Jurisdiction - Hong Kong
Reports and Analysis
Hong Kong – Risk-Based Capital Framework.

9 March, 2015 

 
 
Introduction
 
The process of introducing a risk-based capital (RBC) framework in Hong Kong was officially launched on 16 September 2014 when the Hong Kong Insurance Authority published a Consultation Paper. The RBC regime is expected to be finalised and implemented in the next five years, and will significantly affect the way insurers operate and fund themselves. The consultation period ended on 15 December 2014 and the industry is now awaiting the Government’s conclusions.
 
Currently, the solvency test used in the Hong Kong insurance industry is a simple rule-based minimum capital requirement. The new RBC framework will be in line with international standards and the Insurance Core Principles (ICPs) which were agreed in 2011 by the members of the International Association of Insurance Supervisors. Inspiration will also be drawn from the EU’s Solvency II regime which is due to come into force in January 2016.
 
By international standards, Hong Kong is late in adopting an RBC regime. This is partly due to the fact that the new insurance regulator (the new Insurance Authority) which will be responsible for preparing the legislation and undertaking the necessary administrative tasks has yet to be established.
 
Being a latecomer may, however, play to Hong Kong’s advantage, as the Government has drawn on experiences from other jurisdictions.
 
The delay will also enable the new Insurance Authority to align the RBC with the expected changes to accounting policies, notably IFRS 4 (Insurance Contracts) and IFRS 9 (Financial Instruments).
 
The Framework
 
The requirements under the proposed RBC regime will fall under three “Pillars”, closely resembling the Solvency II regime:
 
Pillar 1
 
Pillar 1 (quantitative aspects) concerns capital adequacy and valuation of assets and liabilities. It will contain two solvency control levels: a higher “warning level” called the Prescribed Capital Requirement (PCR), and a lower “enforcement level” called the Minimum Capital Requirement (MCR). There will be a standardised approach to calculating capital adequacy for the purpose of the PCR and MCR. However, internal models may be permitted subject to regulatory approval. International insurers who have already invested in Solvency II-compliant models and Enterprise Risk Management (ERM) systems should take note of this option. At present, only equity capital tends to qualify for the solvency calculation. This is likely to change as the consultation paper signals a shift to a tiered approach which permits insurers to categorise a wider range of funding (including subordinated debt) as capital. This will create a demand for new bespoke debt instruments, as insurers seek to optimise their capital structure.
Pillar 2
 
It is often said that Pillar 2 (qualitative aspects) should logically come first, as robust internal governance, systems and controls would enable insurers to comply with the quantitative requirements under Pillar 1 and disclosure obligations under Pillar 3. The consultation paper places particular emphasis on the Own Risk and Solvency Assessment (ORSA). The ORSA is the internal process used by insurers to assess risks and solvency position. To ensure that insurers conduct a comprehensive ORSA, insurers will be required to submit their full ORSA documentation annually for review and the new Insurance Authority will be able to apply capital add-ons if the ORSA or ERM framework of the insurer is inadequate.
 
Pillar 3
 
Hong Kong insurers are currently not under any obligation to make public disclosures. The disclosure obligations of insurers are likely to change upon implementation of the RBC framework and ICP 20 on Public Disclosure. ICP 20 requires, among other things, a wide range of quantitative and qualitative information on technical provisions, capital adequacy, financial instruments and associated risks to be disclosed to the public.
 
Group-Wide Supervision
 
The consultation paper proposes that the new Insurance Authority be given explicit powers to supervise the insurer’s entire group. This proposed group-wide supervisory framework would represent a complete shift from today’s regulation of licensed entities on a stand-alone basis.
 
The supervisory approach would distinguish between three different types of insurance groups. The first type would be Hong Kong-based insurance groups which would be subject to complete supervision by the new Insurance Authority. The second and third types of insurance groups would be exempt from certain requirements on the basis that they are subject to separate capital requirements of other regulators or have sufficient group-wide supervision in their home jurisdiction.
 
Regulation Of Branches
 
The solvency margin requirement currently applies to all Hong Kong incorporated insurers at the company level. The consultation paper notes that many other jurisdictions, such as Australia, Singapore and Canada, require branches of overseas jurisdictions to file the same regulatory returns as locally incorporated insurers. A similar treatment is proposed in Hong Kong. This will require separate rules governing capital resources for branches of overseas companies.
 
Summary
 
The RBC framework will have a profound impact on both local and international insurers in Hong Kong. First, insurers will have to assess whether their current operating model complies with the new regime. Secondly, insurers may be required to invest in new systems, processes and human resources to implement the infrastructure required to enable ongoing RBC compliance. Finally, the board and senior management team will need to adopt a risk-based mind-set to decision-making, in accordance with the processes under Pillar 2 of the RBC regime.
 

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For further information, please contact:

 

Robert Ogilvy Watson, Partner, Ashurst
robert.ogilvywatson@ashurst.com

 

Angus Ross, Partner, Ashurst
angus.ross@ashurst.com

 

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