Insurance amendment bills to strengthen Hong Kong’s position as a global risk management centre and regional insurance hub

The bills amending the Insurance Ordinance (Cap.41) (the IO) which are expected to help Hong Kong grow its insurance sector have now been published in the Gazette.

The bills – namely, the Insurance (Amendment) Bill 2020 (the First Bill) and the Insurance (Amendment) (No.2) Bill 2020 (the Second Bill), seek to (i) introduce a new regulatory regime for insurance-linked securities (ILS); (ii) expand the scope of insurable risks for captive insurers; and (iii) provide the Insurance Authority (IA) with direct regulatory powers over the holding companies of multinational insurance groups, enabling the IA to supervise on a group-wide basis.

The bills form part of the Hong Kong government’s initiatives aimed at strengthening Hong Kong’s position as a global risk management centre and regional insurance hub.

The First Bill

The First Bill will amend the IO to (i) create a new regulatory regime for ILS and (ii) expand the scope of insurable risks for captive insurers set up in Hong Kong. The proposed changes will allow Hong Kong to fully capitalise on opportunities arising from the Guangdong-Hong Kong-Macao Greater Bay Area and the Belt and Road Initiative.

(i) Regulatory regime for ILS

ILS such as catastrophe bonds are risk management tools that allow insurers/ reinsurers to raise capital by transferring insured risks to the capital markets through securitisation.

The operation of ILS typically involves the setting up of a dedicated special purpose vehicle (the SPV) by an insurer/ reinsurer (the cedant) which is then followed by a transfer of its insurance risk to the SPV through a reinsurance/ risk transfer contract (the RT Contract). The SPV issues ILS to investors to finance the full amount of risk assumed by it under the RT Contract. The investors receive a return in terms of coupons comprising investment yield and the spread for risk premium. At maturity, the investors would redeem the proceeds of the ILS minus any claims payments made by the SPV to the cedant triggered under the RT Contract.

To create the new regulatory regime for ILS, the following key changes to the IO are proposed:

a new class of insurance business i.e. special purpose business (SP business) will be added – the SP business involves acquiring insurance risk from another insurer/ reinsurer under a RT Contract and issuing ILS to investors to collateralize the risk;
a new type of authorized insurer under the IO will be added. An insurer authorized to carry on SP business will need to be authorized as a “special purpose insurer” (SPI). The SPI will serve the functions of the SPV;
minimum regulatory requirements in relation to SPIs will be introduced. A company seeking authorization as an SPI must meet these requirements (e.g. the company must be fully-funded, the company must appoint an administrator as a controller to manage the SP business etc.); and
restrictions will be imposed regarding the sale of ILS. It is currently proposed that the sale of ILS will be confined to qualified institutional investors (e.g. dedicated ILS funds and hedge funds) by private placement.

(ii) Captive insurers

A captive insurer is an insurance company set up by its parent company with the primary purpose of insuring and reinsuring the risks of the companies in the group to which the captive insurer belongs. At present, there are four captive insurers set up in Hong Kong which are regulated under the IO.

Captive insurers can only underwrite risks in relation to those companies within the captive insurer’s “grouping of companies”.[1] The existing scope of insurable risks has been considered by the industry as being overly narrow (e.g. the risks which a captive insurer can insure/ reinsure are limited to the risks of companies formed and registered in Hong Kong under the Companies Ordinance).

In light of this, the First Bill proposes to amend the IO by expanding the scope of insurable risks to include:

the risks of a body corporate within the “relevant company’s corporate group” to which the captive insurer belongs that is incorporated outside Hong Kong and does not have a place of business in Hong Kong;
in cases where a body corporate belonging to the captive insurer’s “relevant company’s corporate group” controls less than 20% of another body corporate, the proportional share of risks to which the “relevant company’s corporate group” is exposed; or
the risks of an unrelated body corporate (i.e. not within the “relevant company’s corporate group” of the captive insurer), provided that the captive insurer or a body corporate in the “relevant company’s corporate group” to which the captive insurer belongs is given a full risk management mandate.

The Second Bill

The Second Bill will amend the IO to enhance the regulatory framework for the regulation and supervision of insurance groups where the holding company of the authorized insurer is incorporated in Hong Kong.

At present, the IA takes an indirect approach to supervising insurance groups by using its “solo” regulatory powers – it does this by exercising its powers over insurance subsidiaries which it directly regulates (i.e. authorized insurers) to influence the holding companies of insurance groups. There are certain limitations with this approach. For example, if the holding company of an authorized insurer is not fit and proper, the IA’s only recourse is against the authorized insurer and no direct action may be taken against the holding company. Additionally, there are challenges to the IA as group supervisor in conducting group-wide capital adequacy assessments of an insurance group.

To provide the IA with direct regulatory powers to supervise on a group-wide basis, the Second Bill will (amongst other things):

empower the IA to designate a Hong Kong-incorporated insurance holding company (DIHC) within an insurance group to be subject to group-wide supervision (and equally, power to withdraw such designation if circumstances have changed);
empower the IA to determine the scope of the insurance group that is subject to group-wide supervision. Default members of the supervised group will consist of the DIHC, all subsidiaries of the DIHC and any other entities that are, according to applicable accounting standards, treated as a member of the insurance group to which the DIHC belongs;
require a person seeking to become a shareholder controller or be appointed as the chief executive, a director or “key persons in control functions”[2] of a DIHC to obtain the prior approval of the IA;
empower the IA to impose on a DIHC similar regulatory requirements as those which apply to an authorized insurer under the IO (e.g. appointment of an auditor, reporting and disclosure requirements etc.);
empower the IA to conduct inspections and investigations for ascertaining whether a DIHC is complying with the requirements of the amended IO;
empower the IA to take disciplinary actions against a DIHC similar to those which may be taken against authorized insurers under the IO; and
impose an obligation on the 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 International Association of Insurance Supervisors.

The Second Bill is expected to bring Hong Kong in line with international standards. Similar regimes have already been implemented in jurisdictions including the UK, Australia, Bermuda and Singapore.

The bills are expected to be introduced into the Legislative Council for first reading in the near term.

The First Bill can be found here and the Second Bill can be found here.

[1] This includes (a) a company (first company) which belongs to the captive insurer’s “group of companies” (as defined under the Companies Ordinance (Cap. 622)); (b) a company (second company) in which either the captive insurer itself or the first company holds or is entitled to exercise the control of, at least 20% but not more than 50% of the voting power at the general meeting of the second company; or (c) a company which is a subsidiary of a second company at (b).

[2] “Key persons in control functions” under the Second Bill means an individual who is responsible for the performance of one or more of the control functions for the company in respect of its supervised group. The term “control functions” is also defined. It includes risk management function, financial control function, compliance function, internal audit function, actuarial function and any other function specified by the Financial Secretary by notice published in the Gazette.

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