Royal Commission response: Design and distribution obligations


Geoff Atkins

In the last sitting week of parliament, the first piece of legislation responding to the Hayne Report was passed.

New product design and distribution obligations will apply to insurers (and underwriting agencies) from 5 April 2021 requiring them to develop and document a target market determination for each retail client product. New obligations will ensure that product sellers only provide the insurance to the target market.

The aim is to have insurers take more responsibility for the design and sale of their retail client products, to stop offering products with little to no consumer value and actively prevent mis-selling. The changes for insurers in designing their products will impact the product management function along with the compliance requirements for insurers and intermediaries.

In this note we discuss:

  • The design obligations – essentially the target market determination
  • The distribution obligations – conditions, restrictions and reporting

Design obligations

There are 4 new design obligations:

  • to make publicly available target market determinations;
  • review the target market determination as required to ensure it remains appropriate;
  • keep records of decisions in relation to the design obligations; and
  • notify ASIC of significant dealings in a product that are not consistent with the target market determination.

Target market determinations

A target market determination (TMD) only applies to retail clients including small businesses who acquire retail insurance products like motor and travel insurance.

The target market is determined by asking – Would it be reasonable to conclude that the product would be aligned with the likely objectives, needs and financial situation of the retail clients who form part of the target market?

Target customers must be considered holistically and insurers do not need information about individual customers. But they do need to consider the likely objectives, needs and financial situation of their target clients as a group, when developing the product and deciding how it is to be sold. This involves consideration of the key features of the product, including the benefits, risks, complexity and costs that are relevant to the target clients.

A TMD must be in writing and describe:

  • the class of retail insurance clients that are the target market for the product;
  • any conditions and restrictions on the sale and distribution of the product (i.e. how the product can be sold and who it can be sold to);
  • the maximum review period of the target market determination (i.e. how often the product will be reviewed to asses whether it remains fit for the target market – for example every 2 – 3 years);
  • the kinds of information that would trigger an early review of the target market (i.e. when the target market determination may be inappropriate including feedback from insureds) and when product sellers need to provide information to the insurer regarding the need to trigger an early review;
  • the reporting obligations and reporting periods for a product seller to report to the insurer including reporting complaints information from insureds.

Other procedural and compliance requirements apply including:

  • making the TMD available free of charge to the public, including superseded versions;
  • mentioning the TMD in product advertising or directing clients to where the TMD is available.

Reviewing and reporting

TMDs can be reviewed or re-issued at any time but no products can be sold if a trigger event has occurred or it is likely that a product is no longer appropriate for sale. It must be reviewed at reasonable times including within the review timeframes stated in the TMD.

It is not enough to set an arbitrary or regular period (e.g. once a year) as the new laws contemplate that more regular reviews may be needed – for example where an event, factor or circumstance suggests that the TMD is no longer appropriate and the likelihood, nature and extent of the detriment to retail clients means a more prompt review is required. If a trigger event occurs, the insurer must review the product and the TMD quickly and within 10 business days of becoming aware of the event.

Record keeping and ASIC notification

Insurers and agencies making TMDs must collect and keep complete and accurate records of the decisions made and the reasons for those decisions. Records can be requested by ASIC and need to be maintained for 5 years.

If there are significant dealings in a product that are not consistent with the TMD the insurer must notify ASIC in writing within 10 business days of becoming aware. What is “significant” is not defined and will be determined on a case-by-case basis. It must be something that is “worthy of ASIC’s attention” to be significant enough to report.

Distribution obligations

The distribution obligations apply to any person who is selling or distributing a retail client product to a retail client.

Beyond the insurer, this includes AFS licensees like underwriting agencies and brokers acting under a binder, along with agents (including white label partners, authorised representatives and general insurance distributors). It does not apply to referrers or to brokers who give advice to and place insurance on behalf of the client.

A product seller must:

  • Take reasonable steps to ensure their conduct is consistent with the TMD, especially with regard to restrictions or conditions in the determination
  • Collect and provide to the insurer information specified by the insurer and information about complaints related to a product; and
  • Notify the issuer of any significant dealings in the product that are not consistent with the target market determination.

This will require more oversight from insurers including with underwriting agencies that may have their own AFS licence and their product sellers to ensure the TMD is being followed.

It is an offence to distribute a product that does not have a TMD, or if a TMD has been withdrawn because it is no longer appropriate. A product seller has to make reasonable enquiries to identify whether a TMD has been made or if it is not required in order to avoid committing an offence.

Reasonable steps to achieve consistency

Insurers must take reasonable steps to ensure the sale of the product is consistent with the TMD. This includes taking reasonable steps to monitor the conduct of the people selling the product.

A key step for insurers is to decide whether they need to put any restrictions, conditions or special reporting requirements on product sellers. If there are none the only requirement is for the product seller to report complaints. If requirements are needed, though, there may be a need for changes to product seller contracts as well as operational systems, reporting and audit.

Deciding whether steps are “reasonable” includes assessing:

  • the likelihood of whether the conduct of the product seller is consistent with the target market determination;
  • the nature and degree of harm that may result from the product being issued outside the target market;
  • the availability and suitability of ways to eliminate or minimise the likelihood of harm that may be caused; and
  • what was known or ought to have been known about the above.

Insurers dealing with product sellers who have a poor track record of ethical and compliant sales conduct will need to do more to prevent mis-selling and promote compliance.

Collect, provide, and keep distribution information

A product seller is required to maintain complete and accurate records of the following:

  1. the number of complaints that a product seller receives and the dates on which these are reported to the issuer
  2. steps taken by the product seller to ensure that the product is sold in a manner consistent with the target market determination
  3. the dates that the product seller reported information about significant dealings; and
  4. any other information required by the insurer.

This will also give ASIC easier access to information when assessing compliance of insurers and product sellers.

Finity’s view:

For many uncontroversial insurance products (like home and motor) the changes will be limited to the processes, documentation and compliance requirements on insurers and product sellers with no discernible customer impact. TMDs will best be aligned with each PDS and it will be efficient to review the TMD each time there is a significant review of the PDS. Links with the complaints system need to established. There will of course be some increase in compliance costs.

For most add-on insurance products or those with high commissions and/or low claim ratios, the changes will be significant. The design and distribution obligations may be the most significant regulatory tool in response to the concerns about add-on insurance products and how they have been sold. We anticipate that insurers will need a ‘low value product’ framework to guide their decisions in this area and it will be a big challenge for many in the industry.

Much of the concern so far has been about the level of detail that the TMD should encompass. Finity’s view is that for most products the TMD should be simple. We suggest that all stakeholders keep their eye on the objective – to control mis-selling of low value products to vulnerable consumers.

The Fold’s view:

Insurers will need to take a more hands-on and principles-based approach to product development and distribution than they have previously. More is required than drafting a policy wording or writing a PDS, setting prices and then selling the product through a distribution channel.

Underwriting agencies and insurtechs who can leverage their client-centric focus to innovate and develop new products will easily adapt to these changes if they can also use technology to embed and monitor the compliance, review and reporting functions.

By Geoff Atkins and Charmian Holmes

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