A change has occurred in Hong Kong’s insurance regulatory regime. On 26 June 2017, the new Insurance Authority formally took over from the Office of the Commissioner of Insurance as the industry’s regulatory body. The transition marks the blossoming to life of a seed planted back in 2010 when the first consultation paper on the subject was circulated, citing the need to modernise Hong Kong’s insurance regulatory regime.
For those who have followed the passage of the legislation, which has seen the old Insurance Companies Ordinance be given a 21st century make-over to become the Insurance Ordinance, the empowerment of the new Insurance Authority marks the end of a very long road. For the insurance industry, however, this is merely the end of the beginning. Insurers and insurance intermediaries operating in Hong Kong now face the hard work of implementing the changes needed to align their governance, practices and processes with the new requirements in the legislation. So where to begin? Looking through the lens of a lawyer working in an insurance company, the following should be priorities.
The New Levy
As with everything in Hong Kong, finances come first and funding the new regulator takes priority. Unlike its predecessor, the Insurance Authority meets international standards of regulation because it is deemed operationally “independent” from Government. A significant part of that independence comes from the fact that the Insurance Authority’s long-term funding is not to come from tax payers, but from the insurance industry and insurance policyholders. All insurance policies (with certain exceptions) incepting on and from 1 January 2018, will attract a Levy on premium which will be used to fund the Insurance Authority’s existence. The Levy is payable by policyholders, but is to be collected by insurers, although insurers do have a discretion to shoulder it themselves if, for example, the cost of collecting it outweighs the Levy amount.
With the commencing rate set at 0.04 percent of premium due on each insurance policy and graduating to 0.1 percent by 2021 (subject to an overall cap), some would say the Levy falls within a de minimis range. Nevertheless, the system changes its demands on insurers, making it a priority for them to update policy documentation and communicate it in advance to policyholders, whilst advising Finance, IT and business teams on the minutiae of the detail. As a concept, the application of the Levy sounds simple, but Hong Kong is a market where insurance policy design is not dictated by the regulator, but subject to the common law principle freedom of contract. The wide diversity of innovative coverage structures to which this has given rise, serves as one of the Hong Kong insurance market’s strengths. However, it also means that implementing the Levy is no easy task, considering the plethora of different scenarios to which the Levy must apply (multi-year policies, policies involving different currencies, treatment of cancellation and reinstatement, etc). Legal practitioners would do well to equip themselves to advise on these issues.
Key Persons in Control Functions
Of more significance to legal practitioners is the requirement for insurers to obtain approval from the Insurance Authority for their “key persons in control functions”, per the new s. 13AE of the Insurance Ordinance. The key persons in this respect are the individuals employed by the insurer, who are responsible for the performance of the control functions of risk management, finance, compliance, internal audit and intermediary management.
The applications for approval for existing key persons in each of these functions (apart from intermediary management) must be submitted to the Insurance Authority by 30 September 2017. There is a new Form A1 which has been issued for these purposes. This requires, among other things, details of the key person’s reporting lines and where they fit in within the insurer’s management organisation. It also requires demonstration that the proposed key person meets the “fit and proper” requirements laid out in the revamped Guideline issued by the Insurance Authority on the subject.
The “key persons” regime is where we see the true substance of the modernised regulatory regime at work. Being a key person comes with the prospect of personal liability, in the event the insurer itself is found to have committed an offence under the Insurance Ordinance and this is attributable to any neglect or omission on the part of a key person (see s. 124 of the Insurance Ordinance). Extending personal liability to individual members of senior management beyond Directors and the Chief Executive Officer is a principal mechanism by which the new regime seeks to restrain unlawful and undesirable behaviour within the insurance industry. Indeed, we see this same mechanism being used by other industries (eg, the new Manager-In-Charge regime instituted by the Securities & Futures Commission in its circular of 16 December 2016).
For the substance, as well as the form, of the key-person regime to be adopted, legal practitioners would do well to assist their insurer clients with the following practical tips, as well as assisting with the submission of the Form 1As:
(1) Sit down with each key person and explain the personal responsibility and expectations that comes with the role of being a key person. Stress the importance of adopting common-sense techniques such as the need to document discussions, decisions and sign-offs and the rationale behind them.
(2) An appropriate letter of appointment should be drawn up for the key person role. A one-line e-mail confirming that the person is now a key person will set the wrong tone and treats the approval process as a “tick-the-box” effort. A letter of appointment, however, setting the parameters and expectations for the role, not only correctly documents the appointment, but gives it the appropriate status within the corporate governance framework. (For future hires of key persons, these matters should be embedded as part of their employment contract).
(3) Ensure that the key person is empowered to perform their role. This is more than about drawing reporting lines on a chart. It is about ensuring the key person is given the opportunity to raise issues directly to the board. Make the need for the key person to report, a standing item at board and board committee meetings. Key persons must also have untrammelled access to the Chief Executive Officer, so that issues can be raised to the right levels of management as and when needed. In short, all key persons need a substantive seat at the senior management table.
