Briefing
Insurance (Amendment) Bills 2020: the next step in the Insurance Authority’s regulation of Hong Kong’s insurance market
Since its establishment in December 2015, the Hong Kong Insurance Authority (IA) has gradually grown into its role as primary regulator of Hong Kong’s insurance market, taking over regulation of insurance companies from the Office of the Commissioner of Insurance in June 2017, granting its first virtual insurance licence in December 2018 and expanding its regulatory ambit to cover intermediaries in September last year. Throughout this period, implementation work was also undertaken to regularise and align the Hong Kong market with international standards through a range of insurance specific rules and developments, from guidelines on anti-money laundering, to cybersecurity and cooling-off periods. The Insurance (Amendment) (No. 2) Bill 2020 (No 2 Bill), which was gazetted on 20 March 2020, marks a further step in the IA’s evolution and when passed, will enable the IA to exercise direct regulatory powers over Hong Kong-incorporated holding companies of international insurance groups, particularly with respect to the group’s fitness and properness, and capital adequacy; the IA currently regulates such insurance groups indirectly, through subsidiaries licensed by the IA.
The IA has also introduced a new class of insurance business with the gazettal of the Insurance (Amendment) Bill 2020 (No 1 Bill) on the same day, proposing a regulatory framework for a new class of insurance business for “insurance-linked securities”, and expanding the scope of insurable risks of captive insurers.
In light of disruptions caused by COVID-19, neither Bill has yet been read in Legislative Council (LegCo) [1] , and regulatory and legislative focus is likely to remain on COVID-19 related matters in the immediate future, so the timeline for these Bills to come into effect as amendments to the Insurance Ordinance is uncertain [2].
The No 1 Bill
The amendments proposed by the No 1 Bill include:
- establishing a regulatory framework for “insurance-linked securities” (ILS); and
- expanding the scope of insurable risks of captive insurers.
A New ILS regime
ILS are products issued by special purpose vehicles (often themselves owned by insurance firms) which are used to fund an insurer’s liability on the occurrence of a trigger event; a common trigger is a natural disaster or catastrophe and such ILS are colloquially termed “catastrophe bonds”. Because ILS are typically privately placed to investors (often in the capital markets) they allow insurers and reinsurers to tap an alternative source of capital.
The move by the IA to establish a framework for ILS follows the PRC government’s announcement of support for PRC insurers to issue catastrophe bonds in Hong Kong, and it is hoped that the proposed legislative amendments will facilitate Hong Kong becoming the preferred domicile for ILS such as catastrophe bonds, and an ILS hub in Asia although Singapore holds an early advantage.
Under the proposed regime, ILS (which are securitised, complex products) may only be marketed and sold to qualified investors. Consideration of how the Hong Kong Securities and Futures Commission (SFC) will regulate these securities also needs to be resolved.
Expanding the scope of insurable risks for captive insurers
The No 1 Bill proposes that the scope of risks that captive insurers in Hong Kong are able to underwrite be widened, notably to allow captive insurers in Hong Kong to underwrite risks for overseas group companies. This will enable overseas insurers to establish captive insurers in Hong Kong to insure overseas risk, and the IA has indicated that it hopes this will assist the insurance industry to benefit from opportunities arising from the Belt and Road Initiative, as captive insurers in Hong Kong will be able to assist in underwriting BRI-related risk based in other jurisdictions.
The No 2 Bill
Does the No 2 Bill apply to your organisation?
The No 2 bill will apply to insurance holding companies:
1. that are Hong Kong-incorporated;
2. which have the IA appointed as the group supervisor in accordance with IAIS principles (i.e. by agreement between the insurance regulators of entities in the group) [3]; and
3. that are designated by the IA, by notice in the Gazette.
In deciding whether to designate an insurance holding company (a DIHC), the IA may take into account the following:
- the number of jurisdictions outside of HK in which the insurance holding company carries on insurance business;
- the size of insurance and other businesses of the insurance holding company’s group; and
- any criteria promulgated by international standards setting bodies that the IA deems relevant.
We expect the three international groups the IA currently assumes the role of group supervisor for will be the first targets for designation by the IA, although the regime will potentially cover any international insurance group with a significant Hong Kong business, that satisfies criteria 1 and 2 above.
Notably, once designated, the IA will have supervisory authority over the DIHC as well as its “supervised group”, which by default includes subsidiaries and group members (as defined in applicable accounting standards). Under Hong Kong Financial Reporting Standards, subsidiary is broadly defined [4] and it remains to be seen whether and how the IA will seek to more clearly define the ambit of “supervised groups”, and for the example whether it will seek to regulate group members in which a DIHC holds a minority stake.
