The proposed Independent Insurance Authority (IIA) is set to align the regulatory regime with international standards.
The Global Financial Centres Index 2010 places Hong Kong behind only London and New York as one of the top three financial centres in the world. The Asian region, as a whole, emerged from the 2007 world financial crisis largely unscathed in comparison to western Europe and the US. As a result, leading international companies continue to flock to Hong Kong to grasp opportunities for corporate growth in the region.
This is no less the case for leading multinational insurers who are looking for opportunities to expand, particularly as the more established, mature insurance markets offer multinational insurers less scope for growing returns.
Hong Kong has long recognised the potential to draw in insurance investment. However, the regulatory infrastructure has, until now, lagged behind the more developed markets. Although the Hong Kong market is changing, large insurance companies offering a wide range of sophisticated products to a potentially massive market inevitably brings increasingly complex market issues that require a strong, independent regulator. As a consequence, it has been recognised that the Hong Kong regulator needs to rise to meet the challenge.
With this in mind, the Financial Services and the Treasury Bureau (FSTB) of Hong Kong has recently completed a public consultation on plans to establish an IIA. This move would replace the Office of the Commissioner of Insurance (OCI). At present, the OCI is the only financial services regulator in Hong Kong that operates as a government department.
The aim of establishing the IIA is to:
- enable better regulation of insurers and insurance intermediaries;
- provide enhanced protection for insurance policyholders; and
- maintain market stability and competitiveness.
However, the driving objective is clear: to align Hong Kong’s insurance industry with international practice, by the establishment of a regulator that is financially and operationally independent of the government. It must be a regulator that can react to the demands of an increasingly complex insurance market.
An enabling bill is, on current planning, likely to be put to the Legislative Council this year, with a view to the IIA being in place by 2012 or 2013.
Current framework
Unlike most international financial centres, Hong Kong’s insurance industry is not currently regulated by an independent regulator. The current framework is financially and operationally dependent on the Hong Kong government through the Insurance Authority (IA) and the OCI.
The IA, which is responsible for the regulation of the insurance industry under the statutory framework of the Insurance Companies Ordinance (Chapter 41), is a government department under the FSTB. The IA operates through the OCI and the employees of the OCI are therefore, essentially, public servants. As a result, the OCI is subject to government rules and procedures, and is perceived to lack the flexibility to be able to respond quickly to rapid changes and new challenges.
At present, insurers are regulated by the IA through the examination of their financial statements and business returns, as well as on-site inspections. Further intervention measures, such as restricting underwriting and investing activities, removing directors and controllers, taking over companies, and petitioning the court for winding up, are also available to the IA under the Insurance Companies Ordinance. However, unlike regulators in other more developed markets, the IA does not have explicit powers to enter the premises of insurers to conduct inspections and investigations, issue reprimands, impose fines or prosecute offences summarily.
The absence of these powers, and the absence of an independent regulator in Hong Kong in general, is not, of course, in accordance with international practice, nor is it in keeping with the core principles stipulated by the International Association of Insurance Supervisors, of which Hong Kong is a member.
Proposed reforms
Although the existing regime has worked well in the past, the rapid changes in the international financial market have highlighted the need to enhance the IA’s regulatory powers to better regulate the insurance industry and safeguard the interests of policyholders.
Since 1995, Hong Kong insurance intermediaries have been overseen by three self-regulatory bodies:
- 1) Hong Kong Confederation of Insurance Brokers;
- 2) Professional Insurance Brokers Association; and
- 3) Insurance Agents Registration Board.
In addition to criticism of the limited powers of the IA as regards limited investigatory and sanctioning powers, this existing system of self-regulation has drawn criticism as regards conflict of interests, because the self-regulated bodies are trade bodies financed by the same members they are supposed to regulate. Further, as a result of having these three self-regulatory bodies, inconsistencies have arisen in the standards and mechanisms adopted for complaints handling, investigation and disciplinary actions, and this has also been cited as falling short of international requirements.
So, under the new proposals, these bodies would be licensed and required to comply with enhanced supervision by the new IIA. The self-regulatory bodies would then revert to ordinary trade associations. At present, other than the IA’s role in directing these bodies to issue and amend codes of practice and produce information, there is no direct regulation of insurance intermediaries by the IA.
The FSTB has proposed several major changes. These specific proposals were set out in a consultation paper circulated last year. In summary, the proposals are as follows:
- The IIA will replace the OCI and take over the regulatory function of overseeing the insurance industry. The IIA will regulate the insurance intermediaries previously subject to self-regulation. This will include regulation of licensing, inspection, complaints handling, investigation into misconduct and imposing disciplinary sanctions. Under the proposals, the existing self-regulatory organisations will, as noted above, continue to act as trade bodies performing tasks such as industry promotion and training.
- The IIA will be given new supervisory and disciplinary powers modelled on the existing Securities and Futures Ordinance (Chapter 571), including powers to:
- enter into premises of regulated entities to conduct inspections;
- obtain access to records and documents;
- make applications for court orders to compel compliance with the reasonable requirements imposed by the IIA in the course of inspection and investigation;
- impose sanctions such as public reprimands, fines and full or partial suspension, or revocation of authorisation; and
- prosecute summary offences in regulating insurers and insurance intermediaries.
