Regulation on key information documents for packaged retail and insurance based investment products

In June 2016, the European Commission adopted regulatory technical standards (RTS) specifying the content and underlying methodology of the key information document in accordance with the Regulation on key information documents for packaged retail and insurance-based investment products (PRIIPs) (Regulation 1286/2014). The draft RTS were published by the Joint Committee of the European Supervisory Authorities at the beginning of April 2016.

The Regulation, which entered into force in December 2014 and is expected to apply from 31 December 2016, is designed to enhance consumer protection and consumer confidence by responding to concerns that existing disclosures to retail investors of PRIIPs were uncoordinated and did not aid comparability.

Insurance-based investment products

Insurance based investment products are defined under the Regulation as products offering a “maturity or surrender value and where that maturity or surrender value is wholly or partially exposed, directly or indirectly, to market fluctuations”. Broadly, this covers products such as with-profit life insurance contracts with variable bonuses; hybrid life insurance contracts containing both unit-linked and with profit elements; and unit-linked and index-linked life insurance contracts. Excluded from the provisions are defined benefit pensions and individual pension products, where a financial contribution from the employer is required by national law and where the employer or the employee has no choice as to the pension product or provider.

The KID - Key Information Document

Under the Regulation, every manufacturer of investment products (e.g. investment fund managers, insurers, banks) will be required to produce a short form document (a key information document or KID) to retail investors designed to enable them to understand and compare the key features and risks. Persons advising on or selling PRIIPs will be required to provide the KID to retail investors in good time before the investor is bound by any contract or offer relating to the PRIIP. The recitals to the RTS give some guidance as to whatconstitutes “in good time” and also include a template KID.

The Regulation prescribes the form of the KID and provides that it must be a short document (no more than three sides of A4 sized paper), written in a concise manner, using non-technical language that avoids jargon so as to be understandable by the average retail investor, drawn up in a common format, completely standalone and distinct from other marketing material. The KID must be written in the official language (or one of the official languages) of the Member State where the PRIIP is being sold.

Where the PRIIP manufacturer becomes aware of a change that affects, or is likely to affect, the information contained in the KID, the PRIIP manufacturer must review the KID without undue delay.

Under the Regulation, retail investors can hold the PRIIP manufacturer liable for an infringement of the Regulation where damage is suffered as a result of reliance on a KID that is inconsistent with pre-contractual or contractual documents under the PRIIP manufacturer’s control, or is misleading or inaccurate.

Contents of the KID

The KID must include a section entitled “What is this product?”. This includes information on the type of PRIIP and the type of retail investor to whom the PRIIP is intended to be marketed. The details of insurance benefits in the section entitled “What is this product?” of the KID need to include (among other things) a general summary and the key features of the insurance contract.

The KID must include a section entitled “What are the risks and what could I get in return?”, containing a brief description of the risk-reward profile comprising: a summary risk indicator; the possible maximum loss of invested capital; appropriate performance scenarios, and the assumptions made to produce them; information on conditions for returns to retail investors (where applicable); and a statement that the tax legislation of the retail investor’s home Member State may have an impact on the actual pay-out. The three performance scenarios that must be included are an unfavourable scenario, a moderate scenario and a favourable scenario. For insurance-based investment products, an additional performance scenario will be included, reflecting the return the retail investor receives if a “covered insurance event” occurs. The final RTS contain detailed information in this respect.

A section titled “What are the costs?” should detail the costs associated with an investment in the PRIIP, comprising both direct and indirect costs to be borne by the retail investor, including one-off and recurring costs, presented by means of summary indicators of these costs and total aggregate costs expressed in monetary and percentage terms, to show the compound effects of the total costs on the investment. For insurance based investment products, a one-off cost is an entry and exit cost which includes initial charges, commissions or any other amount paid directly by the retail investor or deducted from the pay-out.

Industry reaction to the RTS on the KID

The RTS have drawn criticism from national insurance regulators and other stakeholders in the insurance industry, with many against the use of the quantitative methods for measuring the risk of insurance products. Insurance Europe has argued that such an approach can overstate the risk of insurance-based investment costs.

The decision to include the cost element of the biometric risk premium in the investment cost section of the KID has also drawn criticism, with Insurance Europe arguing that this would be better placed in a separate “insurance section of the KID” that could contain information on insurance cover, benefits and biometric risk premium. It argues that a distinction needs to be made between investment costs associated with the insurance-based investment product and the premiums paid and that, as premiums finance the insurance benefits of the products, they should not be considered costs.

What next?

Stakeholders in the insurance industry have raised concerns about the 31 December 2016 deadline for the application of the Regulation and have called for a one year extension in order to provide product manufacturers time to launch and test the KID.

In respect of the UK, the FCA published a consultation paper in July 2016 containing proposed changes to its Handbook to reflect the Regulation. The FCA noted that its approach to the Regulation would be subject to review in light of any negotiations following the result of the UK referendum on EU membership, but that the tight implementation timetable required it to proceed with the consultation in order to allow firms time to make the necessary changes before the Regulation entered into force. Final rules are expected to be published by the FCA in November 2016.

Author, Nicola Higgs