ASIC's guidance on the Design and Distribution Obligations (DDO)1 is broad ranging and principles based. The purpose of this article is not to summarise it as a whole, but rather to focus on the issues and questions that have been of specific interest to the insurance industry. So, let's start with the question that insurers have been grappling with since the first exposure draft legislation was released in 2017.
What ASIC does do is to suggest that it may be useful to identify a "negative target market" as part of the TMD, which would set out details of those consumers for whom the product is clearly unsuitable. While not required by the Corporations Act, that is likely to be a sensible approach for many retail insurance products, where those are characterised by a generally broad target market, but with a need to exclude several small and specific classes of customers.
ASIC also provides some insurance-specific examples which offer a little further insight. It refers to Tyre & Rim insurance, which in some cases will not cover vehicles used for commercial purposes (for instance, as a taxi) or which are over a certain age. It also refers to Consumer Credit Insurance, which makes some employment types ineligible to claim on the unemployment component of cover and which offers a life insurance component that may not be needed by some customers. In each case, it should be relatively simple to identify the negative target market groups affected and to build that into the TMD.
These examples, though, offer little guidance on how much further a TMD should delve into the product's various exclusions, limitations and conditions. In many cases, those terms will affect the value of the product for certain groups of consumers or in certain circumstances. How far issuers should go in limiting the target market or setting Distribution Conditions to address those potential outcomes remains uncertain, and further guidance from ASIC on this would be valuable. In the absence of that, product issuers will have little choice but to take a cautious approach in setting the TMD around these terms.
In carrying out that work, ASIC states that issuers should also develop a "Product Governance Framework". ASIC places a considerable focus on this framework in its Regulatory Guide, by which it is referring to all the "systems, processes, procedures and arrangements" put in place to comply with the DDO, as well as the key stages in product design, distribution, monitoring and review. ASIC expects issuers to have such a framework in place, for it to be robust and well-documented, and for it to include details of who is responsible for its elements, the timeframes involved and the record-keeping and reporting requirements. These requirements emphasise that the DDO is more than just another compliance requirement; it needs to be an integral part of the insurer's overall approach to product development and management.
It is worth noting too that, in setting the TMD, ASIC contemplates that some current products may not comply with the DDO legislation at all. This could be due to the risks involved with the product, its low value or that it is "inherently flawed". ASIC anticipates that such characteristics might render the product unlikely to be consistent with the objectives, financial situation and needs of "any" potential customers.
By way of example, ASIC refers to funeral insurance which, it notes, has had both a low loss ratio (observed by the Royal Commission to be between 25% and 33%) and the potential for a customer to pay more in premium than they would be entitled to receive on a claim. Accepting that some insurance products may have a justifiable need for lower loss ratios (for instance, because of long-term claims volatility) or low claims payments relative to premium (for instance, because of a high claims frequency), products which have these characteristics should be carefully reviewed as part of DDO preparations to determine whether there is a need for fundamental re-design or, in some cases, withdrawal.
ASIC states that the issuer's full Distribution Strategy needs to be consistent with the TMD. While that may go further than the legal requirements relating to Distribution Conditions, it reflects the reality that a Distribution Strategy which is inconsistent with the target market is likely to lead to DDO breaches, irrespective of how good the Distribution Conditions.
For many insurers, a key part of the Distribution Strategy will be its Choice Architecture. By this, ASIC is referring to the "environment, noticed and unnoticed, that influences consumer decisions and actions". It includes sales processes, for instance how a website sales path is set up, but also design decisions regarding whether to bundle products, how to deal with complexity and where to put default settings.
As ASIC stated in its recent report on disclosure, "choice can never be framed neutrally – 'any way a choice is presented will influence how the decision-maker chooses'"3. In the context of insurance, ASIC's point here is that the processes by which customers decide on limits, excesses, optional cover and the like should assist them to make decisions that produce good customer outcomes and avoid bad ones. Where the potential exists for that not to be the case, insurers will need to consider whether the target market may be impacted. While that could be addressed through additional Distribution Conditions, it may in some cases be simpler to first review the Choice Architecture itself.
As to the Distribution Conditions themselves, ASIC refers to the use of knock-out questions, data and additional customer questions to help limit distribution to those reasonably likely to be in the target market. It also points to the importance of issuers using their own past experience with the product to identify relevant risks. Careful regard should therefore be had to known issues with the existing distribution of insurance products and to make sure that those have been demonstrably addressed.
ASIC states that insurers will need to "take reasonable steps to ensure that the renewal process results in outcomes that are consistent with" the TMD. That, it says, will involve the consideration of a range of factors, including the insurer's own assessment of the events which could lead to the customer's objectives, situation or needs changing and the likelihood of those events occurring, and relevant data in the insurer's hands. Insurers will then need to determine whether the data they hold is sufficient to meet their obligations or whether more data is needed from customers in order to adequately inform its analysis.
As to the method of obtaining more information, ASIC does not comment on the proposition that insurers might present a set of statements to customers on renewal and ask them to advise of any inaccuracies. Having regard to ASIC's general approach on this subject, though, it seems that approach may be viable, particularly given the challenges involved in pursuing alternatives. However, that approach is more likely to meet the "reasonable steps" standard if the statements presented to customers have a sound basis, are sufficiently highlighted to them and the customer is offered a simple mechanism for correction.
ASIC states that it expects to have a "constructive" relationship with industry during the implementation of DDO. It recognises that DDO is a new form of regulation and that, just as the approach taken by issuers and distributors may develop over time, its own approach to administration is also likely to evolve. Those comments should provide some encouragement to insurance industry participants that, provided an earnest approach is taken to compliance with the new requirements, there will be goodwill applied in building and improving arrangements as experience is gained.
A link to ASIC's Consultation Paper and Regulatory Guide can be found here:
For more information on the Design and Distribution Obligations or any aspect of this article, please contact insurance advisory principal, Mathew Kaley.
1 ASIC Consultation Paper 325 Product design and distribution obligations and draft Regulatory Guide 000 Product design and distribution obligations
2 As per Corporations Act ss.764A(1A) and (1B)
3 ASIC Disclosure: Why it shouldn't be the default, October 2019, p.25