The Nature and Art of Financial Supervision – Conduct Supervision – The Demands and Needs Assessment

IDENTIFIED RISKS & EXPECTED CONTROLS I

THE NATURE AND ART OF FINANCIAL SUPERVISION VOLUME VI CONDUCT SUPERVISION THE DEMANDS AND NEEDS ASSESSMENT

IDENTIFIED RISKS EXPECTED CONTROLS

10 May 2023

Contents Revision History..............................................................................................................2 Table of Abbreviations ...................................................................................................3 Introduction ....................................................................................................................4 An Overview 4 The MFSA’s Supervisory Work 4 Scope, Purpose and Structure of this Publication 5 Section 1: MFSA Guidance With Respect to the Demands and Needs Assessment ..6 1.1 What is the Demands and Needs Assessment? 6 1.2 Why should a Demands and Needs Assessment be carried out? 7 1.3 Who is required to carry out such a Demands and Needs Assessment? 7 1.4 When should a Demands and Needs Assessment be carried out? 8 1.5 How should a Demands and Needs Assessment be carried out? 11 1.6 When should a Demands and Needs Statement be provided? 12 1.7 What Records Should be Kept in relation to the Demands and Needs and Assessment? 15 Section 2: Way Forward and Next Steps......................................................................16

Page 2 of 16 Revision History Version Effective date Details 1.0 24 May 2022 Issue of first version of Volume VI 2.0 10 May 2023 Vide Circular

Page 3 of 16 Table of Abbreviations AIIs EIOPA EU IDD IBIP MFSA TIIs Ancillary Insurance Intermediaries European Insurance and Occupational Pensions Authority European Union Insurance Distribution Directive Insurance-based Investment Product Malta Financial Services Authority Tied Insurance Intermediaries

Page 4 of 16 Introduction An Overview Article 20(1) of the Insurance Distribution Directive (‘IDD’) provides that any contract proposed shall always be consistent with the demands and needs of the client. Under the IDD, all insurance undertakings and insurance intermediaries carrying out insurance distribution activities (hereinafter, referred to as ‘insurance distributors’) are required to specify the demands and needs of their clients based upon information obtained therefrom. These requirements have been transposed in Chapter 4 of the Conduct of Business Rulebook. Accordingly, insurance distributors are expected to take active steps to obtain information from their clients to be in a position to carry out this assessment. Insurance distributors shall then consider this information alongside the insurance products they have available to ensure that the insurance policy they finally propose or recommend to a client is consistent with those client’s demands and needs. Insurance distributors shall not offer to clients products which do not meet their demands and needs. Therefore, the assessment of client demands and needs by insurance distributors, prior to the conclusion of the contract, is a key part of the insurance distribution process. The demands and needs assessment provides protection for clients by seeking to minimize the risk of harm to consumers resulting from their purchasing products which do not meet their needs. This assessment is required to be carried out prior to the sale of all types of insurance contracts, not only Insurance Based Investment Products (IBIPs) 1 . The MFSA’s Supervisory Work The MFSA is strongly committed to ensure that conduct of business-related requirements are properly and consistently implemented throughout all insurance distribution channels. Due to their relevance in terms of consumer protection, the MFSA considers that it is of utmost importance that requirements relating to the demands and needs assessment are properly implemented and applied. 1 Art. 30 of the IDD (in the context of IBIPs) applies “without prejudice” to the demands and needs test covered by Art. 20(1) of the IDD. This is also specified in Recital 7 of Delegated Regulation 2017/2359.

Page 5 of 16 The MFSA has been carrying out supervisory work in the area of insurance conduct supervision covering various areas, including also the carrying out of demands and needs assessment by insurance distributors. This includes thematic inspections conducted to intermediaries, including brokers during 2020 and 2021, with a view to assess adherence with relevant requirements of the IDD and the Conduct of Business Rulebook (‘COBR’). The Authority’s findings in this context evidenced a lack of adequate understanding by insurance distributors of the elements of the demands and needs assessment and the manner in which it should be carried out. In this context, the Authority issued a circular on 24 May 2022 setting out the Authority’s expectations with respect to the carrying out of the demands and needs assessment by insurance distributors, prior to the conclusion of insurance contracts with their respective clients. Subsequently, on 23 November 2022, the MFSA organised a workshop to insurance market participants in order to address and clarify any aspects on the manner in which a demands and needs assessment is to be conducted. Scope, Purpose and Structure of this Publication This document is addressed to insurance undertakings and insurance intermediaries regulated by the MFSA, carrying out insurance distribution. Its purpose is to update the circular which was issued on 24 May 2022 and provide further guidance and outline best practices in the context of the demands and needs assessment which insurance distributors are required to make in accordance with their regulatory requirements. Section 1 of this Document sets out the MFSA’s explanations and provide guidance as in the context of the requirement on insurance distributors to assess their clients’ respective demands and needs prior to the conclusion of a contract. Section 2 indicates the way forward, including the next steps which the Authority may take on this matter.

