2015 promises to be busy year of regulatory activities for the insurance industry. Here, we review some of the most important developments that the industry will need to contend with in the coming months.
2014 will be a year to remember in Hong Kong. The Occupy Central movement brought entire districts to a quasi-halt, as pro-democracy activists pitched tents, staged sit-ins and unfurled a sea of umbrellas across large swathes of the city.
As protests showed no signs of abating, stretching into a second month, and a third, concerns started to mount over the movement’s impact on the economy. The retail and tourism sectors were feared to be hit the hardest.
As it turned out, the impact Occupy Central had on the insurance sector was minimal at best. The insurance industry grew solidly, largely oblivious of the events unfolding in the streets – the peaceful nature of the protests meant that business interruption policies, typically tied to property damage, were not enforced.
While protesters shouted “True Universal Suffrage”, demanding a greater say in the next election of their Chief Executive, insurers were busy voicing out their concerns over the raft of sweeping reforms being devised by the regulator and expected to hit the market in 2015.
So, what does 2015 have in store for the Hong Kong industry? The changes awaiting insurers, some of which will take place this year while others are expected in the following years, are nothing short of revolutionary.
2015, too, will be a year to remember for insurers.
IIA – Three letters that spell fundamental change
Coming down the pike in 2015 is the establishment of an independent regulator, the Independent Insurance Authority (IIA). The new authority body will replace the existing Office of the Commissioner of Insurance, a government department headed by the Insurance Authority (IA), under the Financial Services and the Treasury Bureau (FSTB).
The move will bring Hong Kong in line with international practice with the new regulatory body being financially and operationally independent from the government. The IIA will be financed through a levy of 0.1% on all insurance premiums, although it remains unclear whether this amount will be capped.
The IIA will have enhanced supervision power and will oversee all insurance practitioners in Hong Kong. It will also work together with the Hong Kong Monetary Authority to oversee the sales of insurance products by banks.
This will de facto put an end to the two-tier regulation that has prevailed in Hong Kong for more than 30 years.
Under the current regime, insurers and reinsurers fall under the direct supervision of the OCI, while insurance agents and brokers are supervised by either one of the three self-regulatory organisations: the Insurance Agents Registration Board under the Hong Kong Federation of Insurers and in the case of brokers, the Hong Kong Confederation of Insurance Brokers and the Professional Insurance Brokers Association.
Differences in expectations over IIA’s disciplinary powers
The IIA will see to it that intermediaries act in the “best interest” of customers. This provision has drawn the ire of insurers – read the HKFI – for two reasons: unlike insurance brokers, insurance agents, who represent insurers, have a contractual obligation to work in the best interest of insurers, they argued, and not that of their clients. And the disciplinary sanctions outlined in the blue print for intermediaries found liable of misconduct are excessive, they said.
The extent to which IIA’s disciplinary powers will be enhanced is also a concern to the HKFI, which is calling for greater oversight of IIA’s disciplinary procedures. The IIA will be granted power to inspect premises, investigate and impose sanctions - it will be able to suspend or revoke licences, dole out fines, and even recommend prison sentences.
The OCI argued that these added powers will merely put it on par with the SFC, the banking regulatory body, and that statutory safeguards are in place – a right of appeal to the Insurance Appeals Tribunal is guaranteed. But the HKFI countered that the current proposal lacks a system of checks and balances, and said it has obtained legal advice from a London Silk to rebut.
Responsibility Officer
Another key measure that the IIA will require from insurers and reinsurers operating in Hong Kong is the appointment of a Responsibility Officer, whose duty will be to ensure compliance and observance of internal controls by staff and tied agents.
The initial proposal by the OCI that CEOs, no less, were best suited to take on these added responsibilities sent shockwaves across the industry. CEOs can now breathe a sigh of relief – they are now “off the hook”. But risk officers will still have to be approved by the IIA.
Additional costs an issue too
“The anticipated increase in operational costs such as levy, accrediting/licensing charges or additional costs such as ERM auditing fee and compliance cost for fulfilling the regulatory requirements on Filing, Reporting and Licensing may cause resistance from insurers,” said Mr Andrew Mak, Deputy Head of Underwriting at Peak Re.
