Christie Lee, Senior Director of Analytics at AM Best Asia-Pacific Limited in Hong Kong, discusses how recent regulatory developments including a group-wide supervision rule, and tax relief initiatives to support the growth of reinsurance, insurance-linked securities and captive insurance, will enhance Hong Kong’s market competitiveness and sustainability.
Hong Kong, a special administrative region (SAR) of the People’s Republic of China, is a metropolitan and financial centre in Asia with a population of 7.5 million and GDP per capita of approximately US$ 50,000. According to Swiss Re sigma statistics, in 2019, Hong Kong had the highest life insurance density (measured by premiums per capita) among advanced Asia-Pacific markets at US$ 8,979, and the highest life insurance penetration (premiums as a percentage of GDP) globally at 18.26 per cent. On the non-life insurance front, Hong Kong has a fragmented market comprising 91 general insurers and 21 composite (i.e., both life and non-life) insurers. Collectively, Hong Kong’s insurance industry generated gross premium written (GPW) of HKD 566.9 billion in 2019 (US$ 72.9 billion) – of which the life segment contributed HKD 511.5 billion (US$ 65.7 billion), while the non-life segment accounted for HKD 55.4 billion (US$ 7.1 billion).
In 2017, the new independent Insurance Authority (IA) took over statutory functions from the previous insurance regulator, the Office of the Commissioner of Insurance. Since then, the IA has continued to spearhead the modernisation of Hong Kong’s insurance regulatory regime, to place it on a par with international standards and to boost the territory’s competitiveness.
Given Hong Kong’s geographic proximity to China, well-established infrastructure, and reputation as an Asian financial hub, AM Best is of the opinion that the initiatives, including regulatory reforms, introduced by Hong Kong with the support of China’s central government will be positive in shaping the SAR into a risk management hub. This will be opportune to serve the growing needs of Chinese enterprises and reinsurance companies that are expected to arise from the Belt and Road Initiative and the development of the Guangdong-Hong Kong-Macau Greater Bay Area (GBA). Among other new initiatives, the government recently announced a mix of new policies and insurance regulations targeted at tax relief, captives, insurance-linked securities (ILS), and the GBA project, which AM Best notes will benefit the insurance industry at-large.
In July 2020, the Hong Kong Legislative Council passed the Inland Revenue (Amendment) (Profits Tax Concessions for Insurance-related Business) Bill 2019. This bill seeks to amend the Inland Revenue Ordinance to reduce the profits tax rate by half (to 8.25 per cent), for all general reinsurance businesses and selected general insurance businesses of direct insurers, as well as selected insurance brokerage business. The government and the IA are currently in the process of drafting implementation details and subsidiary legislation for the tax concessions, which are expected to be rolled out by early 2021.
AM Best notes that these incentives will increase Hong Kong’s market competitiveness and allow reinsurance companies to capture opportunities arising from the Belt and Road initiative, especially in the reinsurance and speciality risk segments (such as aviation, agriculture, catastrophe, war risk, and trade credit).
Further, under the Equivalence Assessment Framework Agreement on Solvency Regulatory Regime between the IA and the China Banking and Insurance Regulatory Commission (CBIRC) that was first granted in 2017 and extended in 2020, a mainland insurer that cedes business to a qualified Hong Kong professional reinsurer can enjoy a lower reinsurance credit risk charge. This is an important implication that raises the attractiveness of Hong Kong reinsurers (over other offshore reinsurers) to Chinese insurers, given potentially lower costs of capital on ceded business. Combined with the recently announced tax incentives, Hong Kong reinsurers are likely to enjoy a significant competitive edge over their foreign counterparts in tapping into the reinsurance growth potential arising from China’s economic expansion.
Captive Insurance Segment
While the use of captive insurance is well-established in many western markets, the concept remains relatively new to mainland China businesses. Although Chinese enterprises make up a quarter of the companies on the Fortune 500 list, only a handful have formed captives to support their enterprise risk management; this is also partially due to the relatively short Chinese enterprise history and the country’s rapid economic growth since its entry into the World Trade Organisation.
As such, to develop the captive insurance segment in Hong Kong, the IA has introduced favourable regulations including lower minimum capital and solvency requirements; exemption from the need to maintain assets in Hong Kong to match local liabilities; and a tax concession of 50 per cent on the profits tax rate for insurance business. The Insurance (Amendment) Bill 2020, that was passed by the Legislative Council in July 2020, also seeks to expand the scope of insurable risks of captive insurers set up in Hong Kong, to allow greater flexibility and additional revenue sources for captive insurers.
In addition, current insurance regulations in China make no distinction between a captive insurer and a commercial insurer. This implies much higher capital requirements and operating costs as more manpower is required, given that the outsourcing of day-to-day operations is not allowed.