Page 6 of 16 Section 1: MFSA Guidance With Respect to the Demands and Needs Assessment 1.1 What is the Demands and Needs Assessment? In terms of Article 20(1) of the IDD, all insurance distributors are required to take a more active role in identifying their clients’ demands and needs and shall ensure that any insurance policy proposed to clients meets those demands and needs. Article 20(1) of the IDD stipulates that, prior to the conclusion of an insurance contract, the insurance distributor shall specify, on the basis of information obtained from a client, the specific demands and the needs of that client; and shall provide the client with objective information about the insurance product in a comprehensible form to allow that client to make an informed decision. The insurance distributor shall: (a) ensure that any contract proposed by it shall meet the client’s insurance demands and needs; (b) where advice is provided prior to the conclusion of any specific contract, provide the client with a personalised recommendation (explaining why a particular product would best meet that client’s personal circumstances); and (c) modulate such process in accordance with the complexity of the insurance product being proposed and the type of client. The above requirements, which have been transposed into Rules R.4.4.78 to R.4.4.80 in Chapter 4 of the Conduct of Business Rulebook (‘COBR’), mean that insurance distributors cannot simply offer products to clients through generic statements about the type of needs each product will meet. Thus, for example, inserting a generic statement on the product documentation stating that such product meets the demands and needs of clients with a particular profile would not be sufficient since such a statement would not be provided “on the basis of information obtained from the client”, as is required in terms of the IDD requirements.

Page 7 of 16 1.2 Why should a Demands and Needs Assessment be carried out? Insurance distributors are required to ensure that they are distributing the right products to the right clients. The insurance distributor’s assessment of the information obtained from the client, against the relevant insurance products available on the market, will identify which product(s) would best suit the particular client insofar as his/her particular demands and needs are concerned. 1.3 Who is required to carry out such a Demands and Needs Assessment? The demands and needs assessment is required to be undertaken by all insurance undertakings and insurance intermediaries, including Tied Insurance Intermediaries (‘TIIs’) and Ancillary Insurance Undertakings (`AIIs) carrying out insurance distribution activities. With respect to TIIs, and AIIs, entities appointing such intermediaries are also expected to have measures in place to ensure that appointed TIIs and AIIs distributing their products consider adequately and sufficiently the demands and needs of their clients, on the basis of information obtained from their clients, before the proposal of an insurance product is made. Accordingly, such entities appointing such intermediaries are required to monitor the manner in which TIIs and AIIs are carrying out a demands and needs assessment for every policy they sell. For each insurance product distributed, insurance undertakings are expected to provide their appointed TIIs and AIIs with guidance as to how such demands and needs assessments should be carried out and, as best practice, may also consider providing standard templates to assist in the pre-contractual phase of acquiring useful and pertinent information from the client in relation to the type of product offered. As part of their monitoring activities over their TIIs and AIIs, entities appointing such intermediaries are also expected to monitor (on a risk-based sample basis) that their TIIs and AIIs are carrying out the demands and needs assessment in a proper manner and that the products being offered to the client, do in fact match the particular client’s demands and needs.

