Supervision of Insurers

Financial Examination

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The IA is responsible for monitoring and scrutinizing the financial position of insurers. This is done by examining financial statements and returns as well as analysing critical areas to ensure that insurers comply with solvency standards and other requirements stipulated in the Insurance Companies Ordinance ("ICO"). Attention is focused primarily on key risks that impact materially on the financial strength and sustainability of an insurer, with due emphasis placed on adequacy of paid-up capital, asset quality, reserving position and nature of reinsurance arrangements.

Recognising the looming threat of new infectious diseases and other emerging risks, the IA carried out an evaluation on the reinsurance arrangements and other risk management measures adopted by Employees' Compensation ("EC") insurers. Those not having "buy-back" cover must show that they have refrained from underwriting EC business that poses greater exposure to infectious disease claims. All general insurers are required to file an annual submission of reinsurance arrangements and a brief description of guiding principles in setting the retention level and treaty limit for all classes of business.

The IA is obliged to regulate and supervise the insurance industry for the promotion of market stability and protection of existing and potential policyholders. Given the nature and risk exposure of retirement management schemes grouped under Class G business, the Guidance Note on Reserving Standards for Investment Guarantees ("GN7") was promulgated in 2001. In light of the regulatory experience gained since then and the recommendations of a consultancy study commissioned by the Mandatory Provident Fund Schemes Authority, GN7 was updated to reinforce and enhance reserving standards for Class G business by incorporating some guiding principles of reserving methodology. The second edition of GN7 has been issued and will take effect in the financial year ending 31 December 2008.

On-site Inspection

The IA undertakes on-site inspections to acquire better market knowledge and improve direct communication with the industry. Such inspections concentrate on aspects like underwriting, claims handling, asset management, reinsurance arrangements and supervision of intermediaries, the scope and depth of which vary depending on the nature or level of risks involved. The inspection teams will focus on risk management and internal control systems to ensure that business is conducted orderly and in accordance with policies formulated by the Board of Directors or senior management. They will also verify compliance with standing requirements on maintenance of assets in Hong Kong, corporate governance, prevention of money laundering and selling of insurance policies to Mainland visitors.

Market Consolidation

The IA closely monitors all merger and acquisition activities within the insurance industry to ensure that the interests of policyholders in Hong Kong are safeguarded both during and after these corporate reorganisation exercises.

Merger and Acquisition

The following merger and acquisition activities took place during the year:

• AXA (Hong Kong) Life Insurance Company Limited (formerly MLC (Hong Kong) Limited) ("AXA HKLI") and its immediate holding company, AXA Financial Services Holdings Limited (formerly HKMLC Holdings Limited), was wholly acquired by AXA China Region Limited, the immediate holding company of AXA China Region Insurance Company (Bermuda) Limited, on 8 May 2006. After this acquisition, AXA HKLI was renamed as AXA (Hong Kong) Life Insurance Company Limited to reflect the change in ownership.

• Winterthur Swiss Insurance Company, a holding company of Winterthur Life (Hong Kong) Limited and Winterthur Insurance (Asia) Limited, was wholly acquired by AXA S.A. on 22 December 2006. After this acquisition, AXA S.A. became the ultimate holding company of Winterthur Life (Hong Kong) Limited and Winterthur Insurance (Asia) Limited.

• BOC Hong Kong (Holdings) Limited ("BOCHK Holdings") acquired 51% shares of BOC Group Life Assurance Company Limited from Bank of China Group Insurance Company Limited ("BOC Group Insurance") on 1 June 2006. BOCHK Holdings and BOC Group Insurance are both subsidiaries of the Bank of China Limited.

• Old Mutual plc acquired 72.1% shares of Skandia Insurance Company Limited from Royal Skandia Life Assurance Limited in February 2006 to become its ultimate holding company.

• In late-2006, Abbey National plc sold its UK and offshore life insurance businesses to Resolution plc, thus rendering it the ultimate holding company of Scottish Mutual International Public Limited Company and Scottish Provident International Life Assurance Limited.

