A practical business guide to the new design and distribution obligations (DDO)
ASIC’s new DDO regulations offer firms a chance to realise greater business value as well as greater connection to their customers, despite attributing more accountability to distributors.
On October 5, the new DDO are due to take effect, outlining product design, distribution and monitoring requirements for organisations – and placing consumers at the heart of product governance. The requirements essentially challenge the assumption that suitable disclosure leads to informed consumer decision-making. In doing so, DDO place obligations on product issuers and distributors to ensure their products meet consumer needs.
Regulatory Guide 274 sets out ASIC’s interpretation of DDO requirements, expectations for compliance and approach to administering the obligations. The customer-centric approach provides product issuers with a timely opportunity to use their data to best effect. The challenge for product issuers and distributors comes from how to establish effective frameworks that meet DDO requirements and add value by October.
In this practical guide, we help product issuers navigate their way through the DDO regulations, and suggest ways they can use their data to:
- Inform the Target Market Determination (TMD) for each product
- Monitor compliance with DDO requirements on an ongoing basis
- Move beyond compliance and create value through meeting DDO requirements.
Step 1: What information should I consider to inform the TMD?
Firstly, it’s important to define a target market. A target market is defined by the product issuer, who must assess their product as consistent with the objectives, financial situation and needs of a group or ‘class’ of customers. Distribution conditions must be specified, to make it likely that consumers who acquire the product are in the target market. Issuers and distributors must take ‘reasonable steps’ to ensure distribution is consistent with the TMD.
Setting a suitable definition of ‘class’ of customers, changing systems to capture additional information if required and establishing a suitable monitoring framework takes time. To meet TMD requirements, ASIC considers that product issuers will generally need to:
- Describe the likely objectives, financial situation and needs of consumers in the target market
- Describe the product features
- Explain why the product features are likely to meet consumers’ needs.
Unlike personal advice, design and distribution obligations do not require product issuers to assess the suitability of products for individual consumers. As mentioned earlier, consideration needs to be given to the likely objectives, financial situation and needs of a class of consumers. However, ASIC does expect issuers to specify the target market with sufficient granularity and to have tested its product. In some cases, it may be necessary to define the target market as including some classes of consumers and excluding others.
There’s a range of information that product issuers can use to help define the target market. The information available will depend on whether the product is new or existing, and whether the issuer distributes the product directly to consumers or whether distribution occurs through a third party. The following table provides examples of the information organisations may want to consider.
|Customer / risk information
|- Reported claims
- Accepted claims
- Declined / withdrawn claims
- Paid claims
- Lapse rates
- Disputes + outcomes
- Coverage limits
- General and claims conditions
- Premium charged
|- Asset insured
- Policyholder age
- Employment status
- Life stage
Product issuers should consider how customers’ needs change over time. For example, a comprehensive car insurance policy issued today on a 15-year-old Holden may no longer be appropriate, despite the product being fit for purpose when the car was new.
Ultimately, it may be necessary to ask additional questions to ascertain whether a consumer is in the target market and to respond appropriately when customers volunteer relevant information. The law provides an exemption from personal advice obligations to determine whether or not a consumer is in the target market.
Step 2: How do I monitor compliance with DDO requirements?
Monitoring compliance with DDO requirements involves:
- Monitoring whether the product reached consumers in the target market. If it has not reached the target market, why not?
- Assessing how the product performed for consumers. That is, did the product meet consumers’ objectives and needs?
A TMD must specify suitable review triggers, such as loss ratios consistently falling below a level that indicates diminishing value for the class of consumers. Monitoring performance against these review triggers will support product issuers in deciding whether changes to the product and/or distribution are required. It will allow businesses to make responsive, data-informed decisions that will ultimately benefit their bottom line, and ensure they are in tune with their customers and their concerns.
Assessing whether the product has reached the target market
Provided the target market is well defined, it should be straightforward to assess whether a product has reached the target market, with ASIC emphasising the importance of measuring consumer experience by distribution channel. Bundled products (such as home and contents cover) should also be considered separately as the target market for the combined product is narrower than the market for the two separate products.
ASIC’s regulatory guide states that issuers and distributors are not assessed as having failed to take reasonable steps because a consumer outside the target market acquires the product. Instead, ASIC’s concern is when a significant amount of distribution is occurring outside the target market, or the distribution is leading to consumer harm. In these circumstances, the product issuer needs to report the significant dealings to ASIC.
Assessing consumer outcomes
There’s considerable overlap between the metrics considered to determine the target market for existing products and those used to assess consumer outcomes. In the following table, we list a series of questions for product issuers to consider. Again, it is important to measure consumer outcomes by distribution channel. It may also be necessary to further segment the portfolio by risk or customer type – for example, customer tenure, geographic location of risk insured or customer age.
|Is a reasonable percentage of premium returned to the customer in the form of claim payments given the risk? That is, what is the financial value of the product to consumers?
|Gross loss ratio
|Are customers able to claim on the product when they need to? Consideration of rejected and withdrawn claims will inform an assessment of whether distribution practices and/or product terms and conditions are suitable.
|Are products meeting consumers’ objectives? If not, where are the frictions?
|Volume and nature of complaints*
|Do consumers continue to see value in the product?
|Policy lapse rates
Policy cancellation rates
* We suggest monitoring rejected claims, withdrawn claims and complaints both in absolute terms and as a rate. Monitoring these metrics as a rate accounts for differences in product penetration and facilitates comparison between products.
Product issuers need to consider what is a reasonable range for each metric, and the timeframes for measurement, to determine when action is required.
Step 3: How do I capture the opportunities associated with meeting DDO requirements?
There are several factors critical to moving DDO requirements away from a pure compliance exercise, towards a process that provides value. These are:
- Senior management driving the process and engaging with stakeholders across underwriting and pricing, distribution, claims management, product management and actuarial.
- Analysis of existing data to identify frictions in the provision of products. There are a range of data sources that can be analysed to improve design outside of meeting DDO requirements – customer enquiries data, for example.
- A robust debate around suitable metrics to measure consumer outcomes and appropriate triggers. For example, setting a loss ratio trigger, which allows a product issuer to measure whether a reasonable percentage of premium is returned to the customer. This is a useful step in checking whether products are delivering value for consumers.
- Reporting that is modified, as necessary, to embed consumer-focused metrics. It is important that consumer-focused metrics are tracked and shared across the various functions. Well set up monitoring should help issuers identify early trends or erosion in customer value and enable remedial action to be taken before it becomes a major issue. Just as the Board receives regular financial snapshots, we advocate for the Board to receive a regular summary of customer-focused metrics.
A well-designed approach to meeting and monitoring DDO requirements should create value for product issuers and distributors. DDO provide product issuers with a great opportunity – to truly connect with their customers and their needs – this can only be a good thing for our industry.
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