Page 8 of 16 With regards to the appointment of distributors which are located in foreign jurisdictions, it is understood that these will be regulated by the host regulators, and therefore subject to the local regulatory framework. Nonetheless, it is considered best practice to engage on a regular basis in order to assess any possible issues and monitor adherence to the requirements relating to the assessment of demands and needs. 1.4 When should a Demands and Needs Assessment be carried out? A demands and needs assessment should be undertaken before a product is offered to a client and, therefore, before a particular product is identified and consequently before the relative proposal form can be completed. The demands and needs assessment is a stage which is separate and distinct from the completion of a proposal form. In terms of the sales journey, this assessment needs to be carried out before any products are offered to a client and therefore, before the relative proposal form is referred to for completion. In the context of the demands and needs assessment, the questions asked to clients may be similar to those asked for the purposes of underwriting (and which are usually found in a proposal form). However, the purpose of this assessment is not for underwriting and therefore, replies provided by clients should be assessed to identify the product(s) which would best meet the client’s demands and needs and not to establish whether the client’s risk falls within the insurer’s underwriting parameters. Information received from the client in the context of the demands and needs assessment may then be utilised to complete the relative proposal form once a product(s) has been identified by the insurance distributor and chosen by the client. Moreover, reliance by the insurance distributor on the exclusive use of a specific product’s proposal form as a substitute for a demands and needs assessment is not acceptable, as this would mean that a product would have already been selected for the client before the client’s demands and needs assessment is performed.

Page 9 of 16 It is to be emphasised that the requirement to carry out the demands and needs assessment applies regardless of the distribution modality; and applies to all types of insurance contracts irrespective of whether the products: (a) Are complex or non-complex; (b) Are provided with or without advice; (c) relate to general or long-term insurance. Pursuant to Article 20(1) of the IDD, any insurance contract proposed to the client must always be consistent with the demands and needs of the said client. Accordingly, an insurance distributor shall refrain from selling insurance product(s) where: (a) these do not correspond to the client's demands and needs; or (b) where the insurance distributor is unable to ensure (and demonstrate) that the product corresponds to the specific client's demands and needs, due to the refusal by the latter to provide the information requested. The above applies even where the client falls within the target market identified for the relevant insurance product(s). The demands and needs assessment is required to be carried out for all types of insurance products, that is, for both general and long-term business. In respect of long-term business, insurance distributors are requested to ensure that the demands and needs assessment is carried out for both insurance-based investment products (‘IBIPs’), as well as for pure protection products. In the context of IBIPs, Article 30 of the IDD, establishing the suitability and appropriateness applies “without prejudice” to the demands and needs. Therefore, a demands and needs assessment is required in order to identify whether the clients’ needs are better addressed by, for example via a with profits rather than a unit-linked policy. Once this is decided, then, unless the conditions for an execution-only transaction subsist, a suitability assessment or an appropriateness assessment would also need to be carried out. This is required so that the insurance distributor can assess whether the particular product(s) (identified as meeting the client’s demands and needs) that it offers is suitable or appropriate for the client, as applicable, in his/her particular circumstances. The assessment of demands and needs is required whether or not advice is being provided and the specifying of the demands and needs would not amount to a suitability assessment. Where advice is being provided, the demands

Page 10 of 16 and needs test and assessment of suitability could be seen as a continuum, rather than as a break2 . In the case of online sales, a demands and needs assessment is still required to be carried out by the insurance distributor and relevant tools should be tailored for such the medium utilised. This may be achieved by requesting the client to reply to a number of questions relating to, inter alia, what the client is expecting out of the insurance product under consideration. On the basis of the principle of proportionality, a simple, short question set may be used where the product is very straightforward, for example) where there is little variation in cover – that is where the choice is either the cover for loss, or damage, or neither. In compiling online demands and needs questions, care should be taken so that clients are note directly or indirectly nudged into ticking a box confirming that the contract chosen is in line with their demands and needs. Renewals It is good practice for Insurance distributors to clearly request their clients, through the renewal notice, to inform them whether are any material changes in their personal circumstances which would affect the risk insured or if there have been material changes to the risk insured itself during the last period of insurance, these need to be communicated by the client to the insurance distributor. Material changes would ordinarily refer to those changes which would necessitate a change in the type of policy and / or coverage provided under the current policy (for instance, change in use of the property or vehicle). For sake of clarity, changes in sum insureds are not meant to be considered material changes for the scope of this section. Where such material changes are communicated to the insurance distributor, a demands and needs assessment is to be carried out by the insurance distributor prior to the renewal being effected, taking into account these changes. Where there are insurance policies which include frequent renewals (e.g. monthly), it is good practice for the distributor to advise the client point of sale, to inform the 2 Vide EIOPA Q&A no 1638 https://www.eiopa.europa.eu/qa-regulation/questions-and-answers￾database/1638_en

