The incoming Conduct of Financial Institutions (CoFI) regime, introduced by the Financial Markets (Conduct of Institutions) Amendment Act 2022 (CoFI Act), is primarily concerned with licencing and regulating the conduct of financial institutions (i.e. licensed insurers, banks, and non-bank deposit takers) in relation to their consumer business.

However, it will also change how intermediaries distribute products for those financial institutions. For the insurance industry, brokers and other intermediaries can expect greater oversight and expectations from insurers in relation to conduct.

The CoFI regime does not directly apply to brokers and intermediaries (except in the case of incentives). However, insurers, as financial institutions, are required to:

• set and maintain a fair conduct programme which provides for the distribution methods they use (including distribution methods that involve intermediaries) to operate in a manner that is consistent with the fair conduct principle; and
• regularly review whether the distribution methods are operating in a manner that is consistent with the fair conduct principle, and ensuring deficiencies are remedied within a reasonable time.

This will have flow through effects for insurance intermediaries, and their relationships with insurers.

In addition, the CoFI regime prohibits intermediaries from receiving certain sales incentives.

This article sets out some of the matterswhich intermediaries should be thinkingabout in advance of the regime coming into force. In particular, this article examines the key points for intermediaries in the Financial Markets Authority (FMA)’s recent guidance on intermediated distribution (Guidance).

Am I an intermediary?

Under the CoFI Act, a person will be an intermediary if:

• the person is involved in the provision of a relevant service or an associated product to a consumer, meaning either:
  • arranging for the service or for the acquisition of the product; or
  • giving regulated financial advice in relation to the product.
• the person is paid or provided with a commission or other consideration in connection with that involvement; and
• the commission or consideration paid or provided (directly or indirectly), by or on behalf of the financial institution providing the service or the product the intermediary is involved with.

Relevant service, in relation to insurance, means “acting as an insurer”, and associated product means the associated contract of insurance.

For the purposes of the CoFI Act, a consumer is:

• policyholder who enters into the contract of insurance wholly or predominantly for personal, domestic, or household purposes (including any beneficiary or person who is offered such insurance);
• a policyholder under a contract of insurance that provides for life insurance or health insurance (or both); or
• a person who benefits from a contract entered into by a policyholder in order to provide insurance cover for one or more persons, provided the person has the benefit of the cover wholly or predominantly for personal, domestic, or household purposes.

An ancillary point to note in relation to paragraph (b) is the absence of a reference in relation to life insurance or health insurance to “personal, domestic, or household purposes”, meaning that for those types of insurance when a policy holder is considered a “consumer” can be wider than is the case in ordinary parlance.

What can I do to prepare?

Ahead of the CoFI regime, insurers and intermediaries will need to consider carefully their relationship, bearing in mind that a distribution system needs to work for both parties. Intermediaries should:

Understand the insurer’s obligations in making the fair conduct programme

The CoFI regime requires financial institutions to set and maintain a fair conduct programme which provides for the distribution methods they use (including distribution methods that involve intermediaries) to operate in a manner that is consistent with the fair conduct principle.

The FMA states that treating customers fairly is a shared responsibility of financial institutions and their intermediaries. Ahead of the regime, the FMA expects financial institutions and intermediaries to collaborate on constructing the distribution section of the fair conduct programme. In our view, both will need to consider carefully how their relationship may need to be re-calibrated to operate effectively and compliantly for both parties once the CoFI regime comes in to force.

Intermediaries will want to understand the financial institutions’ obligations because, of course, the insurers must operate in compliance with the CoFI regime, and can be subject to substantial penalties for failing to do so. So the financial institutions will be changing the way they are willing to work with intermediaries. At the same time, intermediaries will need to ensure that their roles and responsibilities under the resulting fair conduct programme are practical and achievable. Intermediaries should consider what roles and obligations it is willing to have responsibility for, the level of compliance burden it feels is warranted, including in relation to oversight, reporting and ongoing training. Where the balance between the interests of the two finally lands will be at least in part a matter of commercial negotiation. In constructing a fair conduct programme, financial institutions and intermediaries should consider the following:

• the likely consumers of the products;
• what distribution methods are appropriate and why;
• the roles and responsibilities of the financial institution, and the intermediary;
• how distribution arrangements will be managed or recorded;
• what processes, controls and data areneeded; and
• what product information, training or accreditation will be provided.

Intermediaries and financial institutions are also expected by the FMA to collaborate (to varying degrees) on establishing a framework by which to review the fair conduct programme, and remedy any deficiency.

In undertaking this exercise, intermediaries should consider the following:

Risk-based approach

The FMA has stated in its Guidance that financial institutions should take a riskbased approach to setting controls around distribution arrangements. The Guidance also sets out that a high compliance burden on intermediaries should be avoided. For example, the FMA does not expect constant surveillance of intermediaries or supervision of the intermediaries’ compliance with the financial advice provider (FPA) regime. And if financial institutions do have such contractual powers, that may in future be argued to imply a duty of care in favour of the underlying customers, in the event of failures by the intermediaries. So the balance needs to be carefully considered.

Intermediaries holding a FAP licence will already be subject to complementary conduct obligations under Part 6 of the Financial Markets Conduct Act 2013 (FMCA) and the Code of Professional Conduct, and of course direct supervision by the FMA. The Guidance acknowledges that these intermediaries pose a reduced level of risk to consumers because they are already demonstrating a prescribed level of compliance when distributing products and services.