• The CNA Group executed a scheme of merger under which several insurance subsidiaries of the Group, including Continental Reinsurance Corporation ("CRC"), were merged into The Continental Insurance Company ("CIC"). As the surviving entity under the merger, CIC applied for and obtained authorisation to continue with the runoff of the insurance portfolio of CRC in Hong Kong. CRC, which became extinct after completion of the merger, was deauthorised on 28 December 2006.

Transfer of Insurance Business

Section 24 of the ICO stipulates that an insurer seeking to transfer its long term business to another insurer should apply to the court for an order sanctioning the scheme of transfer, whereas an insurer seeking to transfer its general business to another insurer may do so after obtaining approval from the IA under section 25D. Applications in respect of these two types of transfer that took place in 2006 are summarised in Figure 1.1.

New Authorisation

The IA authorised 11 new insurers in 2006, making up of nine general insurers and two long term insurers. A complete list of authorised insurers as at 31 December 2006 and changes within the reporting period are summarised at Appendices 3 to 6.

Legislative Amendments

As part of an on-going exercise to review provisions in the ICO, the IA will propose some amendments to bring about better transparency and supervisory standards in keeping with international developments. The insurance industry will be consulted on these proposals at an appropriate juncture.

Policyholders' Protection Funds

Since many developed economies have put in place policyholders' protection funds (PPFs), Government has launched a consultancy study on the need to install such mechanisms in Hong Kong. Stage 1 of this study, commencing in 2002, comprised a background review, an assessment on the feasibility of establishing PPFs and available options.

Diverse views were expressed on a consultation paper issued by the IA in December 2003. Although more than half of the respondents were neutral, some indicated clear opposition to PPFs by citing high administrative costs and moral hazards, while others supported PPFs as a safety net. Government will determine the way forward taking into account findings and recommendations to be made by the consultant.

Supervision on Assets of Long Term Insurance Business

Insurers in Hong Kong are already required to identify and separate assets and liabilities attributable to their long term business as well as adhere to regulations for determination of their long term liabilities. But there is no explicit valuation standard on the assets of long term insurance business, nor is there statutory provision for insurers to maintain local assets in support of the corresponding liabilities.

To assess the effectiveness of this regime, Government has launched a consultancy study on the merits of introducing a valuation framework and safeguarding mechanism for supervision of the assets attributable to long term business of local insurers. Stage 1 of this study, commencing in September 2003, comprised a background review and research on international practices. A decision will be taken on whether to proceed further after examining the outcome and latest international trends of regulatory developments.

Employees' Compensation Insurance Residual Scheme

Following the September 11 terrorist attacks and the SARS outbreak, public concern was voiced on the lack of EC insurance coverage for certain high-risk trades. The Hong Kong Federation of Insurers ("HKFI") responded by advocating EC insurance residual scheme ("Residual Scheme") as a venue of last resort for employers who could not secure coverage from the market.

Guided by the five principles of affordability, availability, accessibility, transparency and sustainability, participation in the Residual Scheme is mandatory for all EC insurers, each bearing an element of the accepted risk derived based on their respective market share. The Employees' Compensation Insurance Residual Scheme Bureau ("ECIRSB") whose membership embraces all EC insurers will be formed to take over administration of the Residual Scheme. A member insurer will be appointed to perform underwriting and claims settlement functions, backed by the HKFI serving as the Scheme Administrator.

To ensure that the ECIRSB could function in a smooth and transparent manner, an Advisory Committee with members drawn from employer associations, labour unions, legal/accounting professions, the insurance industry, the Labour Department and the IA was set up in January 2006. The HKFI will finalise the benchmark premium rate for high-risk trades based on actuarial input before rolling out the Residual Scheme in 2007.

Facility for Terrorism Risks

EC Insurance Business

Since January 2002, Government has provided direct insurers carrying on EC business with a facility up to $10 billion in aggregate ("the Facility") to cater for claims arising out of terrorism. This is intended to cope with a withdrawal of reinsurance cover following the September 11 terrorist attacks in the United States.

By the end of 2006, 64 EC insurers have joined the Facility and paid a monthly charge of 3% on their gross premiums, thereby enabling them to cover employment-related claims for death and bodily injuries caused by terrorist acts. Government will keep in view developments and withdraw the Facility once reinsurance capacity returns to the market.