Consequently, in view of the resultant lower capital requirements, reduced tax and cheaper operating cost, Hong Kong is likely to stand out as a more attractive captive domicile (than China) to Chinese companies that are considering setting up captives.
Developing Insurance-Linked Securities
In the last decade, global reinsurers have increasingly adopted ILS as part of their risk management – transferring insured risks to capital markets via securitisation – given the historical lack of correlation between ILS securities and traditional investments. In 2019, global issuance of ILS topped US$ 10 billion, while Bermuda was the most popular jurisdiction for ILS issuance.
The Hong Kong government is keen to leverage its position as a financial hub to promote the SAR as a platform for the issuance of ILS by mainland reinsurers. As such, the passage of the Insurance (Amendment) Ordinance 2020 also provides for a regulatory framework to facilitate ILS issuance in Hong Kong through special purpose vehicles, which will be regulated as a new type of authorised insurer.
Given China’s exposure to natural catastrophes (including earthquakes, typhoons in coastal areas, floods and snow storms), as well as the significant pace of catastrophe risk accumulation due to its rapid economic growth and urbanisation, we expect that ILS can be an effective alternative reinsurance solution for mainland insurance companies. In addition, the Chinese central government policy is supportive of local enterprises issuing catastrophe bonds in Hong Kong.
From an investment perspective, the development of an ILS market in Hong Kong (which presumably will be centered on risks from Chinese and other Asian markets) will also present an attractive alternative to institutional investors looking for greater portfolio diversity as current ILS issuances are largely focused on risks in the US and European markets.
Greater Bay Area Developments
China’s 15-year GBA initiative will connect Hong Kong, Macau, Shenzhen and eight other cities in the Guangdong province – all of which hold geographical and economic significance as their collective output accounts for over 10 per cent of the country’s GDP. The project is aimed at promoting greater economic coordination and development by leveraging the comparative advantages of each city; the insurance industry will inevitably play an important role in risk management. Although the first phase of the initiative does not allow cross-border policy sales yet, there are plans for the set-up of service centres in designated cities to enable insurance companies to provide better after-sales service to customers. Over the long term, there is potential for the development and enablement of cross-border insurance sales and services which will offer abundant opportunities to insurance companies in Hong Kong, in particular life insurers.
Chinese nationals have traditionally been a major contributor to the growth of Hong Kong’s life market; this contribution peaked in 2016 when more than one-third (HKD 73 billion; US$ 9.4 billion) of the life segment’s new business GPW was generated by non-Hong Kong residents from the mainland, thanks to the wide variety of product offerings by Hong Kong insurers. However, life insurance sales from mainland customers have declined since China’s imposition of certain measures to prevent capital outflow.
The unexpected outbreak of COVID-19 placed further strain on Hong Kong’s life insurance sales, given the sharp fall in mainland visitors due to travel restrictions and strict quarantine measures. Chinese nationals may only purchase life insurance policies in Hong Kong in person as cross-border sales are illegal. As a result, new business premiums from Chinese customers plunged by 94 per cent to HKD 800 million (US$ 102.8 million) in the second quarter of 2020, compared to the same period in 2019. Should (and when) later phases of “Insurance Connect” policies allow for cross-border insurance sales, it will materially boost the growth of the Hong Kong life insurance market. Nonetheless, AM Best expects that this will take place over a much longer time frame as both Hong Kong and Chinese governments will need to agree mutually on matters, including regulatory and legal frameworks, taxation, and protecting the interests of market participants.
Continual Regulatory Enhancements
Apart from the above-mentioned measures, the IA launched an industry-wide consultation on a proposed Group Capital Rule (GCR) in August 2020. The new proposed rule will empower the regulator with greater supervisory authority over insurance holding companies and promote closer collaboration between the regulators across many jurisdictions – which will also serve to enhance Hong Kong’s standing as a financial powerhouse.
Currently, the IA acts as the group supervisor to several multinational insurance groups, including AIA Group Limited (AIA), Prudential plc (Prudential) and FWD Group. As the regulator of a group’s main insurance operations domiciled in Hong Kong, the IA currently takes an indirect approach that mainly involves the continual fit and proper assessments of the insurance holding companies’ ability to manage their subsidiaries, as well as liaison and cooperation with other regulators of a group’s member operations. As such, the proposed legislative amendments will extend power to the IA in regulating international insurance groups, while granting it additional authority applicable at the holding company level.
Christie is a senior director and head of analytics of AM Best Asia-Pacific Limited. She leads a team of rating analysts within AM Best that cover all types of rated insurance companies, including life, non-life, reinsurers and captive insurers, for Greater China, Japan and Korea. Founded in 1899, AM Best is the world’s first credit rating agency, and has grown to become the largest credit rating agency in the world specialising in the insurance industry. It is the oldest and most widely recognised provider of credit ratings, financial data and news with an exclusive insurance industry focus.