Page 11 of 16 insurance distributor of any material changes to their circumstances or to the risk insured when these arise. 1.5 How should a Demands and Needs Assessment be carried out? The IDD clearly states that the demands and needs assessment is to be made on the basis of information obtained from the client. This will entail a discovery exercise which would be typically done through a set of questions posed to the client by the insurance distributor. In this regard, the MFSA considers a demands and needs assessment can be carried out in a number of ways. The manner in which a demands and needs assessment is carried out and the extent thereof (that is adopting a proportional approach depending on the type of service provided and the complexity of the insurance product(s) under consideration) is up to the insurance distributor to determine. In order to comply with the requirement to specify the clients’ demands and needs, there has to be a positive action on the part of the insurance distributor in order to specify, on the basis of information obtained from the client, the demands and the needs of that client. Therefore, the said requirement may not be satisfied by the mere provision of the policy quotation and, or the provision of product information/documentation, such as the Insurance Product Information Document (IPID). Indeed, the provision of such information should follow the assessment of the demands and needs.

The onus is on the insurance distributor to ensure that the necessary information from clients is gathered and that demands and needs assessment is actively made on the basis of that information. The MFSA considers as good practice the adoption of a procedure whereby a structured and formal assessment is made in order to ensure consistency in the level of information gathered from all clients by all members of the insurance distributors’ staff; and so that compliance with the relevant requirements in relation to demands and needs can be adequately demonstrated. Naturally, the distributors’ staff members would need to be adequately guided and trained as to how to analyse the information provided by clients in order to be in a position to carry out a demands and needs assessment before offering policies to clients.

Page 12 of 16 It is acceptable to adopt the use of questionnaires for this purpose, but this is not mandatory, provided that sufficient information is collected from clients through other means. Questions may be structured through list of questions, client meeting notes, online forms and exchange of correspondence (e.g. emails). The questions put forward by the insurance distributor must be relevant, and it is up to the insurance distributor to determine what is sufficient for it to be in a position to assess whether the products available meet the client’s demands and needs. It is acknowledged that the sales journey of a commercial policy which may be subject to a more complex sales journey may require time, records of meetings, gathering of documentation, exchanges of correspondence, on-site visits etc. It is therefore accepted that a demands and needs assessment is made via the above interactions as supported by the relevant documentation. Therefore, following the gathering of the relative information from the client, the insurance distributor would need to take into account a policy’s level of cover, the costs, as well as the relevant exclusions, deductibles and other limitations and conditions, in order to ensure that the policy or policies offered would meet the particular demands and needs of the specific client. 1.6 When should a Demands and Needs Statement be provided? On the basis of the information gathered and taking into account the type of client and the nature and complexity of the product offered, the insurance distributor shall, in a clear and comprehensible manner, provide the client with objective information on the product, illustrating its characteristics, duration, costs, coverage limits and any other relevant elements to enable the client to make an informed decision. In this regard, insurance distributors are expected to provide the client with simple, clear and understandable information about the basis on which an insurance product is offered and how it relates to their demands and needs. Insurance distributors are expected to provide a demands and needs statement. Such statement would normally include: (a) a record of the requirements the insurance product is intended to meet; (b) the type of product that is being purchased; and

Page 13 of 16 (c) the reasons why the particular product has been offered to the client, that is, how the product offered would meet the client’s demands and needs on the basis of the information provided by the client to the insurance distributor for this purpose. The demands and needs statement should be given in good time and before the contract is concluded. There is no prescribed format, and the statement may take the form of a summary note of the discussion, or a suitably completed checklist or even a statement highlighting why the product being offered is deemed to be line with the client’s demands and needs. This statement may be provided as part of the pre-contractual documentation provided to the client (for instance, as part of the quotation) or as a separate document. The demands and needs statement is not mandatory to be signed by neither the client nor the distributor3 . However, where the insurance distributor requests clients to sign the demands and needs assessment or statement, this should not be deemed that the onus of the assessment of the demands and needs is being shifted in any manner onto the client. Accordingly, care shall be taken by the insurance distributor when drafting such documents so as to ensure that these do not contain wording to the effect of rendering the client responsible for the demands and needs assessment or for the personal recommendation made, if any, since both the demands and needs assessment and personal recommendations (if any) are always deemed to be the responsibility of the insurance distributor. Accordingly, requesting or prompting the client to confirm in any manner that the contract chosen is in line with his/her demands and needs is not acceptable4 . Furthermore, any such documents would also be expected to be also signed by a representative of the insurance distributor where the latter requests the client to sign such documents. In the context of insurance brokers, unless these wish to provide personal advice (that is, via a personal recommendation), these are expected to consider a sufficiently large number of policies available on the market (where possible) with a view to identify those policies which would meet the client’s demands and needs. A demands and needs statement would be required to be provided to the client for 3 Vide EIOPA Q&A no 2525 https://www.eiopa.europa.eu/qa-regulation/questions-and-answers￾database/2525_en 4 Vide EIOPA’s Report on the Application of the IDD published 6 January 2022, EIOPA-BoS-21/581

