The proposed Independent Insurance Authority - what’s next?
The financial sector has seen rapid transformations in the wake of the economic downturn. To accommodate these changes, Hong Kong felt it needed to improve its system of insurance regulation and replace the current Office of the Commissioner of Insurance (OCI). The OCI is the last remaining financial services regulator in Hong Kong still functioning as a Government operation but on 12 July 2010, the Financial Services and Treasury Bureau (FSTB) released a consultation paper on the proposed introduction of the Independent Insurance Authority (IIA). It was proposed that the IIA would replace the OCI as the new supervisory body for Hong Kong’s insurance industry and would be an organisation independent from Government control and funding.
Intended not only to regulate insurance companies but also intermediaries, it is anticipated that the IIA will be empowered to issue licences, conduct routine inspections and impose disciplinary sanctions against those in breach of their obligations. It will also conduct studies and market research, and perform an educational role to equip prospective policyholders more effectively with the required knowledge to enter the insurance market with confidence. The Government reviewed responses from the public and views from the industry following a three-month consultation period which ended in October 2010 and on 24 June 2011, issued revised proposals for the creation of the IIA.
The current regulatory system
In contrast to independent regulators in financial centres such as the UK and Australia, the OCI is a government department under the FSTB, currently charged with regulating the insurance industry under the Insurance Companies Ordinance. This contradicts the core principles set out by the International Association of Insurance Supervisors (IAIS) and also means the OCI is subject to the procedural requirements of the Administration, thereby causing it to lack the flexibility required to respond to the ever-changing financial sector. Financial statements and business returns are examined alongside the inspection of company premises, and currently the OCI has the authority to take measures to intervene by restricting the underwriting or investment activities of insurers. However, the OCI does not have the explicit power to enter insurers’ premises, issue reprimands or prosecute offences.
Insurance intermediaries in Hong Kong are supervised by three self-regulatory organisations (SROs) - the Insurance Agents Registration Board (IARB), the Hong Kong Confederation of Insurance Brokers and the Professional Insurance Brokers Association. The three bodies handle complaints against individual intermediaries and are able to impose disciplinary sanctions where necessary. Various issues do exist under the current system of self-regulation, namely potential conflicts of interest (as they receive funding from those they regulate), possible adoption of double-standards when dealing with complaints and disciplinary action and restricted investigatory and sanctioning authority. The OCI can direct the SROs to adjust their codes of practice but otherwise there is no direct regulation of intermediaries by the OCI.
The Hong Kong Monetary Authority (HKMA) regulates the banks and is capable of sending complaints to IARB. 30 per cent of insurance products are sold through roughly 18,000 bank staff, all of whom are registered with IARB, who supervise conduct requirements and deal with such complaints. The HKMA has no disciplinary power over bank employees and there is currently no system in place to deal with the specifically distinct nature of bancassurance.
Powers of the Independent Insurance Authority
The Government acknowledges that these were once effective measures but maintains that the OCI’s regulatory powers must be augmented to regulate and further protect policyholders’ interests more effectively. It is proposed that increased supervisory powers should be conferred on the IIA modelled on the Securities and Futures Ordinance, allowing the authority to enter into premises of those regulated and conduct inspections, access records and documents, apply to the court for orders to compel compliance with the requirements set by the IIA, impose sanctions (e.g. public reprimands, fines and revocation of authorisation) and to prosecute summary offences.
Under the proposal, self-regulation of intermediaries will be abolished and replaced with direct supervision of intermediaries’ conduct by the IIA. At present, the SROs supervise around 70,500 intermediaries in accordance with non-statutory codes approved by the OCI. The IIA will be in charge of the licensing and inspection of intermediaries as well as handling complaints and conducting investigations into misconduct. It will also be possible for the IIA to impose disciplinary sanctions.
An enhanced proposal in the recent publication intends to smooth the transition for intermediaries into the new regime. Those already registered with the SROs will be deemed to be licensed under the new regime for three years upon establishment of the IIA, and will be able to carry on business as usual whilst applying for new a new licence. The three SROs will continue in existence once the new regime is introduced, and these will continue to function as trade bodies performing tasks such as industry promotion and training.
