Considerations for actuaries on the Design and Distribution Obligations

From October this year, all issuers and distributors of financial products will need to comply with ASIC’s Design and Distribution Obligations (DDO), which mandate a more consumer-centric approach to designing and distributing products. This article explores what the requirements mean for actuaries working in Life Insurance, General Insurance, and Superannuation.

Background

Following consultation, ASIC released its final regulatory guide (RG 274) on the DDO on 11 December 2020. The final guidance did not significantly change from the original draft. The DDO becomes effective for issuers and distributors of financial products from 5 October 2021. RG 274 sets out ASIC’s expectations on how the regime will operate, its expectation for compliance, and its approach to administering DDO.

The DDOs are intended to help consumers obtain appropriate financial products by requiring issuers and distributors to have a consumer-centric approach to the design and distribution of products. Products should be consistent with the likely objectives, financial situation, and needs of consumers of the target market. DDO requires that each product has a clear target market that it is intended to be sold to, with several reporting, monitoring, and other requirements to support this.

It is important to highlight that the guidance in RG 274 is primarily principles-based, reflecting the intention that the industry is best placed to implement the obligations in the context of their operations and product offerings. ASIC anticipates product issuers and distributors approaches will evolve over time. However, ASIC’s Product Intervention Powers (PIP) have been effective since April 2019 and have been used. These provide ASIC with powers to intervene and impose penalties where aspects of the design and distribution of products lead to consumer detriment.

Considerations for actuaries

The overall impact of the DDO is still uncertain and actuaries will need to give specific consideration to how this might evolve over time for their specific practice areas.  We encourage actuaries, particularly those involved in implementing the DDO in their organisation, to read and understand RG 274 in greater detail, rather than rely on this simplified summary.

Operational impact

Impacts to Actuaries

Industry-Specific Applications

1. Uplift in the product governance framework.

DDO necessitates an uplift to product governance frameworks to make them more consumer-centric.

This includes:

  • Establishing a target market for the product

  • The design assessment and approval, taking account of consumer outcomes and the impact of ‘choice architecture’

  • Documenting the Target Market Determination (TMD)

  • Documenting the product distribution policy

  • Documenting the product monitoring and review policy

  • Updating the product disclosures and communication

 

Actuaries can play a key part in this process by helping assess the consumer value in each product and analysing the link between product features and consumer needs in the target market.

General Insurance:

For example, an insurance product that offers lower upfront affordable premiums but requires a high excess payment at claim time could result in consumers not being able to pay the excess. This may act as a barrier to make a claim or result in an unsuccessful claim and is likely to be inconsistent with the objectives, financial situation, and needs of the intended target market.

Life insurance:

Product options may affect a product’s suitability for a consumer if selected and should be appropriately considered, for example:

  • Waiting periods on income protection insurance products from short to very long (e.g. one month to two years)

  • Own occupation vs any occupation TPD insurance cover

  • Level vs stepped premiums for long term life insurance products

Superannuation:

  • Consideration should be given to consumers’ stage of life in the TMD where relevant e.g. retirement products

  • In particular, whether the product is likely to be consistent with the objectives, financial situation, and needs of the consumers in the target market over time

  • Considerations also arise when a product is intended to be held by consumers over an extended period of time

2. ‘Appropriateness’ requirements stipulate that products need to meet the likely objectives, financial situation and needs of the target market.     

ASIC’s guidance consists of principles-based requirements rather than prescriptive requirements about what to include in a Target Market Determination (TMD).

TMDs are to be based on a class of consumers, not individual consumers, which more closely resembles actuarial pricing practices.

Furthermore, the class of consumers that comprises the target market, needs to be defined with objective, tangible parameters, in order to be considered ‘appropriate’, which actuaries are well versed to assist with.

General / Life Insurance:

For bundled products, ASIC requires issuers to determine whether it will need to meet the TMD content and appropriateness requirements as a bundle in one TMD, or separately. ASIC expects a target market for a bundled product should be defined in a narrower way compared to the target market for products sold individually.

