International focus

The UK Government has published a formal consultation in relation to a new regulatory, corporate, insolvency and tax framework for insurance linked securities (ILS) business in the UK. The Government’s aim is to reinforce London’s standing as the world’s leading insurance market by creating the necessary legal environment to allow the domicile of ILS issuers in the UK. Part of the proposal is to create protected cell companies (PCCs), which would be one of the more radical changes to UK corporate law in recent times.

The plans are focused on the two leading forms of alternative risk transfer, cat bond ILS transactions and collateralised reinsurance.

The first section outlines the Government’s view on the authorisation and supervisory framework for ISPVs. The Government intends to apply the authorisation and supervisory framework applicable to SPVs under Solvency II to insurance SPVs (ISPVs) in the UK.

A core requirement of the applicable authorisation and ongoing supervision of ISPVs will be compliance by ISPVs with the ‘fully funded requirement’, a matter of growing relevance in an era of negative returns on ‘safe’ investments.

An industry concern has been that ISPVs will not achieve PRA authorisation in a timeframe which is commercially viable given the pace of ILS deals. The latest consultation document demonstrates that the Government is looking to address these concerns by moving towards a more streamlined approvals regime, especially for multi-issuance ISPV vehicles. However, questions remain over whether even the timeframes now envisaged will be sufficiently fast to put the UK on a level playing field with more established ILS jurisdictions, such as Bermuda, Cayman Islands, Ireland, Guernsey and Jersey.

The consultation document also proposes amending companies and insolvency law in the UK to allow for the creation of protected cell companies (or PCCs). PCCs allow pools of assets and liabilities to be segregated within a company, such that the assets of one cell cannot be used to meet the liabilities of another cell (and vice versa). PCCs would, amongst other things, make establishing multi-issuance ISPVs more feasible. Such vehicles are now common in the established ILS jurisdictions, as well as in jurisdictions such as Luxembourg where they are also frequently used for repackaging and securitisation transactions. However, PCCs would be novel under UK company and insolvency law and their introduction would be a major development in UK company law.

The consultation asks for inputs in relation to this regime on a wide number of issues (including whether the abbreviation ‘PCC’ could be too easily confused with ‘PLC’).

The new PCC regime is only envisaged to be available for ISPV purposes in the UK. It will be interesting though to see in the long run whether the Government would be prepared to see them used more widely.

For tax purposes, the focus of the consultation is on ensuring that there is no tax leakage at the level of the ILS, while at the same time making sure that ultimately any investors pay tax at the profit they make. Imposing a withholding tax on returns would be one solution but the competitive disadvantage of this is acknowledged. The Government will introduce enabling legislation in the 2016 Finance Bill, so that the tax changes can be made later.

Overall, these proposals are a welcome step forward in making London an ILS ‘hub’, and creating the tax and corporate and the regulatory environment necessary to enable the UK and London to be an attractive alternative to investors and issuers in this increasingly competitive market.

The Insurance Distribution Directive (IDD) (Directive 2016/97/EU), which recasts Directive 2002/92/EC (the Insurance Mediation Directive (IMD)), has been published in the Official Journal on February 2, 2016. The IDD will come into force 20 days following publication in the Official Journal of the European Union. Firms must comply with the requirements by February 23, 2018.

The IDD will be applied to intermediaries and also to insurance and reinsurance undertakings who sell direct to their customers. The activity of insurance distribution includes advising on, proposing or carrying out work preparatory to a contract of insurance or assisting in the administration and performance of such contracts, in particular in the event of a claim.

The IDD requires that all insurance distributors should act ‘honestly, fairly and professionally in accordance with the best interests of its customers’. This requirement imposes a high standard upon all distributors (including direct sellers and those distributing to professional customers) to consider the interests of customers in their business. In addition, distributors are required to ensure that they do not remunerate or assess the performance of their employees in a way that conflicts with the duty to act in the best interests of customers. The IDD also requires firms to operate and review a process for the approval of each insurance product they offer and to review any significant adaptations of existing products before they are marketed or distributed to customers.