Exactly when the IIA will be operational is unknown. The Bill is supposed to be passed in mid-2015, but the intricacies of the legislative process make it impossible to say whether the IIA will be on its feet before the end of the year.
RBC – A new regulatory framework for Hong Kong
The OCI is in the process of developing a risk-based capital regime for the Hong Kong insurance industry. And while insurers would probably not be subjected to the new regime for another two to three years, the wheel has been set in motion.
If the shift to a RBC solvency regime has the potential to be disruptive, with many foreseeing that it will trigger a wave of consolidation and drive smaller insurers out of business, it is also one for which insurers and reinsurers in Hong Kong will be given ample time to prepare.
Some way to go before implementation
The OCI is still reviewing responses to a consultation paper launched in September last year, in which it outlined the contours of the proposed Risk-Based Capital Framework.
“The HKFI welcomes Risk Based Capital development but the industry needs a lot more detail on the proposals which at this stage are rather high level,” said Mr David Alexander of Swiss Re, who is Chair of the HKFI’s taskforce on RBC.
The OCI still needs to flesh out detailed rules, a process that it said will be carried out by taking into account the inputs received during the consultation process. The detailed rules will also be subject to another round of consultations, while a quantitative impact study is conducted. Then the legislation will need to be amended, an exercise that could take a while. In short, it will not be happening tomorrow.
More holistic risk sensitive approach
The new regime will replace the existing rule-based adequacy framework, in place since the 1980s and largely inspired from Solvency I, in which solvency margin requirements are simply determined as a percentage of insurers’ liabilities on their books. The minimum solvency ratio requirement is 100% for all insurers, but in effect the IA expects life insurers to maintain a solvency ratio of 150% and of 200% for general insurers.
The upcoming RBC framework will embrace a much more holistic risk-sensitive approach, by imposing tougher risk management and capital requirements on both direct insurers and reinsurers authorised to carry out insurance business in Hong Kong, whether they operate as locally-incorporated entities or as branches of overseas corporations.
It introduces a myriad of risks (underwriting risk, credit risk, market risk, operational risk, liquidity risk and other non-quantifiable risks) that insurers will need to address, either by, depending on the risk concerned, shoring up their capital reserves or by satisfying the requirements that they have the adequate risk management safeguards in place.
The framework is not without similarities to Basel III, the regulatory framework meant to rein in excessive risk-taking among banking institutions.
Converging with world standards
The move towards a RBC framework is to be understood in a context of globalisation of insurance standards. It will enable Hong Kong to comply with the Insurance Core Principles (ICPs) set out by the IAIS, which seeks to foster convergence towards globally consistent supervisory frameworks.
It will put Hong Kong on par with the group of more advanced economies, many of which had initiated the shift to more risk-sensitive regulatory frameworks in the aftermath of the Global Financial Crisis.
Other economies in the region have either totally revamped their regulatory framework or have been seen tinkering their supervisory regime to embrace the global trend, and the consensus across the region is that Hong Kong has been surprisingly slow in getting on the regulatory bandwagon.
Some concerns
However, many in the market believe that this measure could drive smaller insurers out of the picture, by imposing higher capital requirements and driving up compliance and administrative costs on players already operating on tight margins.
But the OCI came out a few times to say that it will ensure that small and medium insurers are not penalised by the new rules. The RBC, it said, will not necessarily translate into higher capital requirements, contrarily to what is commonly perceived.
Industry observers have also warned against a potential wave of divestments, as insurers get more selective with their capital allocation and shun capital-intensive lines of business.
Reinsurers could also stand to benefit as insurers, eager to stay in the game, could resort to capital relief transactions.
Need to maintain Hong Kong’s competitiveness
There are also concerns that the ease of doing business, once a defining feature of Hong Kong, might give way to a cumbersome regulatory environment, leading the city to lose its business appeal and undermine its ambitions to become the insurance hub of the region.
Mr Alexander holds similar views. “The new regime needs to ensure a balance between policyholder security and cost, to maintain the competitiveness of Hong Kong as a Financial Centre, and to gain ‘equivalence’ and seek ‘equivalence’ with other regimes.”
