The Financial Services and Treasury Bureau of Hong Kong recently published a Consultation Paper entitled “Proposed Establishment of an Independent Insurance Authority” (Consultation Paper), with a proposal to establish a new insurance regulatory authority which is both financially and operationally independent of the Hong Kong Government, and to give the independent body more supervisory powers over the industry.

Current Regulatory Framework

At present, the insurance industry in Hong Kong is regulated by the Office of the Commissioner of Insurance which is a Government Department, headed by the Insurance Authority (IA). The principal regulations are set out under the Insurance Companies Ordinance (Ordinance).

The Ordinance provides for the operation of a self-regulatory regime under which insurance agents and insurance brokers, both at the corporate and individual levels, are registered with and supervised by designated professional bodies approved by the IA.

With regard to insurance brokers, there are two approved professional bodies: the Hong Kong Confederation of Insurance Brokers (CIB) and the Professional Insurance Brokers Association (PIBA). A person who intends to hold himself out as an insurance broker must be authorised directly by the IA or admitted as a member of either the CIB or PIBA. The CIB and PIBA are responsible for handling all complaints against their members, i.e. insurance brokers, and they carry out investigations and take disciplinary actions in substantiated cases. The IA does not exercise direct supervision over the conduct of those insurance brokers.

Similarly, all insurance agents are required to be registered with the Insurance Agents Registration Board (IARB) (which is established under the Hong Kong Federation of Insurers) and are subject to the Code of Practice for the Administration of Insurance Agents. The IARB handles complaints against insurance agents. Disciplinary actions by the IARB include requiring insurers to serve warnings to, and suspend or terminate the appointments of, the offending insurance agents, responsible officers and technical representatives.

Generally this self-regulatory regime has been praised for its flexibility. It can adapt to market developments and self-repair market failures quickly and cost-effectively. Furthermore, the market is fairly intimate: most members of senior management within insurers, insurance intermediaries, the IA and supporting professionals are known to each other and a cooperative approach to many industry issues can be developed. This intimacy also allows for regulation to be enforced lightly but nevertheless effectively; heavier enforcement of the regulations (as seen in the securities industry) does not necessarily eradicate underlying problems.

The Consultation Paper

The Consultation Paper is based upon the findings of a consultancy study carried out by PricewaterhouseCoopers in November 2007 and an extended study in 2009 (Study) following the aftermath of the financial crisis. The Study identified four unsatisfactory areas within the present self-regulatory regime, at least as they apply to insurance brokers: (1) there is perceived and real conflicts of interest as the self-regulatory organisations are also trade bodies financed by their members. In particular, there is a concern that the competition for membership between the CIB and PIBA might lead to more leniency in disciplinary matters; (2) the CIB and PIBA were not fully aligned with regard to their disciplinary procedures, levels of sanctions and complaints handling mechanisms; (3) the self-regulatory organisations only have limited investigatory and sanctioning powers over their members; and (4) Hong Kong’s self-regulatory regime was not in line with international insurance practices where intermediaries are regulated directly by a regulator independent from the industry.

In light of the Study, the Government has proposed to establish an independent IA to take over all the duties and responsibilities presently assumed by the Office of the Commissioner of Insurance. The intention is that such a move would enable better regulation of insurers and insurance intermediaries through the professional and responsive operation of an independent regulatory body, thereby enhancing protection to policyholders and maintaining market stability and competiveness.

It is recommended that the new independent IA should perform a direct, and hence more effective, role in supervising the conduct of insurance intermediaries, including licensing, inspection, handling complaints, investigation into misconduct, and imposing disciplinary sanctions. The Consultation Paper identified two options: the first is to have a strengthened self-regulatory organisation system with enhanced supervision by the independent IA, and the second is to introduce direct licensing and supervision by the independent IA. The Consultation Paper recommended Option 2.

