a new insurance regulator how will this change the industry? · a new insurance regulator how will...

A new insurance regulator

How will this change the industry?

The Actuarial Society of Hong Kong

Will Harrison

Partner, DLA Piper Hong

Kong

7 May 2013

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Introduction

• In October 2012, the Financial Services and the Treasury Bureau of Hong Kong (FSTB) published its consultation paper (CP) setting out key legislative proposals for the establishment of an independent insurance authority (IIA)

• Responses were provided by various market participants and by the Hong

Kong Federation of Insurers (HKFI) on 5 February 2013

• Final bill is yet to be published, but we have a reasonable understanding of what it will contain

• Risk based capital proposals are also relevant

• Question for me to address is what effect might these changes have on the insurance industry in Hong Kong?

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Introduction

• Two broad categories of effects of the proposed amendments to the Insurance Companies Ordinance (ICO) and the establishment of a new independent regulator

• Direct effects of:

• New regulatory obligations imposed by statute

• The supervisory role and enforcement of decisions taken by IIA

• Indirect effects:

• Individual and corporate behaviour in response

• First step is to examine the likely new regulatory obligations and consider how the IIA may seek to exercise its powers

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Key areas of proposed changes

• Key areas addressed in the CP

– Intermediary regulation: licensing and conduct requirements

– Management responsibility: Responsible Officers (R.O.s)

– Misconduct, disciplinary, powers of investigation and inspection, 3rd parties,

self-incrimination and offences

– Bank distribution: delegation to the Hong Kong Monetary Authority (HKMA)

• Summary description:

– New, more detailed provisions: learning-curve issues, lack of clarity

– Onerous new conduct obligations for intermediaries

– Responsibility placed on insurers and R.O.s to use best endeavours to ensure

compliance by intermediaries

– Harsh penalties for breach of obligations

– Intrusive investigative powers to support enforcement

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Intermediary regulation

• Licensing (CP Chap. 4):

– All intermediaries (brokers and agents) will be licensed by IIA

• Intended to restrict the number of principals an agent can have?

– Not in proposed Bill. By guidance note?

– Considered effects of Competition Ordinance?

• Sub-agencies and agents will be maintained

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• "Regulated activities" (CP 4.2.3) – a far more detailed definition than at present:

– "negotiates or arranges a contract of insurance"

– "invites or induces, or attempts to invite or induce, another person to enter

into a contract of insurance"

– "invites or induces, or attempts to invite or induce, another person to make a

material decision"

– "give regulated advice"

• Exemptions exist for incidental activities e.g. by solicitors, loss adjusters etc.

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• CP 5.1.2: Conduct requirements

• Uncontroversial requirements:

– exercising reasonable care, skill and diligence

– advising within competence

– accounting for policyholder's assets

– "have regard" for particular circumstances of policyholder

• Controversial requirements (for agents):

– must act honestly, fairly, in the best interests of the policyholder or potential

policy holder, and with integrity

– must make such disclosure of information to the policyholder or potential

policyholder as is necessary for the policyholder or potential policyholder to be

sufficiently informed for the purpose of making any material decision

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• Controversial requirements (for agents) (cont):

– must use best endeavours to avoid a conflict between the interests of the

licensed insurance intermediary and the interests of the policyholder or potential

policyholder and, in the case of such a conflict, must disclose the conflict to the

policyholder or potential policyholder

• Creates significant difficulties and uncertainties for insurance agents

– Owe duties (care and skill, fiduciary) to their principals

– Agents will not act in best interests of policyholders and necessarily have

conflicts of interest in numerous respects:

• price

• most appropriate policy (e.g. if issued by a different insurer)

– Hoped/expected that this anomaly will be removed in Bill

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• Creates significant difficulties and uncertainties for insurance agents (cont):

– Duty to disclose a better policy of a competitor insurer?

– Duty to disclose its duties to the principal and any remuneration?

• In effect, it would transform agents into brokers and put them in an

impossible situation

• May also give rise to a private law action in tort for breach of statutory duty against the agent and insurer

• Compare with UK Financial Services Authority (FSA) principles of conduct (PRIN 2.1):

– "due regard" to interests of customers and treat them fairly

– "due regard" to the "information needs" of customers and communicate in a

clear, fair and not misleading way

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• Compare with UK FSA principles of conduct (cont):

– must "manage" conflicts of interest fairly

• CP proposals are more onerous than UK rules

• Will impose relatively strict conduct requirements on intermediaries

– importantly, will also impose obligations on insurers/R.O.s to ensure compliance

– could change relationship of insurer/agents and structure of industry

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Responsible Officers

• Both intermediaries and insurers must appoint a R.O. (CP 4.5)

• CEO of insurer is deemed to be the R.O.

