EIOPA sets methodology for calculating value for money

On 7 October 2024 the European Insurance and Occupational Pensions Authority ("EIOPA") published a news on its website concerning EIOPA's methodology on setting value-for-money benchmarks for unit-linked and hybrid insurance products with the aim of tackling several issues identified by the European national authorities related to the mismatch between consumers' expected returns and the actual benefits received, or to unjustified costs, fees and penalties in the unit-linked and hybrid market (the "Benchmark Methodology").

Indeed, since value-for-money is proved to have a significant impact on consumers' trust, it became a key priority for EIOPA to promote a consistent and convergent approach across all Member States.

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Following the publication of EIOPA's Supervisory Statement on value-for-money in 2021 some jurisdictions laid down expectations on value-for-money assessments and developed work on benchmarks (like Italy with Letter to the Market of 27 March 2024 available, also in English, at the following link: https://www.ivass.it/normativa/nazionale/secondaria-ivass/lettere/2024/lm-27-03-24/Letter_to_the_market_of_27_03_2024.pdf?language_id=3). Therefore, also EIOPA started working on developing value-for-money benchmarks ("VfM benchmarks") with the objectives of assisting:

-????????? National Competent Authorities ("NCAs") in identifying products with higher value for money risks and promoting a more efficient and risk-based approach to conduct supervision; and,

-????????? insurance product manufacturers in identifying comparable offers to determine if their products offer value, including the assessment of costs for consumers to ensure they are due and proportional to the expenses borne by the provider and the benefits offered to policyholder.

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As a result of this work, EIOPA launched a public consultation in December 2023 on its proposed methodology for setting VfM benchmarks for unit-linked and hybrid insurance products. Hence, the Benchmarks Methodology published results from stakeholders’ feedback received during the public consultation and the execution of a data pilot in several Member States.

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-????????? The reference benchmarks

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According to EIOPA manufacturers of insurance products should not consider benchmarks as a "safe harbour" since they should continue to ensure that all costs are identified, quantified, due and consistent with the target market's needs.

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Moreover, benchmarks should not be seen and used as price regulation. In fact, EIOPA is aware that the benchmarks cannot capture all products’ specificities and consumers’ needs as they are varied in nature and should not be used as a consumer disclosure tool as the nature of the indicators and the product clustering process require in-depth technical knowledge of the Benchmark Methodology which may not be easy to understand for most consumers.

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Nonetheless, benchmarks are the reference points which, as anticipated:

-????????? support NCAs in their supervisory activities allowing them to identify unit-linked and hybrid products which pose higher value-for-money risks; and,

-????????? when discussed with national supervisors and eventually shared with insurance product manufacturers, enable them to identify the costs and benefits of comparable offers in the market and facilitate their product testing and pricing process, including assessing that all costs are proportionate and due.

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In the Benchmark Methodology, benchmarks are carried out at the level of the combination of wrapper plus specific option (for instance, if one product offers 10 investment options, there will be 10 possible combinations of wrapper plus specific investment option).

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-????????? The Benchmark Methodology

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The Benchmark Methodology?outlines a three-step approach to create reference benchmarks:

1. Features for product clusters à due to the existence of insurance wrappers offering the possibility to invest in a multitude of underlying investment options, EIOPA figured that it is useful for the consumer the s.c. "product clustering". Indeed, investment options are divided into two categories:

o?? Individual investment option: meaning an external or internal fund, a profit participation component or direct lines like stocks or shares; and,

o?? Combined investment option: the combination of multiple external or internal funds according to a pre-determined investment allocation/strategy, either fixed or dynamic, which is predefined by the insurance undertaking.