He added: “The industry would like to see transparent consultation and governance over the process of the development of the RBC regime. In particular there should be some appeal mechanism if the industry feels the rules and/or capital requirements are too severe and would jeopardise the competitiveness of Hong Kong or cost customers too much.”
Others applaud the changes
Others like Ms Penny Fosker, Regional Director, Risk Management Practice of Towers Watson Asia Pacific, believes the upcoming changes are good.
She said in a recent report: “The framework will drive them (insurers) to become more vigilant in optimising their risk-return trade-offs, which in turn, will facilitate sustainable growth and development. From a macro perspective, these developments will enhance the attractiveness of the Hong Kong insurance market and help Hong Kong to maintain its regional and global competitiveness.”
Mr Mak of Peak Re also welcomed the implementation of the RBC framework. “Insurers will need to mitigate their insurable risks while alleviating their financial needs, and we will assist our clients in achieving the optimal balance by the means of reinsurance,” he said.
VHIS proves a headache to life insurers
The reform to the health care system, known as the Voluntary Insurance Health Scheme (VHIS), is another milestone measure that will reshape the face of the Hong Kong health insurance industry, and one that has not left life insurers unfazed.
In December last year, the government launched a public consultation on the much-debated scheme that aims to offer standardised medical coverage through a government-regulated, market operated health insurance scheme, the equivalent of a Hong Kong, stripped down version of Obamacare.
The idea behind the government’s healthcare reform plan is to render private healthcare more affordable and therefore more attractive, in an attempt to reduce strain on public coffers, and bring relief to a public health sector operating at full capacity.
Public health expenditures by government escalating
With public health expenditures expected to increase as the share of the elderly increases and with medical inflation showing no sign of abating (medical inflation hovered in the 8-10% range in 2012, according to the HKFI), the government is looking at ways to get the private sector to foot part of the bill.
The government spent HK$52 billion (US$6.67 billion) on healthcare in 2014-15, accounting for 17% of the total recurrent expenditure of the government, and that share will increase dramatically in the coming years if nothing is done, it warned.
The problem, the government said, lies with the fact that, despite the relatively high take-up rates of private health insurance in the city, with about two million holding indemnity hospital insurance, the private health sector remains largely underutilised.
Dr Ko Wing Man, Secretary for Food and Health, the government department spearheading the reform, was quoted as saying that people holding private healthcare insurance still account for half of public hospital admissions. That figure is disputed by the HKFI.
Individual hospital indemnity insurance products
At the centre of the government’s reform agenda is the provision of individual hospital indemnity insurance products, designed to cover hospital charges and medical-related expenses. All individual plans offered by insurers will need to meet a list of 12 mandatory requirements set out by the government.
Those include guaranteed acceptance for all, no lifetime benefit limit, guaranteed renewal and portability of policy without reassessment, coverage of pre-existing conditions with premium loading capped at 200%, to name just but a few. The government is also looking to create a High Risk Pool that will be financed through public funding.
The HKFI has expressed concerns about the viability of some of the measures floated by the government in its preliminary proposals, adding that these measures go against the fundamental operating principles of insurance.
Among the most controversial points is the standard premium level – HK$3,600 – suggested by the government, which is seen as excessively low and potentially misleading. The mechanisms ruling the High Risk Pool are unclear and its financial viability in the long run doubtful, the HKFI said.
Doctors and hospitals should also be subject to greater pricing transparency, not just insurers, for the scheme to work, it argued. Package pricing for common procedures should be adopted by hospitals.
Insurers hard pressed to offer viable products following reform
The HKFI also lamented the lack of choice that this regulatory reform imposes – insurers should be in a position to offer a range of private healthcare products alongside the newly regulated products, which in some cases, offer a much more economical option to meet the needs of customers, they argued. Failing to do this will only steer people away from the private sector and send them back into the weary arms of the health public sector, a development that would defeat the entire purpose of the VHIS, it said.
The HKFI has submitted a revised version of VHIS proposing ways to make the scheme viable and sustainable. The consultation ends in mid-March as AIR goes to press.
ILAS kept on a tight leash
The Investment-Linked Assurance Schemes (ILAS) business has undergone dramatic changes in recent years. It started the year 2015 on a rocky footing too.
