The Hong Kong government has launched a reform of the insurance sector which will lead to the creation of an independent Insurance Authority. Caroline Thomas, Senior Associate, Holman Fenwick Willan, offers her thoughts on what this might mean for Hong Kong.
Professor KC Chan, The Secretary for Financial Services and the Treasury (Financial Secretary), has described the establishment of an independent Insurance Authority (iIA) in Hong Kong as ‘the most important regulatory reform in the insurance sector since the passage of the Insurance Companies Ordinance in 1983’. This article seeks to explain why the government chose to establish an iIA, sets out where we are currently at in the process, gives a summary of what the reforms entail and finally offers some thoughts on what this all might mean for Hong Kong.
Reasons for the reforms
The iIA is an inevitable development in light of the global trend of increased insurance regulation and in particular the Insurance Core Principles (ICPs) issued by the International Association of Insurance Supervisors (IAIS). The IAIS, of which Hong Kong is a member, is the international standard setting body responsible for developing principles, standards and other supporting material for the supervision of the insurance sector and assisting in their implementation. The IAIS, a member of the Financial Stability Board, is routinely called upon by the G20 leaders and other international standard setting bodies to provide input on insurance issues as well as on issues related to the regulation and supervision of the global financial sector.
The IAIS has established the principle that a supervisory authority for the insurance sector should be independent of the government. ICP 2.4 reads: ‘The supervisor and its staff are free from undue political, governmental and industry interference in the performance of supervisory responsibilities. The supervisor is financed in a manner that does not undermine its independence. The supervisor has discretion to allocate its resources in accordance with its mandate and objectives and the risks it perceives.’
However, under Hong Kong’s current regulatory regime, the Insurance Authority is personified in the Commissioner of Insurance (a civil servant) who is supported by the Office of the Commissioner of Insurance (OCI). Further, intermediaries (namely agents and brokers) are regulated by the Insurance Agents Registration Board (administered by the Hong Kong Federation of Insurers (HKFI)), the Hong Kong Confederation of Insurance Brokers and the Professional Insurance Brokers Associations, which are so-called self-regulatory organisations (SROs) and thus closely connected to industry.
Thus the current regulatory arrangements in Hong Kong clearly do not comply with ICP 2.4 – the OCI is not independent from the government, and the SROs are not independent from the industry.
Independence is not the only aim of the reforms, however. The Legislative Council Brief dated 16 April 2014 (Brief), with which the Insurance Companies (Amendment) Bill 2014 (Bill) was introduced to Hong Kong’s Legislative Council (LegCo) in April 2014, lists two objectives of the iIA – prudential regulation (to ensure that insurers are financially sound) and conduct regulation (to ensure that sale and after-sale of insurers and insurance intermediaries are conducted honestly, fairly and professionally).
As regards prudential regulation, the Brief notes: ‘the challenges in the coming years are to implement a risk-based capital framework for insurers and observe the IAIS’s requirements on macro-prudential surveillance, group-wide supervision and corporate governance of insurers’. As regards conduct regulation, the Brief notes: ‘there has been rising public expectation of robust oversight of insurance intermediaries, especially when insurance products are getting more sophisticated and diversified (such as …annuities for retirement planning …)’.
Where are we in the reform process?
The Bill was passed by LegCo on 10 July 2015 and gazetted on 17 July 2015 as the Insurance Companies (Amendment) Ordinance (Amendment Ordinance). The Amendment Ordinance will come into operation on a date to be specified by the Financial Secretary in the Gazette. It will launch in three stages, over two to three years, to allow for a smooth transition from co-regulation by the OCI and the SROs to regulation by the iIA.
As stage one, the government plans to establish the Provisional Insurance Authority (PIA) by the end of 2015. The PIA will hire staff and lease offices etc. In stage two, which is likely to take place in late 2016 or 2017, the PIA will be renamed the ‘Insurance Authority’. This body, as the iIA, will take over the duties of the Commissioner of Insurance and the OCI such as the prudential and conduct regulation of insurers and enforcing the anti-money laundering regulatory regime. On 9 October 2015 the Financial Secretary gazetted a commencement notice which seeks to bring into effect from 7 December 2015 the provisions of the Amendment Ordinance which are necessary for the establishment of the PIA (that is, stage one).
During stage two, the regulation of insurance intermediaries by SROs will continue but preparations will be carried out for stage three, which is likely to take place in late 2017 or 2018 or later, in which the iIA will take over these functions. Stage three is a major shift – a statutory licensing regime for insurance intermediaries will replace the SROs.
Schedule 11 IO (Insurance Ordinance) provides for the savings, transitional and supplemental arrangements that relate to the Amendment Ordinance and provides that for a three-year transitional period, beginning on the day stage three is implemented, intermediaries licensed by SROs will be deemed validly licensed and that disciplinary and appeal cases arising while the SRO regime was in force, will be followed up by the iIA applying the rules/codes of conduct that were valid at the time.
What do the reforms entail?