Page 14 of 16 each policy so identified, such that the client would be in a position to choose the policy under which to bind cover out of those indicated by the broker. What is Advice? Advice refers to the provision of a personal recommendation to a client, either upon their request or at the initiative of the insurance distributor, in respect of one or more insurance contracts. A personal recommendation would be taken to involve the recommendation provided to a particular client to purchase a particular product after considering the personal circumstances of such client. Accordingly, a recommendation is not a ‘Personal Recommendation’ if it is issued exclusively to the public (for instance, through an advert or newspaper article). The insurance distributor is expected to be clear with the client as to whether it is providing advice or otherwise. It is important to note that whilst advice may be provided both with respect to IBIPs and non-IBIPs, the formal suitability/ appropriateness assessments are only required under Article 30 of the IDD is in the context of the sale of IBIPs. If the insurance distributor is arranging insurance policies only, the insurance distributor is in effect taking the clients’ orders, after carrying out a demands and needs assessment, and effecting the purchase of the insurance product chosen by the client in line with their wishes. In this scenario, when providing information about the product in question, it is important to ensure that no advice is provided unintentionally by such distributor. This could occur, for instance, if the client asks, ‘what do you think?’ or ‘which would you go for?’. In these cases, if the clients such questions, if the distributor does not wish to provide advice, it should inform the client that it is in a position to give a personal recommendation (that is, whether the product is suitable in the client’s particular circumstances) and that as insurance distributor, it has merely assessed whether that product meets the client’s demands and needs.

Page 15 of 16 1.7 What Records Should be Kept in relation to the Demands and Needs and Assessment? The demands and needs assessment carried out by the insurance distributor is expected to be formalised and a record evidencing the manner in which it has been carried out, and the relative result is to be maintained. Accordingly, insurance distributors are expected to keep sufficient records with respect to: (a) the questions asked for the purposes of the demands and needs assessment and the respective replies provided by the client; (b) the result of the assessment which is to be communicated to the client; (c) a copy of the demands and needs statement provided to the client. TIIs and AIIs are also expected to keep the above-mentioned records in order to enable the entities appointing them and on whose behalf they act, to monitor the extent and the manner in which such demands and needs assessments are being carried out by their respective appointed TIIs and AIIs. In general, effective record-keeping will enable the insurance distributor’s compliance function to monitor the extent and manner in which the demands and needs test is being carried out and to demonstrate that it is actually being carried out. Accordingly, it is expected that this monitoring including, where applicable with respect to TIIs and AIIs, would feature in the insurance distributor’s compliance plan, on an ongoing basis.

Page 16 of 16 Section 2: Way Forward and Next Steps The MFSA has engaged and is engaging on a bilateral basis with the entities at which it has conducted an inspection in the context of conduct-related matters, including the carrying out of the demands and needs assessment. All insurance distributors, including those which have not been subjected to an MFSA inspection are encouraged to come in line with the MFSA’s guidance as outlined in this document. Moreover, it is also to be highlighted that the MFSA’s guidance, principles and expectations as outlined in this document may in due course be incorporated as new rules, and, or guidance within the COBR. It is strongly recommended that insurance distributors also refer to the Q&As, published on EIOPA’s website, some of which also cover this matter. The guidance and best practices contained in this document are without prejudice to any possible amendments to the IDD and to any other expectations or guidance which may be published by EIOPA in the context of the demands and needs assessment in due course. Contacts In case of queries with respect to the above, please do not hesitate to contact the Authority on csuinsurance@mfsa.mt.

Page 17 of 16 Malta Financial Services Authority Triq L-Imdina, Zone 1 Central Business District, Birkirkara, CBD 1010, Malta communications@mfsa.mt www.mfsa.mt