Motor Insurance Business

Supervision of Insurance Intermediaries

Agents

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Insurance agents in Hong Kong are supervised under a self-regulatory system backed by Part X of the ICO operated through the Insurance Agents Registration Board ("IARB") and complemented by the Code of Practice for the Administration of Insurance Agents ("Code of Practice"). The IA collaborates with the IARB in handling complaints lodged against insurance agents and in monitoring their compliance with the Code of Practice.

Brokers

Similarly, insurance brokers in Hong Kong must be members of a self-regulatory body approved under section 70 or authorised under section 69 of the ICO. At present, the Hong Kong Confederation of Insurance Brokers and the Professional Insurance Brokers Association are approved bodies subject to oversight by the IA.

Statistics

Statistics on insurance intermediaries, their responsible officers, chief executives and technical representatives as at 31 December 2006 are shown at Appendix 7.

Promulgation of Guidance Notes

The IA reviews and updates different guidance notes promulgated to the industry from time to time. A full list of these guidance notes is at Appendix 8.

Anti-Money Laundering and Combating Terrorist Financing

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In accordance with revised recommendations made by the Financial Action Task Force on Money Laundering as well as the Guidance Paper on Anti-Money Laundering and Combating the Financing of Terrorism issued by the International Association of Insurance Supervisors ("IAIS"), the IA promulgated in July 2005 a Revised Guidance Note on Prevention of Money Laundering and Terrorist Financing to strengthen regulatory requirements, notably in customer acceptance and due diligence. To facilitate compliance, the IA hosted a seminar and convened another one jointly with the Narcotics Division and the Joint Financial Intelligence Unit ("JFIU") to boost awareness of the insurance industry on this subject.

Furthermore, to ensure that the anti-money laundering framework in Hong Kong is on a par with prevailing international standards, Government is contemplating legal obligations on customer due diligence and record keeping. The IA is working with relevant parties on this initiative and will consult the industry in due course.

On reporting of suspicious transactions, the IA has continued to circulate updated lists of suspected terrorists published by international sources or gazetted under local legislation. With the JFIU posting Quarterly Suspicious Transaction Report Analysis on its website since 2005, the IA has appealed to all insurance institutions in Hong Kong for support in improving the quality of their reports.

International and Domestic Cooperation

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Rapid pace of globalisation, rise of financial conglomerates and strategic alliances forged between financial services providers are prompting regulators worldwide to exchange information and experience. In this context, the IA has maintained regular dialogue with its local and overseas counterparts and participated actively in international events.

In mid-2006, the Commissioner of Insurance attended IAIS committee meetings held in Ottawa and concluded a memorandum of understanding on cooperation with the Office of the Superintendent of Financial Institutions of Canada and the National Association of Insurance Commissioners of the United States. In late-2006, the Commissioner attended the 13th IAIS Annual Conference and committee meetings held in Beijing. Through its membership on the IAIS Insurance Fraud Subcommittee, the IA has actively contributed to deliberations on international supervisory standards.

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During the year, the IA received an official delegation from the CIRC, representatives from the Royal Monetary Authority of Bhutan and the Financial Services Authority ("FSA") of the United Kingdom. On his part, the IA paid a courtesy visit to the FSA and hosted the 6th Joint Meeting of Insurance Regulators of Guangdong, Hong Kong, Macao and Shenzhen in November 2006.

Locally, the IA attended regular meetings of the Council of Financial Regulators and the Financial Stability Committee. It also established a communication channel with the HKFI and other industry bodies to discuss topical issues. On promotion of Hong Kong, the IA attended the 6th Asian CEO Insurance Summit held in Bangkok, the 5th Asian Conference on Catastrophe Insurance held locally and the 23rd East Asian Insurance Congress held in Brunei.

New Promotional VCD/DVD - "Hong Kong - An International Insurance Centre"

In order to promote Hong Kong as an international insurance hub, the IA has hired a professional film producer to update the promotional VCD/DVD - "Hong Kong - An International Insurance Centre". This project aims to highlight not only our favourable business environment and world-class regulatory regime, but also our unparalleled advantage as the gateway to Mainland China.

Copies of the promotional VCD/DVD will be distributed through the network of Hong Kong Economic and Trade Offices located in different countries.