select a product (even if the sale is conducted via another entity) the activity should fall within the scope of IMD

Professional requirements: The Commission proposes to introduce requirements whereby all persons in insurance companies who are responsible for insurance distribution and sales of insurance products demonstrate the knowledge and ability necessary to perform their duties. The UK takes the view that IMD requirements should be “sufficiently high level” to allow member states to develop frameworks which are appropriate to the local business models and distribution channels.

2.2 Conflict of interest and remuneration

The Commission is clear that it wishes to act, clearly fortified by the financial crisis, on the loss of trust in consumers for financial products. Recognising that this is a very sensitive political issue for Member States they seek to establish high-level principles for both conflict of interest and the disclosure of remuneration in particular. At present this may be limited as the Commission seem to be waiting to use the existing MiFID model, although this to is also under review.

2.2.1 Remuneration – “on-request” disclosure

The current IMD is silent on the question of remuneration and Member States are free to impose their own remuneration requirements on sellers of insurance products.

It is not yet clear whether the Commission will propose mandatory disclosure. In its advice CEIOPS took the view that an “on-request” remuneration disclosure regime should be introduced in IMD2 for insurance intermediaries. The UK supports this position but opposes any suggestion that in order to ensure a “level playing field” a similar regime should apply to insurance undertakings, with insurance undertakings being required to disclose some form of “commission equivalent” based on the cost of acquiring the business. The rationale being that insurance undertakings and intermediaries operate under different business models and the remuneration conflicts that can apply to intermediaries are less prevalent for insurers. Application of common disclosure requirements would therefore be inappropriate. The outcome of this debate remains unclear and therefore remains a strong lobbying point.

2.2.2 Conflicts of interest – High level principles imported from MiFID

The current IMD is unclear in relation to conflicts of interests and transparency rules. Conflict of interests can arise both in the relationship between a broker and an insurance company and between a broker and third parties, such as asset managers. Such conflicts of interests may compromise the objectivity of the advice given to customers. The Commission wants insurance intermediaries to act honestly, professionally and in line with the interests of their customers.

CEIOPS agreed with the Commission that a useful starting point would be to use the MiFID Level 1 regime as it already contains clear and sophisticated rules on conflicts of interests, transparency and inducements and that these rules have been identified as a clear benchmark for the distribution of insurance PRIPs

2.3 Cross-border business

It is easy to forget that the original IMD was intended to create a single market with a system of registration of intermediaries in order to facilitate the cross-border exercise of their activities. The "single passport" under IMD is based on the principle of registration in the home MemberState. The industry and the Commission agree that this original aim has not been achieved and the market for cross-border financial services business in general is still very limited in the retail insurance sector.

There is general support for the Commission position by CEIOPS to improve the legal framework for the notification processes and to integrate definitions of freedom of services (FOS) and freedom of establishment (FOE) into the IMD as well as to encourage a more transparent use of the general good rules.

One area of scrutiny is likely to be the practice of “round tripping” where intermediaries who experience problems in one territory simply set up in another. One trade association has already drawn attention to the possible use of such arbitrage to route around the “demands” of the ‘RDR (these firms would also fall beyond the complaints regime of the Financial Ombudsman Service (FOS) and not have to pay Financial Services Compensation Scheme (FSCS) levies).

3. Timetable

The Commission plans to table a new proposal in late 2011. It will then be for the co-legislators, the European Parliament and the Council to consider it in depth and to take a final decision.

4. Summary

The fact that CEIOPS favours a minimum harmonisation directive is an interesting one. It seems that individual national regulators want to retain the right to play a significant role in the regulation of retail products and are able to respond to local market (and political) pressures.

In this case the FSA (and successor) will hope to lead the way at the EU table (and regain some lost credibility?) as the UK has gone furthest in seeking to harmonise conduct of business rules on a horizontal basis and thus protect the landmark RDR project. What will be of interest is if the EU follows the UK and seeks to move on from point of sale issues to the “product intervention” approach (6).

References:

1. Insurance Mediation Web page DG MKT

2. MiFID review

3. PRIPS Web Page DG MKT

4. Retail Distribution Review (RDR)

5. Distance Marketing of Consumer Financial Services Directive (DMCFSD).

6. Product Intervention DP11/1

© Ian Williams