ASIC tells the insurance industry to take a hard look at their design and distribution obligations (DDO) and check target market determinations (TMDs).
When you see your target, your aim is perfect.”
Dr Woodie Flowers, renowned engineer and Massachusetts Institute of Technology professor
The corporate regulator has sent a stark warning to the life insurance industry: apply DDO to cut the risk of harm to consumers or face the risk of a stop order and investigation.
In this insight, we look at Australian Securities and Investments Commission’s (ASIC) first life insurance stop order (with more to come) and – critically – what life insurers should do.
As life insurers compliance with DDO becomes an increasing focus for ASIC, insurers must address regulatory risks, including by take a consumer-centric approach to the design and distribution of products, and regularly reviewing and refining target market determinations (TMDs).
When did ASIC issue its first life insurance stop order?
On 18 July 2023, ASIC issued its first stop orders for life insurance products because of alleged deficiencies in the products’ TMDs. In letters to the life and general insurance industries, ASIC has flagged that further stop orders and design and distribution obligations (DDO) related investigations are underway.
In a market that is heavily invested in white labelling arrangements, whether it’s lining up for your weekly groceries or flicking through your in-flight magazine, the risk of stop orders affects not just insurers, but also product distributors.
It’s a strong reminder to the insurance industry to take a consumer-centric approach to the design and distribution of products, and highlights the importance of regularly reviewing and refining TMDs.
What is the DDO regime – and how has ASIC applied it?
The DDO regime in the Corporations Act 2001 (Cth) (Act) commenced on 5 October 2021. Under the DDO regime, a product issuer must make a TMD which, amongst other things, describes the class of retail clients for whom the product is likely to be appropriate (target market), and specifies conditions on the product’s distribution, and triggers for the review of the TMD. ASIC Regulatory Guide 274 “Product design and distribution obligations” (RG 274), issued in December 2020, sets out ASIC’s interpretation of the DDO regime and expectations for compliance.
ASIC recently reviewed over 100 TMDs across general and life insurance products, and has written to the Council of Australian Life Insurers, the Financial Services Council and the Insurance Council of Australia outlining their key findings and how TMDs need to be improved (see ASIC’s media release at here).
As a result of ASIC’s review, ASIC issued 38 interim stop orders related to 67 pet insurance products in June 2023 (see ASIC media release 23-174MR) and has now issued interim stop orders related to two income protection products (see ASIC media release 23-192MR).
ASIC has also commenced civil penalty proceedings against a distributor of an investment product and an issuer of a credit product for alleged DDO breaches.
What should the industry do?
It’s clear that that the industry needs to regularly review and refine their TMDs.
In its letters to industry, ASIC has highlighted a number of areas which require improvement, including:
Defining the target market for the product (including its key attributes)
Section 994B(5)(b) of the Act states that a TMD must “describe the class of retail clients that comprises the target market (within the ordinary meaning of the term) for the product.” In RG 274, ASIC notes (at para 83), “An issuer would be in breach of its obligations if it described the target market too broadly (with insufficient granularity) such that the product (including its key attributes) would not likely be consistent with the likely objectives, financial situation and needs of an identifiable class of consumers included in the target market.”
The stop orders issued by ASIC in respect of life insurance products related to TMDs that ASIC consider failed to consider the impact of key eligibility criteria (ie age and minimum employment criteria) on the suitability of the product for certain classes of consumers.
The stop orders in respect of pet insurance products related to TMDs that failed to consider the financial situation of consumers, such as their ability to afford premiums and to pay for veterinary treatment upfront before receiving a partial reimbursement following approval of their claim.
In its letters to industry, ASIC noted that some TMDs described target markets with less detail than needed. For example:
- Some TMDs referred to consumers’ objectives and needs (ie the objective of obtaining cover) but failed to include details of the consumers’ financial situation (ie their ability to pay premiums and other costs under the policy).
- Many TMDs did not include an explanation of why the product is likely to be consistent with the likely objectives, financial situation and needs of consumers in the target market.
- The extent to which a product provides value to consumers in the target market is an important factor in complying with the appropriateness requirement.
- Some TMDs used broad statements to describe the target market. When pursuing a broader target market, the issuer has a greater responsibility to justify how the product is likely to be suitable for such a wide range of consumers.
- If different premium structures are available, the TMD should consider consumers’ life stage or need for premium stability.
- Any features that impact the product’s suitability for a class of consumer (eg exclusions, eligibility requirements, limitation on cover) should be described in the TMD.
Distribution conditions
Section 994B(5)(c) of the Act states that a TMD must “specify any conditions and restrictions on retail product distribution conduct in relation to the product.”
The stop orders issued by ASIC in respect of life insurance products related to TMDs that ASIC considered did not specify any meaningful distribution conditions.
In its letter to industry, ASIC noted that “TMDs should describe why the distribution conditions will make it likely that products will be distributed to the target market (eg. the use of call scripts, staff training and accreditation, staff monitoring, ‘knockout questions’).”
Review triggers
Section 994B(5)(d) of the Act states that a TMD must “specify events and circumstances (review triggers) that would reasonably suggest that the determination is no longer appropriate”.
ASIC noted that “Insurers should identify review triggers using data such as claims ratios, number of policies sold, policy lapse and cancellation rates, average claims durations, claims denied and withdrawn, and the nature and number of complaints.”
Review periods
Section 994C(5)(g) of the Act states that a TMD must “specify a reporting period for reporting information about the number of complaints about the product.”
ASIC noted that:
“An initial review period of one year for new TMDs is more likely to ensure that any problems with the TMD can be addressed quickly.
Ongoing review periods of no less than two years are more likely to ensure TMDs remain appropriate and insurers can apply the insights obtained from their review triggers.
A significant impact on the product such as a change to the TMD based on a review trigger, a significant dealing outside the target market or a change in a product’s distribution channel would suggest that the TMD’s next ongoing review should be within 12 months.”
The findings are consistent with ASIC’s earlier Report 760: Insurance in Superannuation (Report 760), released in March 2023, following ASIC’s review of a range of TMDs from 15 superannuation trustees. ASIC found that:
- the target market description for the insurance component of their choice products in some instances was too broad, or did not describe the eligibility criteria or exclusions eg. did not include clear statements that particular consumers should be regarded as within or outside the target market based on characteristics such as age or pre-existing conditions; and
- some TMDs did not include review triggers relating to claim outcomes, such as claims ratios or rates of denied or withdrawn claims, or review triggers relating to insurance take-up or cancellation rates.
What next? A clear message from the regulator
ASIC specifically recommended that trustees “check their TMDs to ensure that these clearly describe the target market for their choice superannuation products (including the insurance component) and include appropriate review triggers.”
ASIC’s message is clear and consistent - reducing the risk of harm to consumers caused by poor product design, distribution and marketing is one of ASIC’s strategic priorities, and insurers must demonstrate a “a consumer-first mindset through their design and distribution obligations and proactively refine their TMDs and products.”