It was initially proposed in July 2010 that the HKMA would regulate insurance products sold through banks on the basis that the HKMA would regulate bank conduct in line with IIA’s standards and would be allowed to exercise powers similar to those of the IIA. As the banks’ regulator, the HKMA would be more suited to dealing with the more sophisticated clients and sales environment that exist in the bank market compared with the ordinary insurance market. However, numerous respondents raised concerns regarding the potential risk of double-standards and inconsistent disciplinary decisions. The Government has since taken a step back from such plans and introduced a more stable option whereby the IIA, as a fundamental principle, will be primary and lead regulator for all insurance intermediaries and the only regulator to set requirements and standards of conduct. The HKMA will work closely with the IIA who will delegate to it specified powers in order to assist them with the regulation of intermediary activities in banks. Under the new proposed regime, disciplinary powers are to remain vested with the IIA and the HKMA will actively participate in the disciplinary process. It is hoped that this measure will increase the transparency of the whole operation.
Structure and cost of the Independent Insurance Authority
Non-executive directors from a cross-section of the community (including members from relevant professional fields) will make up a Governing Board to ensure the proper exercise of powers by the IIA. The initial proposals also included plans to establish a statutory appeals tribunal to deal with appeals from insurers and intermediaries against relevant IIA decisions, and an independent process review panel appointed by the Chief Executive to monitor the internal procedures of the IIA and HKMA with regards to regulating the sales of insurance products. The latest detailed proposals have seen additions to the checks and balances of the operation - the Government has now proposed to set up at least two Industry Advisory Committees, one for Life and the other for Non-Life Insurance, to utilise the experience of insurance practitioners and provide expert advice to the IIA’s Governing Board. The IIA will also be empowered to appoint expert panels to seek advice in disciplinary procedures where necessary.
It is projected that the IIA will cost HK$240 million to run per year with 237 anticipated staff. To help cover these costs, a fee structure has been formulated comprising a fixed licence fee applicable to all insurers and intermediaries, a variable licence fee payable by insurers calculated on the basis of their individual liabilities, user fees for specific services (such as applications for transfers of business) and a levy of 0.1 per cent on insurance premiums for all insurance policies. The Government aims to recover costs during the first five years of the IIA’s operation and has agreed to soften the financial blow to the industry by waiving the licence fee for intermediaries, adopting an incremental approach to achieve target levels of variable licence fees and levies on policies and granting a lump sum subsidy of HK$500 million to the IIA. Respondents have commented that the levy may in effect be prejudicial and force high premium policies offshore, and that reinsurance contracts should be exempted from the levy to avoid double-charging. As a result the prospective funding structure was modified and in the recently published detailed proposals provided for a cap to be imposed on the levy for non-life policies with annual premiums at or above HK$5 million, and life policies with single or annualised premiums at or above HK$100,000. Reinsurance contracts will also be exempted from the levy and once the IIA’s reserve reaches a level equivalent to 24 months of its operating cost, the levy and fee levels will be reviewed.
According to the FSTB, industry statistics show high premium policies only account for a small portion of the total pool and it is intended that the revised proposals will help minimise the impact on policyholders. Hong Kong, as a member of the IAIS, must strive to have an authority equipped with adequate resources and necessary legal firepower to regulate the industry efficiently and effectively. The standard has been set both locally and internationally; all facts point to the conclusion that a regulatory body operating within the Government structure has insufficient flexibility to deal with the adapting financial sector.
The proposals will undergo another course of fine-tuning as the Government once again engages the views of the industry and stakeholders. It does seem that we are heading in the right direction - it is expected that the key draft legislation will see the light of day in early 2012. Hopefully with the establishment of the IIA, Hong Kong will reach the required international standard and be in a position to reclaim consumer confidence throughout the insurance market.
For further information, please contact Marie Kwok in Hong Kong.
Legislative Council passes the Anti-Money Laundering and Counter-Terrorist Financing (Financial Institutions) Ordinance
On 29 June 2011, following two periods of public consultation, the Legislative Council passed the Anti-Money Laundering and Counter-Terrorist Financing (Financial Institutions) Ordinance (the Ordinance). The Ordinance was gazetted on 8 July 2011 and will come into force on 1 April 2012.
The Ordinance aims to develop a legislative framework which implements the requirements set down by the Financial Action Task Force, the international anti-money laundering standard setter. Schedule 2 of the Ordinance codifies customer due diligence and record keeping requirements that financial institutions will need to adopt. Financial institutions are required to carry out customer due diligence in certain specified circumstances. For example, a financial institution should complete due diligence before establishing a business relationship with a customer or entering into a transaction involving an amount equal to or above HK$120,000 (or HK$8,000 in the case of a wire transfer). Additionally, a financial institution should always carry out due diligence when it suspects that a customer or its accountant is involved in money laundering or terrorist financing.