– No indication that can delegate or appoint an alternative person

– Is the CEO the appropriate person to undertake the role?

– Subject to objection from HKFI and others

• Brokers and agents

– R.O. must be person responsible for whole of applicant's business in relation to

a regulated activity and must be a technical representative (TR)

– Who would this be? CEO and a TR?

– Very rigid and prescriptive approach – compare FSA

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• Conduct requirements:

– Authorised insurer/licensed insurance agency/licensed insurance broking

company:

• Must establish and maintain proper controls and procedures for securing

compliance by agencies/individual agents/TRs with conduct requirements

• Must use best endeavours to secure compliance as above

– R.O.s of insurer/agency/broker must use their best endeavours:

• To ensure their entity has established proper controls and procedures as

above

• to ensure that their entity uses its best endeavours to secure compliance as

above

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• Concerns/issues raised with FSTB:

– Why impose a "best endeavours" obligation on R.O.s?

– Very high standard of care – higher than "reasonable" standard adopted by

FSA, higher than duty of care imposed on solicitors/auditors etc.?

– Best endeavours has been said to require commencement of litigation/"leaving

no stone unturned" – not realistic?

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Misconduct

• Similar provisions for insurers and intermediaries:

– Contravention of the ICO or condition of licence granted under the ICO

– Act or omission that relating to any regulated activity/carrying on of a class of

insurance business which, "in the opinion of IIA, is or is likely to be prejudicial to

the interests of policyholders or potential policy holders or the public interest"

• CP proposes subsidiary legislation and guidelines from IIA – but must flow from primary legislative provisions. No details given

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Misconduct

• Concerns over proposals:

– Not clear what will be contained in subsidiary legislation/guidelines? Devil

will be in the detail

– In light of broad duties already imposed on intermediaries, it is not clear why

a discretionary sanction exists - on the basis of the "opinion" of the regulator

– For insurers, there are no specific new conduct requirements to breach E.g.

honesty and fairness. How does an insurer make sure it is not undertaking

"prejudicial" conduct?

– What does "(potential) policyholders" mean? The specific policyholder or a

general class of policyholders?

– What does "prejudicial" mean? Charging a premium or taking a commission

is prejudicial to a policyholder's interests

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Disciplinary and penalties

• Disciplinary actions:

– Insurers: relates to conduct of insurer and directors and controllers

• where insurer is guilty of "Misconduct"/director or controller not "fit and

proper"

• BUT, proposed sanctions only apply to insurers, not individuals. Is this

intended?

– What is the point of imposing duties on insurer's R.O.s if no sanction

for breach?

– Intermediaries: relates to conduct of R.O.s and licensed insurance

intermediaries

• where RO or intermediary is guilty of "Misconduct" or not "fit and proper"

• BUT, proposed sanctions apply only to individuals, not corporate brokers

or agencies. Why?

– Why such different treatment for insurers and intermediaries?

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• Sanctions:

– Revocation of authorisation/licence/approval

– Suspension of authorisation/licence/approval

– Public or private reprimand

– Prohibit application to carry on class of insurance business/licensed activity

for period

– Pecuniary penalties:

• Greater of: 3 x profit made/loss avoided and HKD 10 million

• HKD 10,000 maximum daily default penalty

• Payable to IIA within 30 days or other period as specified

• IIA must first publish guidelines on exercise of penalties and have regard

to them

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• Pecuniary penalties (cont)

– Guidelines must include certain factors: whether conduct -

• was intentional, reckless or negligent

• caused loss to or imposed costs on any other person

• damaged integrity of industry

• resulted in a benefit to any person

• Financial hardship of respondent not a necessary factor c.f. FSA

guidelines on penalties (DEPP 6.5D)

• Concerns with proposals:

– Maximum level of fines is very high:

• effect on individual agents, brokers, intermediary R.O.s in particular

• should consider potential hardship

• out of proportion to similar sanctions for other professionals

• risk of inhibiting proper development of industry

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Powers of inspection, investigation & suspension

• Similar powers for both intermediaries and insurers

• Inspection:

– To ascertain whether an intermediary/insurer is, has, or is likely to be able to

comply with the ICO and any conditions imposed

– Inspector may enter at any reasonable time the business premises of an

intermediary/insurer, inspect and take copies of business records and make

enquiries of an intermediary/insurer

– Intermediary required to produce record/answer enquiry

• Also extends obligation to certain 3rd parties that inspector has reasonable

cause to believe has information or records E.g. auditors, solicitors

• No express preservation of legal professional privilege for solicitor/client

communications

– No privilege against self-incrimination – must answer. Appears that such

answers can be used in criminal prosecution

Date of presentationInsert filename here 19

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• Investigation:

– If IIA has reasonable cause to believe:

• An offence under the ICO has been committed

• Any provision of the ICO has been breached

• Fraud, defalcation, misfeasance or other misconduct have taken place

• Manner which person has engaged in regulated activity/carrying on of class

of insurance business is prejudicial to the interests of policyholders etc.