- The IIA will, in line with international standards, be proactive in educating policyholders on the features and risks of insurance products, and will conduct research and studies relevant to the industry.
- The IIA will be funded by various licensing fees, user fees and levies. This funding mechanism will recognise the insurance supervisory principle that the regulator should be financially independent. Estimates in the consultation document indicate that the IIA will need a workforce of approximately 237 staff at an annual cost of HK$240m.
Funding for the new IIA would eventually come from the industry, although to mitigate the effect on the industry (and therefore policyholders), transitional arrangements will be in place for the first five years following establishment of the IIA. These arrangements would include a waiver of licence fees for insurance intermediaries licensed directly by the IIA and an incremental increase in the levy to be imposed on insurance policies. The government will also provide initial funding of HK$500m (approximately $64.2m/£40.7m at the time of writing).
The proposal envisages co-operation and close collaboration between the IIA and other financial regulators, to address cross-sector issues. At present, over 30% of insurance products sold in Hong Kong are distributed through banks. Banks that sell insurance products, it is proposed, would be regulated instead by the Hong Kong Monetary Authority (HKMA), which, under the plan, would be given similar powers to regulate the conduct of bank employees involved in insurance sales. Relevant bank employees engaging in the sale of insurance products will still be required to be licensed by the IIA.
The HKMA does not, however, have direct power to discipline those bank employees. It is therefore proposed that the HKMA will have the power to impose additional conduct requirements to those set by IIA to cater for the specific circumstances in banks associated with the sale of insurance products.
Of course, the plan for the new IIA is in line with international best practice and will benefit the financial services industry in Hong Kong as a whole. Tightening regulations has been a policy pursued vigorously by the Hong Kong government ever since the 2008 Lehman Brothers minibonds scandal. Nearly 30,000 Hong Kong investors bought the high-risk derivatives before the New York-based investment bank collapsed. Many Hong Kong banks have now agreed to a deal that has partially compensated investors for their losses.
Checks and balances
To ensure adequate checks and balances, various governance measures are proposed to ensure the proper exercise of powers by the IIA. It is proposed that:
- a governing board comprising predominantly independent non-executive directors should be appointed by the government to provide leadership and direction, and to guide the IIA in the development of a corporate strategy to achieve its objectives and perform its functions effectively;
- the annual report should be tabled before the Legislative Council;
- the annual budget and corporate plan should be subject to the approval of the Financial Secretary;
- a statutory appeals tribunal should be established to handle appeals from insurers and insurance intermediaries against relevant decisions made by the IIA; and
- an independent process review panel should be established to review its internal operating procedures, including those that ensure consistency and fairness.
It is proposed that the last two items should also apply to the HKMA in respect of its performance of supervisory functions over bank employees selling insurance products.
Comments
The proposed reforms will certainly enhance the competitiveness and international standing of Hong Kong’s insurance industry. In addition, it will provide enhanced protection for policyholders in line with the latest international standards.
The regulator’s strength will be much improved by the range of supervisory functions it is proposed will be granted to the IIA. Such powers will allow the IIA to adopt a proactive approach in pursuing complaints by policyholders and investigating misconduct by individual intermediaries.
Among the advantages of the proposed system for insurance industry regulation is that the new IIA would have, as the consultation document notes, the advantage of not being subject to ‘intricate government rules and procedures’, which, in turn, should permit it ‘… greater nimbleness and agility in coping with market dynamics and in attracting professionals to join as regulators, thereby enabling Hong Kong to better meet new challenges of the ever-changing financial market’.
Insurers and insurance intermediaries operating in Hong Kong should, of course, expect to bear an increased burden of compliance. The new funding mechanism may also lead to significantly increased costs pressures on insurers and insurance intermediaries. Insurers and insurance brokers may also be required to deal with duplicated regulatory efforts by the HKMA, in relation to its new powers to impose additional requirements with regard to the sale of insurance products in banks.
The dual regulation proposals have also been met with criticism in the press. The idea that the new IIA shares its duties with the HKMA shows, say critics, that the government has not learned from past mistakes in letting two regulators – the HKMA and the Securities and Futures Commission – regulate the securities industry. Such comments are a reference to the aforementioned Lehman minibonds scandal. This will doubtless continue to be a much-discussed topic in the run up to the final legislation.
Conclusion
The proposals are a major development in insurance regulation in Hong Kong. This would bring the regulatory regime in line with international practice for regulators to be financially and operationally independent of the government.
Of course, the devil is in the detail, and the detailed legislative proposals are yet to be seen. In particular, details of the proposals for the direct regulation of insurance intermediaries, and how it is proposed that the IIA will regulate insurers in respect of capital, conduct of business and investments, are yet to be circulated.
By Andrew Carpenter, associate, Holman Fenwick Willan, Hong Kong.
E-mail: andrew.carpenter@hfw.com.
