New rules and increased regulatory focus for ILAS

Recent announcements by the Hong Kong Federation of Insurers (HKFI), the Hong Kong Monetary Authority (HKMA) and the Hong Kong Securities and Futures Commission (SFC) highlight increasing regulatory focus on the sale of investment-linked assurance schemes (ILAS). The result is:

• more detailed disclosure requirements;
• a more prescribed sales process for ILAS; and
• for banks, a need to clearly identify that customers have a dual objective of investment and insurance before offering ILAS to them.

What are ILAS?

ILAS are life insurance products where the value of the policy is linked to underlying investments, typically investment funds, with a small additional death benefit. ILAS can offer a policyholder / investor a single platform to access investment funds from a range of investment managers. They have been a core product offering of many independent financial advisers in Hong Kong for a number of years.

How ILAS are regulated in Hong Kong

The hybrid nature of ILAS, with elements of both insurance and investment, pose challenges for a Hong Kong regulatory system that has different regulators for different industries.

The issuers of ILAS are insurance companies and are regulated by the Insurance Authority (IA). The IA focuses on prudential regulation of insurers, rather than product-specific regulation. Authorised insurers are also required to become members of, and comply with the rules of, the HKFI, which is a self-regulatory organisation.

ILAS themselves fall within the definition of “collective investment scheme” under the Securities and Futures Ordinance (SFO) and so need to be authorised by the SFC before they can be offered to the public in Hong Kong. However, contracts of insurance are excluded from the definition of “securities” under the SFO. The SFC has previously made clear in a circular dated 13 August 2009 that it does not regulate (and will not grant licences to) persons who only offer ILAS to the public and advise on the investment choices within ILAS.

The persons who offer ILAS and advise on the investment choices within ILAS need to be either insurance agents (if acting as agents of the insurer) or insurance brokers (if acting as agents of the policyholder). Separate self-regulatory organisations regulate insurance agents and insurance brokers. A number of banks (typically acting as insurance agents) offer ILAS to their customers as part of their wealth management business and are also subject to HKMA oversight in conducting these activities.

The pressure for change

The last several years have seen an increased regulatory focus on the selling process for investment products, particularly structured products and other investment products that use derivatives to obtain exposure. The recent announcements from the HKFI, the HKMA and the SFC relating to ILAS are a continuation of that trend.

In addition, there has been increased awareness of the possibility of regulatory arbitrage by financial advisers who offer investment funds and asset allocation advice to their clients through ILAS, without the additional regulatory obligations that apply to an SFC-licensed adviser if it were to offer or advise on the same investment funds directly.

New selling and disclosure requirements for insurers – the HKFI announcement

The HKFI issued a circular to ILAS issuers on 22 April 2013 setting out updated requirements relating to the sale of ILAS. The HKFI circular sets out a recommended ILAS sales process that each ILAS issuer must adopt, including:

1. a financial needs analysis for each applicant, that must at a minimum contain the questions in the form attached to the circular;
2. a risk profile questionnaire for each applicant;
3. an “Important Facts Statement” (IFS) that must follow the templates in the circular and must be given to and signed by each applicant; in particular, the IFS must include a statement that remuneration will be payable to insurance intermediaries;
4. a suitability check, requiring the ILAS issuer to (among other things) verify whether the ILAS and its key features such as the premium amount and term suitable and affordable for the applicant(s) based on the information disclosed by the applicant(s); and
5. post-sale requirements, including a requirement to make a recorded audio call using an approved script within 5 working days after sale confirming a customer's consent to the suitability assessment.

Insurers are required to implement the updated requirements no later than 30 June 2013.

The circular is available in the Downloads section of the HKFI website www.hkfi.org.hk.

New selling requirements for banks – the HKMA announcement

On the same day that the HKFI issued its circular to insurers, the HKMA issued a circular to banks setting out the HKMA's expectations of banks when selling ILAS. In addition to highlighting the IFS and the importance of following the ILAS sales process set out in the HKFI circular, the HKMA emphasised that banks must make pre-sale disclosure in writing of the monetary and non-monetary benefits they receive from the sale of ILAS. The HKMA circular includes a template that banks must use in making this pre-sale disclosure.

The HKMA circular also set out guidance on the standards the HKMA expects banks to meet in selling ILAS, based on findings from on-site examinations and off-site reviews. Areas the HKMA identified include:

• Considering a customer's ability to afford an ILAS over the life of the product in assessing suitability;
• Considering total premium payable over the life of the ILAS for the purpose of determining a customer's asset concentration;
• Appropriate due diligence by the banks to ensure they have a thorough understanding of the nature, features, structure and the associated risks of the ILAS, including its underlying funds;
• Ensuring customers understand when a premium holiday is available under the ILAS, and the risks and consequences of exercising a premium holiday; and
• Only offering ILAS where appropriate for a customer's needs or objectives; the circular states the HKMA view that, in general, ILAS are not suitable for customers who do not have a dual objective of investment and insurance – the circular noted that, where a customer's objective is documented as “investment” only, there is no reasonable rationale for recommending products with insurance elements to the customer.

The circular is available in the Guidelines & Circulars section of the HKMA website www.hkma.gov.hk.

New product disclosure requirements – the SFC announcement

Lastly, the SFC issued a circular to ILAS issuers on 3 May 2013 setting out enhanced disclosure requirements applicable to the product key fact statements (KFS) of SFC-authorised ILAS. For SFC-authorised ILAS, ILAS issuers will need to prepare both an IFS (required by the HKFI) and a KFS (required by the SFC). Although there are a number of common disclosure items, the form and content of each are different.

The enhanced KFS disclosures include:

• a statement of the purpose of investing in the ILAS;
• new total fees and charges disclosure, setting out the total fees in investing in the ILAS as a percentage of the total premiums to be paid by investors;
• more prominent disclosures on certain long-term features, including upfront charges, early surrender or withdrawal charges, and loyalty bonuses; and
• disclosure relating to remuneration of the insurance intermediaries who offer or recommend the ILAS.

All new applications for SFC authorisation of ILAS, and all applications for authorisation that were submitted prior to 3 May 2013 but remain outstanding, must comply with the enhanced disclosure requirements.

Existing SFC-authorised ILAS have until 30 September 2013 to comply with the enhanced disclosure requirements. Revisions to the KFS of existing ILAS which solely reflect the enhanced disclosure requirements do not require the SFC's prior approval. The revised ILAS offering documents (including the KFS) must be filed with the SFC within one week from issue, together a prescribed filing letter and completed information checklist.

The updated version of the illustrative KFS template, the prescribed filing letter and information checklist are available in the Circulars section of the SFC website www.sfc.hk.