Option 1

Under Option 1, the independent IA would be empowered to require the three self-regulatory organisations (CIB, PIBA, IARB) to harmonise their disciplinary regimes to minimise inconsistencies and ensure early complaints resolution. The independent IA would be given additional powers to sanction insurance intermediaries, in the event that reliance on self-regulatory organisations’ self-regulatory process was deemed inadequate. These powers could include: powers to investigate and impose supervisory sanctions such as fines, reprimands and suspension and revocation of the membership of the self-regulatory organisations.

Merits of this option include minimising changes to the current regime and, therefore, reducing the impact on affected stakeholders. However, this will not remove the conflicts of interest (real or perceived). In addition, enhanced supervision by the independent IA under this option may give rise to duplication of efforts by the independent IA and the self-regulatory organisations, as well as the regulatory gaps that this approach might create. Indeed, the independent IA would, in any event, still need to be equipped with the necessary regulatory expertise and powers as if it assumed all the direct regulatory functions as proposed under Option 2.

Option 2

Under Option 2, the independent IA would assume all regulatory functions over insurance intermediaries. The three self-regulatory organisations would continue to perform the functions of a trade body. This option would give recognition to the increased public expectation of regulators, and the international trend of replacing self-regulation with independent regulation.

It is believed that under Option 2 the independent IA would be able to adopt a more proactive approach in following up complaints by policyholders and misconduct of individual intermediaries and in identifying industry-wide issues and market conduct that are central to the protection of policyholders. The direct supervision of intermediaries by the independent IA, it is thought, would enhance public confidence in the professionalism of the practitioners, thus helping foster the further development of the industry.

In addition, the Consultation Paper addresses the conduct of insurance intermediaries selling insurance products in banks. According to market statistics, of the 68,000 insurance intermediaries in Hong Kong, some 18,000 are bank employees who are registered with and supervised by the IARB in their marketing and sale of insurance products, and over 30% of insurance products sold in Hong Kong are distributed through banks. However, at present, the Hong Kong banking regulator, the Hong Kong Monetary Authority (HKMA) does not have any direct power to discipline individual bank employees in respect of their conduct of insurance business.

The Consultation Paper proposes to impose the HKMA to impose conduct requirements onto bank employees in addition to those stipulated by the independent IA under Option 2. It is also proposed that powers similar to those for the independent IA would be vested in the HKMA, including the power to conduct inspections and investigations, and impose disciplinary sanctions. The independent IA would continue to be responsible for licensing bank employees and determine whether they are fit and proper to remain licensed as an insurance intermediary having regard to any disciplinary sanctions that might have been imposed.

While the integration of all three self-regulatory organisations may help to minimise the inconsistencies in handling complaints against insurance intermediaries, it may be argued that the proposed centralised regime may lack the adequate resources to handle the workload which is presently shared amongst three organisations.

Furthermore, having two regulators for the insurance sector might create the same problem that has been seen in the securities industry where the Securities and Futures Commission regulates securities brokers and the HKMA is the watch dog for the securities departments of banks, which can lead to double standards. It would also appear that the power to impose disciplinary sanctions on bank employees will in practice be exercised by the HKMA, and not by the independent IA. Even if the HKMA adopts the independent IA’s insurance standards, it will be difficult for the HKMA to enforce those standards in the same way; this problem was highlighted within banks in the way that securities regulations were enforced following the Lehman Mini Bond scandal.

Conclusion

The Consultation Paper intentionally does not address any issues in the Ordinance other than the regulatory regime. However, the changes required to the Ordinance to effect the proposals may be a good opportunity to ‘tidy up’ the Ordinance in other respects.

In our view, regulation needs to be dynamic to reflect changes in the market. The proposals set out in the Consultation Paper clearly describe a new regulatory model intended to improve the regulation of the insurance industry in Hong Kong. The model may still require further development, nevertheless it represents a sound base on which to develop a new regulatory regime for Hong Kong without succumbing to the risk of over-regulation. Nonetheless, change of regulation is not necessarily the only answer; further development of existing regulation and structures may be equally, and possibly more, effective. Hong Kong’s unique markets, compact yet powerful, may suggest that a consolidation of regulators may be a better solution, possibly along the lines of the ‘twin peaks’ model adopted in Australia and being considered in the UK.