The Amendment Ordinance is what is termed an amendment ordinance. It amends the Insurance Companies Ordinance and renames it the Insurance Ordinance (IO) to reflect the fact that its application will significantly widen. In this article, I will focus on the five aspects of the iIA set out below.
1. Legal structure, composition and financing
The iIA will be a body corporate (and no longer part of the government). It will be made up of a chairperson, a chief executive officer and no fewer than six other directors of whom a majority must be non-executive directors (NEDs) (new Sections 4AA(1) and (2) IO). At least two NEDs must have industry knowledge and experience and the others must have knowledge and experience in other areas such as actuarial science, accounting, law and consumer affairs (new Sections 4AA(3)(a) and (b) IO). The iIA is required to appoint at least two industry advisory committees – one for long term business and the other for general business (new Section 4C IO). It is expected that there will be periodic meetings and that the committees may use these to raise industry concerns with the iIA.
Annex E to the Bill records that, as at April 2014, the OCI had 150 staff members, including the Commissioner of Insurance, 48 insurance officers, 22 officers of the general grades and 79 non-civil service contract staff. It is proposed that, to achieve the desired institutional independence and operational flexibility, the iIA should recruit its own staff, with the OCI’s current staff being retired, redeployed to other departments or otherwise (it is expected that some OCI staff will apply for iIA roles). At inception, the iIA is likely to have over 50% more staff than the OCI currently has (around 250 staff). This increase is in part explained by the fact that the iIA will take over the regulatory roles of the three SROs.
The iIA is to be self-financed (giving rise to savings to the public coffer of HK$110 million per annum, being the recurrent funding for the OCI). The proposal is that the government will make a lump sum provision of HK$500 million to the iIA to facilitate its initial operations and that the iIA will eventually be financed solely by:
licence fees payable by insurers and insurance intermediaries (which will be waived for the first five years), user fees for providing specific services by the iIA, and
a levy of 0.1% on insurance premiums (which levy will be prescribed by subsidiary legislation).
It is proposed that the levy will be introduced over a five-year period (Y1 0.04%; Y2 0.05%; Y3 0.06%; Y4 0.07%; Y5 0.085%; Y6 0.1%), subject to caps of HK$100 per life insurance policy and HK$5,000 per non-life insurance policy in a year.
2. New licensing and corporate governance requirements for insurers
An authorised insurer will not be able to appoint an individual as controller (as defined in new Section 13A(12) IO and including the managing directors and chief executive); or a director (new Section 13AC IO); or a person in a ‘control function’ of an insurer (excluding captives) without iIA approval. The term ‘control function’ is defined in new Section13AE(12) IO and includes the following functions: risk management, financial control, compliance, internal audit, actuarial and intermediary management.
In all cases, iIA approval will not be forthcoming unless it is satisfied that the individual is a fit and proper person (as defined in new Section 14A IO) to be so appointed. Approval can also be revoked. This gives the iIA the power both to block and revoke appointments of ‘controllers’ and directors (which the current Insurance Authority already has) and persons in ‘control functions’. The iIA will have similar powers to block and revoke the appointment of actuaries (new Section 15 IO).
3. New licensing and corporate governance for intermediaries
Currently the SROs collectively issue five categories of licences and these same categories of licence will be issued by the iIA (see box below).
The crucial point to note is that the iIA regime is activity-based, the idea being that persons who engage in ‘regulated activities’ (be they individual insurance agents, technical representatives of insurance agencies or insurance broker companies, or employees of insurers) should be subject to the same licensing and conduct requirements (Section 64G IO). It will be an offence, punishable by fine and even imprisonment, under new Section 64G(4) IO, for a person to (or hold themselves out as) carry out a ‘regulated activity’ without a licence.
The new Schedule 1A of the IO will contain the definitions set out below.
Part 1 Regulated Activity
- Any of the following is an act specified for the purposes of Section 3A(a)—
- the act of negotiating or arranging a contract of insurance
- the act of inviting or inducing, or attempting to invite or induce, a person to enter into a contract of insurance
- the act of inviting or inducing, or attempting to invite or induce, a person to make a material decision, and the act of giving regulated advice.
The definitions of ‘material decision’ (contained in new Part 2 to Schedule 1A IO) and ‘regulated advice’ (contained in new Part 3 to Schedule 1A IO) are respectively making a decision in relation or giving an opinion in relation to the following:
- the making of an application or proposal for a contract of insurance
- the issuance, continuance or renewal of a contract of insurance
- the cancellation, termination, surrender or assignment of a contract of insurance
- the exercise of a right under a contract of insurance
- the change in any term or condition of a contract of insurance, and
- the making or settlement of an insurance claim.
There are some exceptions to the new licensing requirements, for example for counsel, solicitors, public accountants, actuaries and loss adjusters (new Section 123(1) IO) but also for (re)insurers and intermediaries. For example, a new Section 123(2) IO will provide that a person acting on behalf of an authorised insurer or a licensed insurance intermediary is not prohibited from carrying on a regulated activity if carrying on that activity only involves the discharge of clerical or administrative duties for the insurer or the intermediary.