– For purpose of considering whether any person is guilty of misconduct/is not fit

and proper

– If it relates to a bank, IIA must consult with HKMA first

– Similar powers as for inspection (save for entry onto premises)

• Also applicable to 3rd parties – E.g. auditors/solicitors

• No privilege against self-incrimination

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• Concerns with proposals:

– Is it intended to override legal professional privilege when powers are applied to

3rd parties?

– Is it intended to use self-incriminating evidence that a person was compelled to

provide to prosecute them?

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Offences

• Offences regarding inspections and investigations (intermediaries and insurers):

– Failure to comply with a "specified requirement" without reasonable excuse

• Indictment: HKD 200,000 fine/1 year imprisonment

• Summary: HKD 50,000/6 months imprisonment

– Failure to comply with a "specified requirement" with intent to defraud

• Indictment: HKD 1 million fine/7 years' imprisonment


– Giving document or answer that is false or misleading in a material respect and

knows or is reckless as to whether it is so



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Offences

– Giving document or answer that is false or misleading with intent to defraud



– An officer or employee of an intermediary/insurer who with intent to defraud

causes or allows an intermediary/insurer to fail to comply with a "specified

requirement" or to give a false or misleading document/response



– Also note summary procedure before Court of First Instance - contempt of

court for failure to comply with a "specified requirement" as alternative to

prosecuting offence – why two penalties for the same conduct?

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Banks' intermediary activities

• IIA will delegate powers of inspection, investigation and suspension to HKMA (CP 6.4)

– delegation must be approved by the Chief Executive (CE), who may impose

conditions

– IIA and HKMA will sign a memorandum of understanding setting out detailed

arrangements

– staff secondment arrangement between IIA and HKMA

– IIA and HKMA will agree on annual supervisory focus and have regular liaison

meetings

• IIA will consider all investigation reports of HKMA and decide if disciplinary action is warranted

• CP indicates IIA may take over an HKMA investigation and provide for joint inspections by IIA and HKMA – but legislative proposal does not

contain this

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• IIA is required to consult HKMA on preparing guidelines for intermediary conduct requirements insofar as they relate to banks – is this necessary?

• Other "checks and balances" to ensure consistency:

– All disciplinary decisions of IIA and HKMA will be reviewed by the Insurance

Appeals Tribunal

– IIA must consult HKMA before exercising any disciplinary power in respect

of a bank

– An independent "Process Review Panel" established by the CE "to review

internal process and procedures of the use of the proposed regulatory

powers by relevant regulators" – what does this actually mean?

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• BUT: with different regulators undertaking inspections and investigations, different practices, standards and results will inevitably result

– What benefits does having the HKMA undertake such activities really bring?

– Is banking distribution of insurance really different to any other agency channel?

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Possible effects on the industry

Direct effects on industry participants:

•Initial management time/legal & compliance costs to understand new rules

and implement systems and processes

•Ongoing: additional legal & compliance resources/external counsel costs

•Additional senior management (R.O.s) time to monitor intermediary compliance

•More common conduct investigations/enforcement actions: management and legal & compliance time, significant external counsel costs

•Individual agents: particular difficulties and disproportionate costs of compliance with new and complex rules/investigations/potentially draconian pecuniary penalties

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Consequential effects on industry participants:

•Higher level of enforcement activities will generally favour entities with higher current levels of compliance (usually larger, international players)

over currently less compliant competitors

•Placing personal responsibility onto CEO/senior management of insurer for intermediaries' compliance:

– insurers will demand greater confidence that agents are compliant as they

cannot monitor every individual agent: favours dealing with corporate agencies

that assume responsibility for these issues

– insurers may require indemnities backed by professional indemnity insurance

from agents/agencies

– further development of alternative distribution channels: internet/affinity

schemes, social media etc. that cuts out agents?

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Consequential effects on industry participants:

•Consolidation of highly fragmented industry possible, particularly if risk

based capital rules significantly raise cost of capital of insurers

– positive effect on profitability of industry?

– generally, there may be a move from a 'clubby' practitioner tone of the industry

to a larger, more corporatised scenario

•Investment-linked assurance schemes (ILAS) remain in cross-hairs of regulators:

– concerns remain over selling practices and size of commissions

– ripe area for issue of guidelines relating to "prejudicial conduct"

– could IIA follow FSA and ban commission-based selling of ILAS products?

•Active international promotion of industry?

– could IIA follow MAS in Singapore to actively promote around the world?

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Thank you

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