The October blitz begins

The October blitz begins

Of all the regulatory changes starting this month, new rules governing the design and distribution of products will have the most significant impact

By Bernice Han

This month regulatory reforms have picked up the pace following a pause to allow the general insurance industry and wider financial services sector to focus on pandemic challenges.

No more. Now the industry must include regulatory reform among the imperative issues it’s already facing – climate change impacts, climbing claims and financial woes, to name a few.

Relevant to the general insurance industry:

• The commencement on October 1 of strengthened breach reporting rules, followed four days later by the introduction of product design and distribution obligations (DDO) laws, hawking prohibitions, a deferred sales model for add-on insurance and a new disclosure duty for consumer contracts.

• New standards and guidelines relating to complaints handling and internal dispute resolution processes started on October 5, after the release last year of a new regulatory guide, RG 271, from the Australian Securities and Investments Commission (ASIC).

The raft of measures stemming from the Hayne royal commission also reflects work already underway before the government-appointed inquiry into financial services sector misconduct proceeded in 2018 and concluded with a final report in February the following year.

The reforms usher in an era of more stringent governance to protect consumers, carrying harsher penalties for non-compliance.

Two important new acronyms:

DDO: Design and Distribution Obligations require insurers and distribution partners to ensure products are designed to meet the needs of consumers and are delivered to the consumers they are intended for.

TMD: Target Market Determination. A document that must accompany every product setting out its target market, distribution conditions, and information related to review and monitoring.

Significant resources have been put in by the industry in preparation for the changes. These include reviewing underwriting criteria, overhauling back-end support systems and staff retraining.

The Insurance Council of Australia (ICA) has been working closely with its members to support them in navigating the “once-in-a-generation regulatory reforms”, the most significant of which commence early this month, a spokesman told Insurance News.

“The aim has been to support members’ understanding of the reforms and the expectations set by regulators.”

In terms of industry-wide impact, insurance experts and lawyers agree the DDO regime presents the biggest shake-up for insurers, brokers and other intermediaries.

Recommended by the 2014 Financial System Inquiry and supported by the Hayne royal commission, it requires insurers and distribution partners to ensure products are designed to meet the needs of consumers and are delivered to the consumers for whom they are intended.

The DDO rules apply for the entire life cycle of a product.

“This is not a set-and-forget duty,” Finity Principal Raj Kanhai told Insurance News. “It’s ongoing monitoring and compliance obligations.”

If an insurer wants to sell a particular product, it must first establish there is an appropriate market for it. In other words, if the conditions for sale set by ASIC are not met, the product should not exist.

Every product must be accompanied by a target market determination (TMD) document which sets out the target market, distribution conditions, and information related to review and monitoring.

Insurers must also specify in the TMD the distribution conditions and restrictions that make it likely that the consumers who acquire the product are in the target market.

Under the DDO regime, it is also the duty of insurers, brokers or intermediary partners to consider distribution methods and factors that could affect whether consumers receive a financial product that is likely to be consistent with their likely objectives, financial situation and needs.

The DDO laws complement powers granted in 2019 to ASIC giving it the discretion to ban a product if there is a risk of significant consumer harm. The regulator exercised its product intervention power that year to ban a lending model in the short-term credit industry.

Mathew Kaley, Principal at law firm McCabes, says DDO readiness has required a “significant amount of work” from the industry and the October 5 start date is very important.

“The consequences of not being ready are that the insurer would need to cease retail product distribution conduct,” he told Insurance News.

“If a target market determination is required but not in place, the insurer, and potentially it’s distributors, will be in breach on October 5 if they continue to sell the product.”

On the positive side, Mr Kaley says that “where the DDO is properly implemented, it should materially improve insurers’ ability to meet customer expectations and positive claims outcomes”.

The DDO regime may seem draconian but other jurisdictions such as the UK and European Union already have similar laws in place to protect consumers.

Avryl Lattin, Partner at law firm Clyde and Co, says the additional requirements for TMDs and reporting obligations on distributors will see a sharp focus on making sure that products are directed at the intended customer base.

“The regulators have long sought the power to prevent poorly designed products from being marketed, rather than just dealing with the consequences after the fact,” she told Insurance News.

Wotton + Kearney Partner and Financial Lines Practice Leader Cain Jackson says the DDO laws will involve a “shift in mindset” for some insurers because it has “added a ‘product governance’ dimension” to their existing obligations.

On products that may fall foul of DDO rules, he says the array of class actions directed at add-on insurance highlights the types of areas which could be targeted under the new regime.

“Low claims ratios and the sale of numerous insurance products to a generic market as part of a one-sizefits-all sales process are likely to raise red flags,” he said.

The significance of the overall reform package creates what Mr Jackson describes as “an obvious tension”. Insurers aim to generate profits from the sale of insurance.

“Selling insurance which produces low claims ratios is, on one view, good business,” Mr Jackson said. “However, this (DDO) legislation seeks to temper the pursuit of profit with, in essence, a fitness for purpose requirement.

