The Office of the Commissioner of Insurance (“OCI“), the Hong Kong insurance regulator, issued a new guidance note (the “Guidance“) on underwriting life business (other than investment-linked assurance scheme (“ILAS“) business, which is covered by the earlier guidance note GN 15) on 30 July 2015. The Guidance has been under discussion with the industry for several years and is a move away from the light-touch regulatory regime which has characterised the Hong Kong insurance market. The Guidance will apply to new products with effect from 1 April 2016 and to current products with effect from 1 January 2017.
The Guidance is centred around two broad concepts familiar to insurers regulated in the United Kingdom, namely the concepts of “fair treatment of customers” (“TCF“) and “policyholders’ reasonable expectations” (“PRE“). While TCF is essentially a fairness principle without clear contours, the meaning – and the actuarial determination – of PRE is controversial, and the OCI’s guidance adds little clarity in stating that it is reasonable for policyholders to expect to receive a “fair proportion, if not all” of any non-guaranteed benefits.
What is clear, however, is that the Guidance imposes detailed requirements with regard to product design, communications, sales and post-sale arrangements in respect of life insurance products and leads to major changes in Hong Kong practice. Even authorised insurers who follow international practice in the management of their Hong Kong business will need to give time and resources to ensuring that proper processes for various stages of the product lifecycle are established in accordance with the Guidance.
Insurers will have to give more thought to policyholder communications
Insurers will have to give careful consideration to the compliance of new and existing products with the TCF principle, including by considering sales channels and the fairness of fees and charges. Up to now, Hong Kong insurance companies have placed most reliance on the policy terms and conditions when considering their obligations to policyholders. In the future, they will need to consider more carefully historic and future communications with policyholders, particularly with regard to whether they give rise to any PRE which go beyond the contractual terms of the products.
The sales process will be subject to detailed rules
With regard to the sales process, adequate and clear information must be given to customers in plain language and legible font size. Key product risks, such as exclusions, premium adjustments and termination conditions, must be clearly identified. The suitability of a product for a particular customer will usually need to be assessed through the use of a “financial needs analysis” form. Customers should then be presented with different options suitable to their specific needs.
Upfront commissions will be prohibited
Indemnity commissions (understood to mean full upfront commissions on the value of a life policy) and other arrangements offering advance payment of commission, rather than payment on an earned basis, are to be strictly prohibited. The prohibition is in line with that already in place for ILAS business. This is a major change for an intermediary industry which has so far often relied on hefty upfront commissions for the sale of life insurance products. Typical clawback arrangements are not seen as effective to discourage agents from mis-selling high value life policies or churning their policyholder clients.
The OCI is reluctant to provide detailed guidance on the types of commission structures that are or are not permitted and instead recommends that insurers seek the OCI’s assessment in individual cases.
More onerous post-sale obligations
Insurers will be required to make post-sale confirmation calls to “vulnerable customers”, which includes the elderly and customers with a basic education level or no regular source of income. Those calls are already mandatory for ILAS business and the OCI considers that they have been a success in reducing unfair sales practices. Annual communications to all customers with updated projections for non-guaranteed benefits are also required.
Detailed new rules will also apply to the governance of with-profits business and universal life business.
The Guidance dedicates a detailed appendix to the regulation of “participating policies” (i.e. with-profits business) (the “With-Profits Appendix“). The governance arrangements set out in the With-Profits Appendix are very detailed and make the Hong Kong regime more aligned with other sophisticated regulatory regimes such as the one applicable in the United Kingdom.
Insurers will be required to have with-profits policy
Insurers must put in place a detailed corporate policy with regard to with-profits business, covering, among other things, the surplus sharing arrangements, charges for guarantees, the investment strategy and the smoothing mechanism. Insurers will be required to put in place measures to manage potential conflicts of interest between their duties to shareholders on one hand and to policyholders on the other, such as the establishment of a with-profits committee or the determination of a fixed profit sharing ratio between shareholders and with-profits policyholders. The appointed actuary of the insurer will be required to submit an annual report recommending the level of policyholders’ profit share to the board of directors.
Detailed rules will apply to the sales process
During the sales process, a detailed benefit illustration separating guaranteed and non-guaranteed policy benefits must be provided to the customer. Risk factors that affect the determination of their bonuses must also be disclosed to customers, such as claims, interest rates, market risk and expense factors. In addition, insurers will be required to disclose on their websites the “fulfillment ratio” in relation to each product, being the average ratio of actual bonuses against the illustrated amounts at the point of sale. Annual updates setting out declared bonuses and updated projections must also be sent to policyholders.
Similarly detailed requirements will also apply to the sale and governance of universal life policies.
The new requirements can be expected to result in significant changes to governance, sales and administration processes for life insurers who currently only comply with the minimum standards set by existing regulation.