New Section 123(3) IO provides that employees of authorised captives and authorised reinsurers are also exempt from the licensing regime (the rationale is that they do not distribute insurance to consumers). New Section 123(4) IO provides that an employee of an authorised insurer does not need to be licensed if he carries on a ‘regulated activity’ that only involves the discharge of underwriting or claims handling duties for an insurer. There remain some grey areas, such as whether employees of insurers who have settlement authority require a licence. These will hopefully be addressed in guidelines which the HKFI is pushing the government to publish. It is not inconceivable that the iIA will establish new licence categories for the staff of insurers as the above listed five categories of licences do not obviously cater for them.
Every licensed business entity (see above table) must appoint a responsible officer (RO), who must be approved by the iIA, and who must be given sufficient resources to promote compliance with the Insurance Ordinance (new Sections 64ZE and F IO). ROs will be responsible for ensuring that internal and control systems are in place to promote compliance with the conduct requirements within a body corporate. The iIA will have the power not to approve an RO unless it is satisfied that the individual is a licensed technical representative and is fit and proper.
4. The iIA’s new powers
The sections of the iIA Ordinance setting out the iIA’s powers have borrowed from the legislation that establishes the Securities and Futures Commission (SFC). Consequently the iIA will have teeth – namely express powers to conduct inspections, initiate investigations and impose disciplinary sanctions on authorised insurers (Part VA and amendments to Part X IO). A licensee guilty of misconduct or considered not fit and proper will be subject to disciplinary sanctions, including suspension or revocation of licence or financial penalty up to the greater of HK$10 million or three times the amount of the profit gained or loss avoided (Section 81(4)(e) IO) and/or a reprimand.
The iIA’s powers will be draconian and one concern that was raised was that the iIA’s function of carrying out investigations and making disciplinary decisions might not be sufficiently separated. (By contrast Hong Kong’s new competition regime is divided into a Competition Commission that investigates and prosecutes offences and a Competition Tribunal which sanctions them.) A proposal that the iIA should be mandated to consult the proposed expert panel before making major disciplinary decisions, such as the revocation of licences, was rejected. However, assurances have been made that the iIA will put in place ‘Chinese walls’ to ensure that its investigative staff will not be involved in the disciplinary process and the determination of disciplinary sanctions. Furthermore, the iIA is likely to make reference to fining guidelines similar to those currently adopted in other financial regulatory regimes to be taken into account when determining the quantum of a pecuniary penalty.
5. The establishment of the IAT
New Part XII and Schedule 10 of the IO establish the Insurance Appeals Tribunal (IAT). Again, the sections of the IO relating to the IAT will be based on the legislation creating the tribunal to which SFC decisions can be appealed. The chairperson of the IAT must either be a former judge or must be eligible for appointment as a judge. For determining a review, the Financial Secretary, on the recommendation of the chairperson, must appoint two panel members as ordinary members in relation to the review.
Reviews to the IAT must be brought within 21 days (new Section 100 IO). The IAT can determine reviews in respect of iIA decisions (for example, authorisation, licensing and disciplinary decisions) and has the power to confirm, vary or set aside the decision; or remit the matter to the iIA with any directions it considers appropriate (new Section 101 IO). It has the discretion to award costs (new Section 106 IO). However, late in the legislative process, specific provisions were added to the Bill providing that, with the consent of both parties to the review, the IAT may make a determination on the basis of written submissions only. This documents-only procedure (new Section 102(2) IO) is aimed at giving appellants a lower cost alternative.
Conclusion and what next?
An independent and professional insurance regulator whose statutory functions include ‘promoting competitiveness of the insurance industry in the global insurance market’ (new Section 4A(2)(f)(ec) IO) should bring Hong Kong in line with modern supervisory standards and practice and enhance the standing and stability of the jurisdiction. Section 4A(2)(f)(ec) IO was added following consultation and it will be very interesting to see how the iIA interprets it. Certainly Hong Kong’s insurance industry faces significant competition from Singapore.
There is no doubt that the introduction of the iIA will lead to more regulation of the insurance industry in Hong Kong, with the iIA empowered to adopt a watchdog role similar to the SFC and the Hong Kong Monetary Authority. Many of the details will be spelt out in guidelines and revised codes of conduct to be published by the iIA in due course. These codes and guidelines are expected to draw out the differences between the two types of intermediary – broker and agent, and hopefully clarify what the requirements on intermediaries to act in the best interests of policy holders and to disclose conflicts of interest (new Sections 90 IO) will mean for both – and specifically for insurance agents. It is likely that the iIA will require intermediaries to disclose commissions or other advantages received.
The introduction of the iIA may well have repercussions for the structure of the Hong Kong insurance market. Not only will the iIA likely be a more stringent regulator, but more reforms are to come – the government has signalled that the iIA will introduce further reforms including risk-based capital, a policy holders protection fund, group wide supervision and increased consumer protection. It is not inconceivable that the increased regulatory burden (and risk-based capital or insurers) will trigger consolidation – Hong Kong being a small market with many players.
That said, there is still time to adapt and insurers and intermediaries should avail of this time to prepare themselves for the upcoming changes.
Holman Fenwick Willan