We consider that intermediaries which are FAPs, and the financial institutions using them, can therefore legitimately take the view that a lower level of controls is warranted in relation to their distribution arrangements, than in relation to those intermediaries that are not themselves regulated.

Roles and responsibilities

A financial institution is required to have clearly defined roles, responsibilities and accountability arrangements in relation to identifying, monitoring and managing risks associated with conduct that fails to comply with the fair conduct principle.

In practice, what roles and responsibilities are taken on by an intermediary will vary. For example, if an intermediary is a licensed FAP, it may be responsible for assessing the suitability of the product for the consumer. In some cases, responsibility may be shared.

In relation to product information, the FMA expects that financial institutions will be responsible for providing product information and training. For intermediaries who are FAPs, this can take into account the standards of competence, knowledge and skill that they must meet under the financial advice regime.

Review framework

Financial institutions are required to include in their fair conduct programmes effective policies, processes, systems and controls for regularly reviewing whether distribution methods are operating in a manner consistent with the fair conduct principle.

Financial institutions are encouraged in the Guidance to take a risk-based approach to the frequency and the intensity of the review. The FMA has made clear that it does not expect constant surveillance of intermediaries, or monitoring of individual actions. Intermediaries can therefore expect, depending on the perceived risk of the distribution arrangement, a degree of sample-based monitoring.

Intermediaries should expect financial institutions to ask them to report key metrics (such as claims, loss ratios, complaints, cancellation rates) to the financial institution in order to allow the financial institution to assess whether the distribution method is compliant with the fair conduct principle.

The review required is in relation to how the distribution method supports the fair conduct principle. However, financial institutions may wish to combine this with a review of the performance of the intermediary with other obligations under the distribution arrangement.

Remedying deficiencies

Financial institutions also required to include in their fair conduct programmes effective policies, processes, systems and controls for ensuring any deficiencies in the operation of its distribution methods are identified and remedied within a reasonable time.

The FMA has stated in the Guidance that this is not a ‘one size fits all’ approach. However, intermediaries can expect consequences from financial institutions in relation to non-compliance with the fair conduct programme, or the CoFI Act more generally. For example, a financial institution may wish to include non-compliance with the fair conduct programme as a material breach in relation to the distribution agreement.
 

A financial institution is required to have clearly defined roles, responsibilities and accountability arrangements in relation to identifying, monitoring and managing risks associated with conduct that fails to comply with the fair conduct principle.

Review contractual agreements

The Guidance sets out that contractual arrangements between the financial institution and the intermediary is good practice. Intermediaries can therefore expect financial institutions will seek to impose a distribution agreement, or amend the current distribution agreement to include new provisions for the incoming CoFI regime.

The distribution agreement should clearly record the expectations of each party in relation to the distribution section of the fair conduct programme.

Commissions

The CoFI regime introduces a prohibition on certain sales incentives. An incentive will be prohibited if a relevant person’s entitlement to the incentive, or the nature or value of the incentive, is determined or calculated in any way by direct reference to a target or other threshold that relates to the volume or value of the services or products. In relation to intermediated distribution, the relevant persons are the intermediary itself (in relation to commissions by the financial institution) or employees of the intermediary involved in the provision of the financial institution’s relevant services who have direct contact or act on behalf of one or more consumers (in relation to commissions by the intermediary to employees).

Financial institutions and intermediaries will accordingly need to adapt the distribution agreement to set out a compliant commission structure.

We also consider there may well be benefit to setting out and agreeing when a commission is payable and when an intermediary is entitled to retain its commission (including, for example, in the event of a refund of premiums).

Assurance

The distribution agreement should state whether the intermediary has a contractual obligation to comply with the fair conduct principle in the CoFI Act, or the fair conduct programme of the insurer. The distribution agreement should set out what assurances and/or indemnities are given by the intermediary in relation to compliance with the fair conduct programme.

The FMA notes in its Guidance that a formal attestation or audit from an intermediary in relation to compliance with the fair conduct programme “may” not be necessary (but is one tool by which financial institutions can ensure compliance). In our view this is a matter for the parties to decide what is appropriate in the context of their relationship.

Remedying deficiencies

Deficiencies may need to be remedied by either the intermediary or the financial institution through, for example, additional training or through changing the service or product design. Intermediaries and financial institutions therefore need to ensure that the recorded arrangement is flexible enough to allow for introducing new remedies for identified deficiencies.

Review internal policies

Intermediaries will need to consider what internal policies, systems and processes will be needed in order to meet the expectations set out in the financial institution’s programme.

In particular, intermediaries will need to ensure that their policies, systems and processes are compatible against each of the fair conduct programmes for each of the financial institutions that they work with.

We accordingly recommend that intermediaries will need to carry out a gap analysis as between each of the resulting fair conduct programmes in order to ensure that its internal policies, systems and processes cover the requirements. Where possible, intermediaries may aim to align each of the fair conduct programme requirements across the financial institutions that they work with. However, they will need to consider carefully their competition law obligations before sharing these internal policies and processes with the financial institutions as part of the collaboration process.

It will be clear from the above that adapting to the new CoFI regime will require the commitment of substantial time and resources, by both financial institutions and the intermediaries they work with. It may well involve redefining what have been long-standing relationships. Both financial institutions and intermediaries may well find that they want to reduce the number of parties they deal with to keep the negotiations and ongoing relationships manageable.

As a result it will be important to start early on the process of working together to find an answer which will be acceptable for both parties to a distribution arrangement. We would recommend a well-planned and carefully thought through approach – which should involve intermediaries making sure they understand the CoFI regime obligations of the financial institutions they deal with.