What are a DIHC’s key obligations?
As mentioned above, the IA’s stated objectives are to ensure fitness and properness of DIHC’s across insurance groups, and put in place group capital requirement obligations, to protect policyholders and market integrity. It proposes to achieve these objectives in the following ways.
IA to pre-approve controllers and specified officers. The No 2 Bill proposes that the IA’s prior approval must be obtained before a person may become a shareholder controller or be appointed as a specified officer (i.e. Chief Executives, Directors, and Key Persons in Control Functions of a DIHC). This approval can be revoked should the individual become not fit or proper.
In practice, we expect that the IA will take a similar approach to that it takes with respect to authorised insurers, under the Insurance Ordinance [5], in granting approvals, although under the DIHC regime [6] the definitions of shareholder controller, Chief Executive, Director and Key Persons in Control Functions are directed at group level. So DIHCs will likely be required to make fresh applications to obtain IA approvals for relevant persons at group level. The IA has not said whether there will be a “passporting” system for individuals who are already approved at authorised insurer level.
Compliance with IA’s regulatory, intervention and enforcement powers. In order to allow the IA to regulate the fitness and properness of DIHCs (and their supervised groups), the No 2 Bill provides the IA with a full suite of supervisory and enforcement powers, which broadly mirror those the IA has with respect to authorised insurers under the Insurance Ordinance.
These powers are discussed below and are proposed to be supported by civil and criminal sanctions similar to those available against authorised insurers under section 41P of the Insurance Ordinance. Penalties include revocation and suspension of licence (this could have extremely wide-ranging effects for a DIHC’s group), significant fines [7] and public and private reprimands.
Capital adequacy. The IA proposes to require a DIHC to ensure compliance with group capital requirements for the supervised group that are in line with the risk-based capital standards and guidance issued by the IAIS for Internationally Active Insurance Groups, subject to a transitional period [8]. The IA has not provided details of its proposed group capital requirements and suggests that this be specified in subsidiary legislation, subject to negative vetting by LegCo. This builds on the work already carried out by the IA in implementing a risk-based capital regime for the insurance industry in Hong Kong and it remains to be seen how the IA’s existing capital adequacy regime [9] for Hong Kong insurers will operate alongside that for DIHCs.
Fees. Finally, a DIHC will be obliged to pay prescribed fees to the IA for recovering the cost of the IA in acting as the group supervisor of the supervised group. The IA intends that the annual fee payable by a DIHC will be prescribed by applying a specified percentage to the group’s insurance liabilities as reported in the last return submitted to the IA.
What supervisory and investigative / enforcement powers will the IA have with respect to DIHCs?
The IA’s powers with respect to DIHCs (and their supervised groups) will include:
- appointment of an external auditor;
- appointment of a supervisory manager to manage the affairs, business and property of the DIHC (including the exercise of the DIHC’s control and influence over supervised group members);
- to protect a DIHC’s solvency, imposition of restrictions on intra-group transfers of assets, and major acquisitions; and
- a broad suite of enforcement powers, including the ability to require the production of information, documents, financial statements and auditor’s reports, and conduct on-site visits and raids.
The investigative and enforcement powers of the IA (both with respect to DIHCs, and authorised insurers) are similar to those of the SFC and the IA’s enforcement function includes personnel with SFC experience. We expect that there will be parallels between the way in which the IA and the Securities and Futures Commission wield their enforcement powers going forward.
1. The first reading scheduled for 25 March 2020 was vacated, due to COVID-19-related closure of LegCo.
2. A spokesman for the Financial Services and the Treasury Bureau has said that it is targeting “early passage of the [No 1] Bill so as to boost the financial services industry and the economy at large amidst the challenging times”.
3. The three international groups which the IA currently assumes the role of group supervisor for are AIA, FWD and Prudential.
4. Under HKFRs 10, a parent controls a subsidiary when “it is exposed, or has rights, to variable returns from its involvement with the subsidiary and has the power to affect those returns through its power over the subsidiary”. In other words, the parent does not have to hold over 50% of the shares in the subsidiary, provided it has de facto control over revenue allocation.
5. See sections 13A, AB to AH, and B of the Insurance Ordinance Cap 41.
6. See section 95A of the proposed amendments to the Insurance Ordinance Cap 41.
7. Of up to three-times profit made, or loss avoided, or HK $10 million per offence.
8. The duration of the transitional period is not yet specified.
9. See GL-21, Guideline on Enterprise Risk Management, which applies to IA-licensed insurers and took effect on 1 January 2020, with full implementation expected after a transition period in around 2022. https://www.ia.org.hk/en/legislative_framework/circulars/reg_matters/files/cir_20190103.pdf.