But, since the policyholder's perspective might differ from the manufacturers, the following principles contained in Annex I of the Benchmark Methodology apply:

o?? data collection and benchmarks’ calibration will be carried out at the level of the combination of wrapper plus specific option and they should be inclusive of all costs;

o?? manufacturers will be required to report a set of values for the calculation of value-for-money indicators for each combination of wrapper plus specific investment options;

o?? manufacturer’s reporting of data concerning the wrapper plus specific option should be sufficiently varied to populate the highest number of clusters and allow the calculation of the respective benchmarks;

o?? in case of Multi-Option Products (MOPs), the data will be collected at the level of the most sold, the most expensive and the cheapest combination of wrapper plus specific investment option. In case of hybrid products with pre-determined strategy, the reporting may be reduced given the more limited number of options available; and,

o?? the selection of the most expensive and the cheapest combination is based on reduction in yield at recommended holding period (RIY at RHP) whereas the most sold refers the gross written premium (GWP).

Nonetheless, to avoid confusion on whether one product falls within more than one cluster, different versions of the same wrapper will be considered as different products and fall within their respective clusters.

In order to ensure an adequate number of clusters with homogeneous products the Benchmark Methodology contains minimum clusters which can be further developed depending on data availability and the initial setting of benchmarks.

The minimum clusters are based on six clustering features resulting into a maximum of 204 product clusters (for all product categories), and one extra feature for the profit participation component resulting in 12 additional product clusters. This does not mean that all clusters will be populated in the first exercise given that all possible combinations of clustering features might not be available and/or be representative of the market. Annex II includes the representation of the minimum clusters resulting from the combination of the following features:

o?? product category à distinguishes between pure unit-linked and hybrid products in which the unit-linked part is combined (or can be combined) with profit-sharing features. Due to the heterogeneity of fund allocation approaches between unit-linked and profit-sharing, it is necessary to create subcategories of hybrids;

o?? premium frequency à refers to the different needs of consumers in terms of premium payments. Two main categories are included:

§? single; and,

§? regular.

o?? recommended holding period (RHP) à three categories are considered:

§? short: i.e., insurance wrapper with less than 10 years RHP;

§? medium: i.e., insurance wrapper between 10 and 20 years RHP; and,

§? long: i.e., insurance wrapper with more than 20 years RHP.

o?? level of biometric coverage à differentiates products that offer a significant level of coverage for consumers from the premium paid to RHP. Two categories are considered:

§? significant

·?????? If short RHP: insured event scenario at RHP covering 150% or more of the premium paid at that time

·?????? If medium or long RHP: insured event scenario at half RHP covering 120% or more of the premium paid at that time

§? other: all other cases.

o?? underlying asset classes à considers the most relevant asset classes and applies to pure and hybrid unit-linked products. Where there is more than one asset class supporting the product, the predominant asset class at the start of the contract will be considered. Three categories are developed for this grouping feature:

§? equity

§? asset allocation funds

§? rest

o?? summary risk indicator (SRI) à will allow to differentiate between risk of the investments and foster comparison between similar products. SRI are group in two or three categories according to the underlying asset class.

Please note that, even though the abovementioned criteria are listed in the document at issue, EIOPA states that final clusters and benchmarks will be fully determined once a full dataset is available.

1. VfM indicators around which benchmarks will be calculated à benchmarks will be calculated for each cluster based on a list of indicators covering costs and returns. The indicators cover very important metrics for assessing value-for-money considering the costs and benefits of the products. All indicators will also be assessed during the first calibration exercise and revised if the analysis of the collected data shows a low level of statistical significance. Here are the indicators reported in the Benchmark Methodology: Entry costs à the costs paid at policy subscription;??????????????? Total costs indicator à the assessment of all costs borne by the policyholders; Reduction in yield (RIY) à its calculated according to the PRIIPs KID methodology with both wrapper and investment costs; Surrender à according to EIOPA, comparing the surrender value with the premium paid will provide valuable information to the? value-for-money assessment; Internal rate of return (IRR) à its calculated according to PRIIPs KID methodology with the RHP of the underlying investment; Insurance benefit à the premium which is given back to consumers if the insured event occurs; Break-even return à this metric will enable to understand the minimum performance of the underlying investment which is required to break even.