“There is a natural tension between the two – equally legitimate – objectives.

“Insurers will now need to navigate their way through that sometimes difficult balancing exercise, particularly where products arguably perform ‘too well’.”

In the most extreme cases, some products may be withdrawn completely or customers refused cover either because DDO criteria are not met or insurers and distributors prefer to err on the side of caution.

Finity’s Mr Kanhai says the amount of effort the industry has invested to be DDO-ready is massive.

“It’s across all retail products, and there are lots of them, and lots of insurers have multiple policy wordings that they distribute through different intermediaries and through different channels.”

The National Insurance Brokers Association has been providing support to its members ahead of the array of changes taking place in October. Outgoing Chief Executive Dallas Booth says there’s been a “massive amount” of work involved, particularly at the larger brokerages.

In relation to the other changes in October, Ms Lattin of Clyde & Co says the introduction of a deferred sales model for add-ons and anti-hawking provisions will have a substantial impact on a number of existing “established” distribution channels in respect of specific product lines.

“We have seen early indications that there will be distribution channels and product lines which insurers are likely to abandon given the restrictions and the cost of compliance,” Ms Lattin said.

Mr Kaley of McCabes says the rules attached to the deferred sales model, which puts a four-day pause on the sale of add-on insurance, may have led to a rethink by some insurers as to whether it still remains worthwhile to sell the affected products.

“It has been reasonably challenging to apply the model to some distribution channels, and there are also some areas of uncertainty about how it will work in different contexts,” he told Insurance News.

Where that is the case, he expects some insurers will have chosen to withdraw from the channel, rather than implement the model.

“Implementation of the model is also likely to prompt a change in consumer behaviour,” Mr Kaley said. “Some customers will not wait for the deferral period to pass, for instance, but will instead purchase from another insurer directly. It will be interesting to see what happens in this space.”

Ahead of its implementation, Treasury has finalised the model’s list of regulations to prevent high-pressure sales tactics.

Business-related add-on insurance products where the premium exceeds $1000 are exempted. Other product classes that do not fall under the deferred sales regime include compulsory third party for motor vehicles, third party property, fire and theft for vehicles and vessels, comprehensive cover for cars and vessels, insurance sold within super, transport and delivery, travel insurance, home building, home and contents and landlord insurance.

Looking beyond October, the biggest change for the industry will come on January 1, when claims handling and settling services for insurance products will begin to be regulated as a financial service under the Corporations Act.

While ASIC has given the industry a one-year transition period, Mr Kaley says preparations are still ongoing, with less than three months before the laws set in. These include reviewing of internal systems and processes as well as contracts with third party providers.

The review of processes for oversight of third party providers is also still continuing.

Gallagher Bassett Partnership Manager John White says the reforms should provide better outcomes for consumers. He says insurers are already adapting to the new pace and cultural shift that comes from the implementation of these reforms.

Finity says the scale of regulatory changes is the biggest in two decades since the collapse in 2001 of HIH Insurance.

The corporate failure of the insurer – among the largest in the country at that time when it went into liquidation – led to several far-reaching reforms following a royal commission.

“One of the things we can say is insurance is a highly regulated industry, and it is not going to go back the other way,” Mr Kanhai said. “Although it can feel like regulatory activity is akin to a pendulum, the general trend is that it mostly goes in one direction.”

The regulatory changes taking place in October build on earlier reforms that have already been implemented, such as the application in April of unfair contract terms to insurance contracts.

Here is a snapshot of the measures that are commencing in October:

October 1

Strengthened breach reporting:

Australian Financial Services licensees need new processes in place for notification to ASIC of deemed significant breaches, to cover investigations that may need to be notified (need process for identifying), identifying and notifying gross negligence and serious fraud. Failure to notify is an offence.

October 5

Product design and distribution obligations:

Target market determinations must be in place and published. Products that usually require a product disclosure statement will be affected by the new regime. Hawking prohibitions The laws extend strengthened prohibitions across

financial products and update bans to take account of technological changes. ASIC has confirmed that where add-on insurance is exempt from the deferred sales model regime, the hawking arrangements will apply, and offerors must then consider whether the product is “reasonably” within the scope of the consumer’s consent.

Deferred sales model for add-on insurance:

There will be a four-day pause on sale of add-on products after a customer has entered into a commitment to acquire the main item or service.

Duty to take reasonable care not to make a misrepresentation:

The new duty for consumer insurance contracts shifts the onus to insurers to obtain all necessary information to assess insurability and the premium calculation. This means that consumers will no longer have to surmise what information may be required by insurers, as is currently the case under the Insurance Contracts Act.

Internal dispute resolution regulatory guide (RG) 271:

RG271 explains what financial firms must do to have a compliant internal dispute resolution system in place that meets ASIC’s standards and requirements. The standards and requirements highlighted in this guide are enforceable.