Before the conclusion of an insurance contract, intermediaries are required to provide details about themselves and must describe to their customer the nature of their remuneration and whether the contract will work on the basis of a fee or commission (or other type of arrangement). Insurers selling directly will be required to disclose the nature of the remuneration received by its employees in relation to the contract sold (i.e. bonus payments). The IDD also enables Member States to restrict the payment of commission as has been done in the UK under the Retail Distribution Review rules, in operation since 2012.

In his recent speech at the Insurance Council of Australia Annual Forum ASIC’s Peter Kell delivered a scathing commentary on the state of the add-on insurance market, saying that the industry had made insufficient progress towards delivering better consumer outcomes in the area and sounded a warning: if ASIC is still raising similar concerns in 2017, ASIC’s focus will be on stronger enforcement action. As Mr Kell said, ‘It’s time to get your houses in order’.

The speech followed the release of two reports into the sale of add-on insurance products through car yards. The findings in those reports were critical of the nature of add-on insurance products, the manner in which they are sold and the lack of oversight of distribution channels.

ASIC’s focus on consumer outcomes

The consumer protection recommendations of the Financial System Inquiry (FSI) signal a philosophical shift from a disclosure-based regime, based on ensuring consumers have sufficient information to make informed investment choices, to one aimed at ensuring that the financial services environment promotes positive consumer outcomes.

Two recommendations are particularly pertinent for the insurance sector. The FSI recommended imposing an obligation on product issuers and distributors to consider and monitor a range of factors to ensure that financial products meet the needs of their target market. The purpose of the obligation is to ensure organisations are responsible for ensuring that products are designed and distributed in a way that does not create consumer detriment. The FSI also recommended that ASIC be granted a product intervention power, to enable it to take a more proactive approach to reduce the risk of significant consumer detriment. This would allow ASIC to modify, or even ban, products that are considered harmful for consumers.

The Australian Government has taken on these recommendations, and intends to consult further on their implementation by the end of 2016.¹

Ahead of their likely implementation, ASIC has been approaching its market surveillance with an eye to product design and development, with a strong focus on consumer outcomes rather than issues surrounding disclosure or misleading sales practices.

In early 2015 ASIC identified ‘add-on’ insurance products as a key area of concern due to the poor outcomes they generate for consumers, and has called on the insurance industry to improve practices and standards in this area. Add-on insurance is offered to consumers in a range of transactions, from taking out a credit card to buying a car.

The report

To demonstrate the need for reform, ASIC has recently released a report that details the deficiencies of life insurance products sold through car yards. These products commonly provide a lump sum payment of the outstanding car loan balance upon the death of the insured. The report calls on the insurance industry to take significant steps to address the low value offered to consumers, and ensure that the product is targeted only to consumers for whom it is appropriate.

ASIC performed a review of five major life insurers offering car yard life insurance, estimated to make up over 90 per cent of the market, from FY10 to FY14. The report concludes that car yard life insurance offers poor value for consumers and is often sold to consumers who have limited knowledge of, and need for, the product.

A call for change

ASIC has now done a lot of work in the add-on insurance space. Along with this current report, ASIC has conducted a consumer research study to further understand customer experiences when purchasing add-on insurance², and is currently conducting a similar review of general insurance sold through car dealers.³ The report calls on insurers to proactively improve the design and distribution of add-on insurance products, as well as their procedures for monitoring the conduct of intermediaries. If they fail to do so, ASIC has indicated, not only in the report, but also through industry briefings, that it will increase its enforcement action.

If the consumer protection FSI recommendations are implemented (as is expected over the next 18–24 months), ASIC will have a broad power to actively intervene in the design and distribution of these products, including amending marketing material, restricting distribution, or even banning certain products. If the industry fails to act on this call to action before the FSI recommendations are implemented, this report, coupled with findings from related surveillance conducted by ASIC, may well provide the evidence ASIC requires of significant consumer detriment, allowing ASIC to use its new powers without delay.