Please note that, according to EIOPA, these indicators should be evaluated jointly in order to assess them in a comprehensive manner.

Finally, EIOPA will evaluate the composition of the clusters and, if necessary, implement further adjustments to benchmarks applicable and/or adapt clustering criteria.

1. Data collection and calibration of the benchmarks à following the collection of data from undertakings and the calculation of the indicators, benchmarks will be established for each cluster based on the quartiles of the distribution of the indicators. Benchmarks will be set at the third quartile (Q3), except for the surrender, IRR and insurance benefit indicators for which benchmarks will set at the first quartile (Q1) because, as opposed to the other indicators, lower values represent higher value for money risk. Considering that the indicators and benchmarks require testing and possible adjustments, the methodology refers to the initial benchmark calculations, but, in order to limit the burden on the market, EIOPA will rely on the data collection process attached to the annual Cost and Past Performance (s.c., CPP) report and readjust the questionnaire and scope to ensure the collection of suitable data for both CPP report and benchmarks.

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Finally, the Benchmark Methodology has a section called "non-clustering features and other considerations" in which EIOPA states that all the abovementioned steps of the methodology do not consider other qualitative benefits that unit-linked and hybrid products can offer to consumers. Therefore, EIOPA will also collect data and inform NCAs about the following important features:

-????????? Guarantees à both 80% or more premium guaranteed at RHP and the effective date of the guarantee could be a reason for higher costs;

-????????? Digitalization à EIOPA will identify and share with NCAs the value of adding digital features to insurance products;

-????????? Risk mitigation techniques à the existence of dynamic allocation between a minimum number of assets during product lifecycle and/or between a significant number of countries/currencies/other characteristic (with the purpose of mitigating financial risks) could be considered a reason for higher costs;

-????????? High number of early surrenders and high exit costs/penalties à useful to determine if surrender metrics require investigation;

-????????? Claims rejected for the biometric coverage à to determine, for instance, if value-for-money issues exceeds the analysis of insurance benefit indicator and demands NCAs further analysis of riders, claims management and exclusions;

-????????? Results from previous years' exercises; and,

-????????? Materiality of the product à in view of the risk based of the Benchmark Methodology, NCAs can decide, for example, to entail higher costs/lower benefits because of the specific market targeted.

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It is important to highlight that EIOPA plans to conduct a regular review of the Benchmark Methodology in such a way as to ensure adjustment and improvement over time. Specifically, the Benchmark Methodology will be reviewed on a two-year basis until a certain stability is reached. Moreover, EIOPA does not plan to share benchmarks with insurance product manufacturers and/or publish them before dialogue with NCAs and only when the methodology is sufficiently tested and stable. Instead, EIOPA will circulate the benchmarks to NCAs for supervisory purposes (such as, as mentioned above, the identification of products with higher value-for-money risks).

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Finally, even though EIOPA considers them two separate areas, the developments in the area of value-for-money within the Retail Investment Strategy (RIS) may inform future reviews of the Benchmark Methodology. Indeed, the Insurance Distribution Directive (IDD) do not explicitly refer to value-for-money benchmarks. Nevertheless, Article 25 of the IDD requires insurance product manufacturers to have product oversight governance arrangements and a product approval process.

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EIOPA's Supervisory Statement of 2021 is available, only in English, at the following link: https://www.eiopa.europa.eu/publications/supervisory-statement-assessment-value-money-unit-linked-insurance-products-under-product-oversight_en.

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EIOPA's public consultation of December 2023 is available, only in English, at the following link: https://www.eiopa.europa.eu/eiopa-consults-its-methodology-setting-value-money-benchmarks-2023-12-15_en.

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The Benchmark Methodology is available, only in English, at the following link: https://www.eiopa.europa.eu/document/download/76e6a517-04e1-4f20-8e1e-712f0e2dd16b_en?filename=EIOPA-BoS-24-332%20-%20Methodology%20on%20Value%20for%20Money%20Benchmarks.pdf