For customisable products, the issuer must consider the range of choices and options available to the consumer in defining the target market for the product.

Life Insurance:

Considering the future needs of the target market, and how suitable/flexible the product is, is very important for products that may be in force for 15+ years. For example, a younger person with many life decisions ahead may have very different needs at the time of taking out a policy than at a later date.

Superannuation:

  • Note that while MySuper products and interests in defined benefit schemes are excluded from DDO, Choice products are included

  • Where a super fund offers different financial products (e.g. pension and accumulation products), a TMD must be made for each product as the target market is likely to be different

  • Where various investment options are offered in a Choice product, this will likely involve a single TMD that describes the different groups of investment options offered as part of the product. Note that Wrap products will likely need a separate TMD for each PDS provided

  • Where insurance is offered as part of a super product, this is a key attribute that will need to be taken into account as part of the TMD and might require the use of information provided by the insurer. Note that in such instances there is no obligation on the insurer who issues the group insurance policy to prepare a TMD as they are not distributing directly to a consumer

3. Data analysis and risk assessments will assist in meeting ‘reasonable steps’ requirements and setting review triggers

Reasonable steps

Product issuers and distributors are required to take ‘reasonable steps’ to ensure their products are sold to consumers in the target market.

ASIC indicates that the use of data analysis and a risk assessment (of the likelihood and potential harm to consumers) will assist in meeting the ‘reasonable steps’ requirements and ongoing suitability requirements.

Data analysis, risk assessments, assessment of pricing impacts, and changes to underwriting processes are all aspects that actuaries may be involved with and support.

Review triggers

The RG requires TMDs to specify review triggers (events that reasonably suggest that the TMD is no longer appropriate).

Whilst many issuers would already be exploring their data landscape and looking to implement review triggers, ASIC encourages segmenting the data to get a full picture of the data being reviewed and related product insight.

Ensuring accuracy in the calculation of these metrics and setting well-defined thresholds for each metric (that would be the point at which a review is triggered) are aspects that actuaries may be involved with and support.

General / Life Insurance:
Reasonable steps requirements

The TMD is to include the ‘negative market’ i.e. consumers for which the product is clearly not suitable. ASIC has indicated that the use of underwriting knock-out or direct questions may assist in making ‘reasonable steps’ in this regard.

Review triggers

Review triggers may include data points such as claim ratios, the number, nature, and magnitude of paid, denied, and withdrawn claims, the volume of sales, including penetration rates, policy lapses or cancellation rates, average claim duration, and the nature and number of complaints and related trends.

ASIC has also recommended segmenting the data by distribution channel and underwritten risk type.

Superannuation:

Review triggers

Superannuation products are often offered through a number of distribution channels e.g. direct-to-public, via employers or through financial advisers.

Consideration needs to be given to the risks of the product’s distribution being inconsistent with the TMD in each of its distribution channels.

4. Standardisation of TMDs will assist in achieving the objectives of DDO

While TMDs are not intended to be consumer-facing documents, they will be publicly available, and inconsistencies may make it difficult for consumers and distributors to compare target markets between products and limit their usefulness.

ASIC has commented that they consider some degree of standardisation will be useful in achieving the objectives of DDO.     

As actuaries, we should consider how we can support these efforts as they will require input from several different professions and bodies across the industry. The FSC is currently working to develop template TMDs for its members to use.

5. Appropriate thresholds and consideration of the likelihood and potential harm to consumers are required to determine ‘significant dealings’ to be notified to ASIC.

ASIC must be notified of ‘significant dealings’ i.e. sales/renewals of products, outside of the target market. ASIC’s guidance on the factors to consider when determining this include:

  • Number of sales/renewals to consumers outside of the target market as a proportion of total sales/renewals

  • The actual or potential harm to consumers

  • The nature and extent of inconsistency in distribution with the TMD

Actuaries may be involved in quantifying appropriate thresholds and the likelihood and potential harm to consumers.

 

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