ILAS products have come under close scrutiny from the regulator after a raft of highly publicised media reports linked them to aggressive sales practices and mis-selling.
The most significant change affecting ILAS is probably the ban on indemnity commissions that was enforced on 1st January 2015, a measure that will particularly affect IFA companies who rely heavily on such commissions. Commissions on ILAS products can now only be paid on an earned basis.
IFAs selling ILAS are also now required to conduct after sales calls to ensure clients understand the specific features and risks ILAS products carry – a measure that used to apply only to “vulnerable” customers. Commission amounts will now also need to be disclosed.
The OCI has been keeping ILAS on a watchful eye for a while. The regulator introduced a series of measures in 2013, after commissioning a series of mystery shopper calls and visits that exposed discrepancies in the sales process of such products.
Many argued though that these additional measures, the latest in a long series taken by the regulator aimed at better protecting investors, have rendered the whole sales process overtly cumbersome and contributed to a dramatic drop in the sales of ILAS in Hong Kong.
But the measures introduced over the years have not been in vain, according to the regulator.
“The number of complaints relating to ILAS policies has substantially dropped from over 500 in 2009 to around 350 in 2014. We expect the number of complaints to decrease further in the coming years,” Commissioner Annie Choi of the OCI told Asia Insurance Review.
CIES revoked in another blow to ILAS industry
In another blow to the ILAS industry, the government revoked the Capital Investment Entrant Scheme in January 2015. The programme, launched in 2003, allowed foreign nationals to set up residence in Hong Kong, in exchange for investments of HK$10million in certain designated investment vehicles.
These included real estate (but only until October 2010, the government then decided to exclude real estate investments from the scheme in a bid to dampen the inflationary pressures affecting the Hong Kong residential market), funds run by asset management companies, and since July 2010, ILAS.
The plan was particularly popular with Mainland Chinese, who made up 90% of the 25,000 candidates approved under the programme. It was also believed to have provided a significant boost to life insurers selling ILAS.
Ms Choi said the suspension of the CIES will not have a significant impact on the insurance industry. “The premium income of the specific ILAS products qualified under CIES only accounted for about 1% of the total premium of the Hong Kong insurance industry in 2014,” she said.
This scheme was lauded as presenting significant opportunities for lifers in Hong Kong and at least 10 life insurers were participating in that scheme. But the plan by the government to scrap the scheme caught the market by surprise, and will force life insurers to look for other revenue streams to maintain their growth rates.
Policyholder Protection Fund – Who protects the insurers?
The government has also been mooting plans to introduce a Policyholder Protection Fund (PPF) that would protect policyholders in the event of an insurer’s insolvency.
A consultation process was launched in 2003, and 12 years on, it is unclear as to when exactly the PPF will be launched. The fund was expected to be up and running in 2014, but a public consultation is still underway and the government is believed to be still in discussion with the industry on the parameters of the fund. The industry expects the government to introduce a Bill in the Legislative Council sometime in 2015.
At present, there are two insolvency funds for statutory motor and employees’ compensation insurance but none offering a financial backstop to general and life insurance policyholders.
The PPF will consist of two distinct funds – one for life insurance and one for general insurance (GI) policyholders. Funds would pay policyholders up to HK$1 million in the event of an insurer’s insolvency.
The mere idea of the PPF, when first floated by the government, received mixed support. While some welcomed the move, arguing that it would contribute to enhancing trust in the industry, others said that it will introduce moral hazard and encouraged irresponsibility among insurers in the pricing of their policies.
While discussions continue, outstanding issues of fundamental importance remain, said the HKFI, which if left unchanged, could have a significant impact to the industry, it warned.
SMEs should not be included
Among the most disputed points is the decision by the government to include SMEs in the plan. The initial version of the PPF, when first introduced by the government, was meant to cover Life and GI individual policyholders only. The government subsequently decided to include SMEs in the plan. The HKFI contended that the fund size is too small to cater for the SME segment, which is exposed to an array of complex risks with long-tail liabilities.
There should also be a cap on levies, it argued. Under the current proposal, insurers will be required to pay 0.07% of their premium income for 15 years after the set up of the PPF, but the rate will be increased significantly, should an insurer become insolvent.