(4) Ensure the potential exposures of the key person are properly managed from the outset. Make sure the indemnity provisions in the company’s Articles of Association are up-to-date and extend to key persons. Similarly, legal practitioners would do well to advise insurers that key persons should be insured persons under the company’s own Directors’ & Officers’ insurance coverage. Preparing for the worst, ensures that key persons are not constantly in defensive mode, but are given the courage to operate pro-actively and practically in the business environment. Corporate governance becomes nothing more than words on a page, if those operating the corporate governance regime are not given the leeway to be practical.
(5) Encourage all key persons to make time to sit down with each other regularly and exchange views on what they are seeing in the organisation. A regular meeting like this quickly embeds best-practices across the organisation, ensures nothing falls through the cracks and creates a esprit de corps amongst the control functions which makes the whole substantively stronger than the sum of its parts. It also serves as a means of spotting problems, before they materialise into something substantive.
(6) Finally, ensure that all key persons are announced to the company, so everybody knows their role as gate-keepers and the importance of it to the company’s everyday functioning. This will give key persons the platform they need to communicate awareness of the expected standards of behaviour that all employees should adopt in order to stay within the lines, thereby building the right culture. Key persons can also instil this culture by making sure it is known what information they expect colleagues to provide when seeking “sign off”. A request which simply says “can you sign this off” demonstrates a lack of consideration for the requirements which matter. A request which includes a description of the attributes of the proposal which ensure fair treatment of customers, demonstrates that the business is benchmarking itself against the right standards from the outset. That’s when you know you have the culture right.
As such, the appointment of key persons is the first of the “new requirements” on the to-do list when it comes to the governance requirements of the new Insurance Ordinance. Getting this right will set your insurer clients up for success going forward.
Growing Focus on Sales Practices and Fair Customer Treatment
Beyond the immediate changes which came into effect on 26 June 2017, looms the most significant expansion of regulatory power wrought by the new legislation. So significant in fact, that the industry has been given a two-year hiatus to ready itself.
At some point within this two-year period, the current self-regulatory regime for insurance agents and insurance brokers will be replaced with direct regulation by the Insurance Authority. Further, this new licensing regime is expanding beyond existing brokers and agents to encompass any person carrying on “regulated activities”. In this regard, “regulated activities” are widely defined. They include virtually all core insurance processes, such as arranging, negotiating or inviting persons to enter into insurance policies, giving advice on applying for insurance, exercising a right under an insurance contract, and making and settling insurance claims. Employees of insurance companies who carry out these activities now without being individually licensed may therefore need to be licensed in future.
The two-year hiatus is intended to give the industry breathing space to prepare, but the time lag creates its own problems as the industry is already undergoing significant change before the new requirements are made clear. New distribution channels embracing technology are continually being rolled out across the board to improve customer experience. Online platforms which automate quoting and binding of insurance contracts are set to become the norm for more than just plain-vanilla consumer insurance products. InsureTech is fast turning from buzzword to reality.
How can legal practitioners assist in aligning these new distribution mechanisms with the spirit of the new legislation when its details have yet to be formulated in much needed codes and guidelines? A good starting point would be by looking to where the new provisions of the Insurance Ordinance originated, namely the Insurance Core Principles (“ICPs”) promulgated by the International Association of Insurance Supervisors. The ICPs are, after all, the international standards with which the Insurance Ordinance seeks to align.
A golden thread which runs through the ICPs, is the need to ensure “fair treatment of customers”. As such, legal practitioners would do well, when advising on the new purchase pathways and other mechanisms that technology is enabling, to benchmark these processes against some basic customer fair treatment principles. Certain common sense questions which view the process from the customer’s standpoint should be asked, such as:
- Is the prospective customer given the opportunity to review policy terms and conditions before making a purchase?
- Are key terms and exclusions being brought to the customer’s attention?
- Is the customer given a practical route by which he or she can ask questions on the coverage?
- Does the security underpinning the platform ensure customer data is adequately protected?
- What is the approach to handling complaints?
Giving advice on legislation which has not yet come into force (and codes of conduct or guidelines that have yet to be issued) is no easy task. By going to the ICPs which have provided the basis of the new legislation, however, legal practitioners can at least encourage insurers to set some common-sense benchmarks around the principle of “customer fair treatment” when rolling out new systems, sales processes and products. This would certainly assist in setting the insurer up for success when the legislation finally bites.
The new Insurance Ordinance and the new Insurance Authority mean the beginning of a period of great regulatory change for the insurance industry at a time when it is going through change itself through the general embracement of technology. Legal practitioners have a key role to play in advising insurers in this changing environment. Those market participants pro-active in addressing the necessary changes are the ones who will best adapt, survive and thrive.