The provisions of the Ordinance which discuss the due diligence measures to be applied to beneficiaries of an insurance policy are the same as those that were set out in the proposed Bill. Again, these are contained in Schedule 2 of the Ordinance. A financial institution must record the name of the beneficiary if he or she is identified by name. If the beneficiary is designated by description or other means, a financial institution must obtain sufficient information about the beneficiary to satisfy itself that it will be able to establish its identity at the time the beneficiary exercises a right under the insurance policy or at the time of payout.
Sections 2(1) (a), (c) and (d) of Schedule 2 of the Ordinance lists circumstances in which a financial institution may carry out simplified due diligence measures. These measures include:
- identifying and verifying the customer’s identity on the basis of documents, data or information provided by a governmental body, relevant authority and/or other reliable and independent source recognised by the relevant authority;
- if a business relationship is to be established, obtaining information on the purpose and intended nature of the business relationship with the financial institution, unless the purpose and intended nature is obvious;
- if a person purports to act on behalf of the customer, identifying the person and taking reasonable measures to verify the person’s identity on the basis of documents, data or information provided by the sources stated in (1) above.
If a financial institution fails to comply with the provisions on customer due diligence and record keeping, the financial institution commits an offence and is liable on conviction on indictment to a fine of HK$1 million and to imprisonment for two years. If an employee of a financial institution or a person who is concerned with the management of a financial institution, knowingly causes or permits the financial institution to contravene a specified provision, he also commits an offence and is liable on conviction on indictment to a fine of HK$1,000,000 and to imprisonment for two years. Furthermore, the relevant authorities are empowered to take disciplinary action against a financial institution that has contravened customer due diligence and record-keeping requirements. They can require the financial institution to take remedial action and to pay a pecuniary penalty not exceeding HK$10 million or three times the amount of the profit gained or costs avoided as a result of the contravention.
Guidelines for financial institutions on the legislative requirements are currently being developed and industry consultation will be conducted later this year.
For further information, please contact Winnie Lee in Hong Kong.
Market performance of the Hong Kong insurance industry for the first quarter of 2011
The first published statistics on the performance of the insurance market in Hong Kong in 2011 provide a divided picture, with rising premiums contrasting with falling underwriting profit.
The OCI’s provisional figures detailing the performance of Hong Kong’s insurance industry in the first quarter of 2011 reveal that total gross premiums have increased by 13.3 per cent, when compared to the same period in 2010, and now total HK$56.3 billion.
General insurance business stood at HK$10.3 billion in gross premiums, a rise of 11.2 per cent compared to the first quarter of 2010, while net premiums rose by 8.4 per cent over the same period to HK$7 billion. However, the overall underwriting profit of general business fell by 13.8 per cent from HK$559 million in the first quarter of last year to $482 million this year.
The growth in premiums in the general insurance business was driven by an increase in accident and health business (with net premiums up 11.1 per cent compared with the first quarter of 2010 to HK$2.4 billion), good growth in general liability business (up 16.1 per cent to HK$13. billion) and a increase in motor vehicle premiums (growing 6.4 per cent to HK$650 million).
Meanwhile, the underwriting profit of direct insurance business decreased slightly this year, falling from HK$383 million in the first quarter of 2010 to HK$370 million. While the employees’ compensation business turned 2010’s first quarter loss of HK$50 million into an underwriting profit of HK$4 million, the OCI reported that a deterioration in claims experience led to a fall in the underwriting profit of motor vehicle business from HK$61 million to HK$2 million.
The new office premiums business (excluding retirement scheme business) performed particularly strongly in the first quarter of the year with premium growth of almost a third (32.1 per cent) in comparison with the same period in 2010, taking total new office premiums to HK$16.9 billion. This overall figure includes an increase in new office premiums in the individual life and annuity (linked) business of 28.7 per cent to HK$11.2 billion and an even more impressive 40.4 per cent growth in individual life and annuity (linked) business to HK$5.6 billion.
Of the total new office premiums issued in the first quarter of 2011, 9.9 per cent (amounting to HK$1.7 billion) were issued to Mainland visitors.
Within reinsurance inward business, the increase in net premiums from HK$1.3 billion to HK$1.4 billion was primarily attributable to the strong growth in the property damage business. But this area also suffered from a drop in underwriting profit from HK$175 million to HK$113 million which the OCI attributes to adverse claims experience.
The figures illustrate a good start to 2011, particularly in terms of premium growth, whilst emphasizing the need to concentrate on underwriting profit going forward.
For further information, please contact Wynne Mok in Hong Kong.