Consumer Council Submission to the Financial Services and the
Treasury Bureau on the Proposed Establishment of a Policyholders'
Protection Fund (24 June, 2011)
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1. The Consumer Council (the Council) is
pleased to submit its response to the Financial Services and the
Treasury Bureau (FSTB) regarding the consultation paper on the
proposed establishment of a Policyholders' Protection Fund (PPF) in
Hong Kong.
2. This paper sets out the Council's
response to the recommendations made in the consultation paper in
respect of the key aspects of the proposed PPF, including its
coverage and level of compensation, funding mechanism and
governance arrangements.
The Establishment of a PPF
3. The Council welcomes the
establishment of a PPF in Hong Kong for reasons that it will act as
a 'safety net' for better protection of policyholders' interest in
the event of insurer insolvency and enhance public confidence in
the insurance industry.
4. As protection schemes are already in
place for other financial sectors in Hong Kong, the Council
considers it equally important that policyholders' funds should
have similar protection, given that they could represent a major
source of liquidity for many consumers.
5. Having said that, the Council has
concern over the issue of cost shifting to policyholders under the
proposal of collecting levies for the PPF from insurers. The
Council is of the view that there should be safeguards in place to
ensure that the cost would not be directly passed on to
policyholders.
6. The Council also urges that the regulatory
standards and requirements for supervision of insurers should not
be in any way relaxed notwithstanding the establishment of the PPF
in Hong Kong.
Key Features of the PPF
Scheme
7. The following sets out the Council's
response to the recommendations as to the proposed PPF that have
direct implications on consumer interests.
Coverage
Individual and SME
policyholders
8. The Council fully supports focusing
the coverage of the PPF on individual and SME policyholders who are
generally less capable of protecting their own interests in respect
of insurance. This proposal also matches a policy objective of
protecting vulnerable policyholders which is also adopted for some
overseas protection schemes.
Life and Non-life
schemes
9. As regards the form of participation,
the Council considers that mandatory participation of all
authorized life and non-life insurers in the PPF is crucial. A
voluntary system is unlikely to provide universal protection to
policyholders. Rather, it may give rise to the undesirable scenario
whereby insurers will refrain from joining the PPF to reduce the
costs associated with the levy, hence leaving the vulnerable
insured at risk of loss upon insurer insolvency. The Council
therefore fully supports the proposal of making it a mandatory
requirement for all insurers to participate in the PPF.
10. The consultation paper also proposes
that the PPF will accept claims in respect of all life and non-life
policies, with exceptions for policies in respect of reinsurers,
wholesale retirement schemes, captive insurers, and those that are
already covered by the Employees Compensation Insurer Insolvency
Scheme and the Motor Insurers' Bureau's Insolvency Fund Scheme. The
Council has no objection to this arrangement provided that there
are some safeguards to ensure that correct representation regarding
PPF membership and coverage can be ensured.
11. In addition to the proposed
exceptions, the Council wonders whether exemption from the PPF
would be provided, for instance, where an overseas insurer is
already subject to similar protection scheme in another
jurisdiction. The Council considers it important for the Government
to clarify this and provide detailed information on the basis for
granting such exemption (for example, circumstances under which an
overseas insurer can apply for exemption from participation in the
PPF).
12. Another issue the Council would like
to raise is related to the proposal that the PPF will cover all
life and non-life policies written in Hong Kong, which would
exclude offshore policies from the scope of the PPF. As the
consultation paper lacks information on the amount of offshore
policies in Hong Kong, the Council suggests the Government to
explore if the exclusion would substantially lessen the level of
policyholder protection.
13. In any case, consumers should be
made aware of whether insurers they are dealing with or policies
concerning them are eligible for protection. The Council considers
that for insurers (or policies) not covered in the PPF, there
should be some safeguards to ensure that consumers are not led into
believing that protection exists when it does not. Moreover, rules
should be made to require scheme members' disclosure of the nature
and extent of PPF protection applicable to their policyholders, and
such information should be made available to existing and potential
policyholders.
14. As to the setting up of two separate
and independent schemes (i.e. the Life Scheme and Non-life Scheme)
under the PPF, the Council supports this proposal given the
different nature of life and non-life policies.
Policies that pre-dated the
PPF
15. The Council supports the proposed
coverage of the PPF to include all in-force policies as at the date
of the introduction of the PPF as well as new policies issued
thereafter.
Conditions for activating the
PPF
16. In relation to the proposed
conditions for triggering the activation of the PPF, the Council
supports laying down specific circumstances under which the PPF may
be triggered in the event of insurer insolvency. The Council would
welcome disclosure of such information to the public to enhance
general awareness.
Eligible claims
17. The Council welcomes the proposal of
not setting any cut-off date for the submission of claims, to
provide better protection for policyholders.
Level of Compensation and
Application
Compensation
limit
18. It is proposed in the consultation
paper that a 100% compensation cover for the first HK$100,000 and
80% of the balance, with a maximum limit of HK$1 million for an
eligible claim, be adopted.
19. A question regarding the above
proposed percentages and cap on the level of compensation is
whether policyholders should bear a share of any loss or whether
100% cover should be provided for a claimant. The Council has
concern if the compensation limit of HK$1 million would provide
adequate policyholder protection, and views that a scheme providing
100% compensation could give full protection to policyholders and
promote market confidence.
20. Notwithstanding that, the Council
recognizes that a higher cap could increase the costs of
participation in the PPF which might be passed on to policyholders.
Considering the Government estimation that the proposed coverage
would meet over 90% of the claims, the Council has no objection to
the proposed tapering method (i.e. claim of a certain amount met in
full and remaining balance met to a lesser extent) with a
compensation cap of HK$1 million for claiming the PPF at an
introductory stage.
21. The Council also suggests that a
review of the full payment amount, the percentage for the balance
and the compensation cap be conducted at a later stage, to ensure
they will remain effective in protecting the interest of
policyholders in Hong Kong.
Basis of
compensation
22. The consultation paper proposes that
compensation should be applied on a 'per-policy' basis for life
insurance policies and a 'per-claim' basis for non-life insurance
policies. The Council supports the proposed approach as this would
be simpler to administer and could provide certainty to
policyholders.
Arrangements in the event of
insurer insolvency
23. For continuity of protection in the
event of insurer insolvency, the Council supports the proposals
that the PPF should be able to transfer a policy to a replacement
insurer wherever possible, and pay to affected policyholders an
"ex-gratia" payment having regard to the losses arising from
premature surrender of the policy concerned or procuring a similar
policy from another insurer.
24. In allowing consumer choice, the PPF
Board should make clear to affected policyholders that they can
choose to terminate the policy concerned or accept transfer of
policy to another insurer. The Council urges the PPF Board to
ensure that information to facilitate policyholders' decision
making will be properly and effectively brought to their
attention.
Funding
Mechanism
Funding model
25. In the consultation paper, a
progressive funding approach for the PPF is proposed for
consideration, i.e. a combination of the pre-funding and the
post-funding models, with an initial moderate levy rate
complemented by a stepped-up levy rate upon occurrence of
insolvency. The consultation paper remarks that the progressive
funding model is a more pragmatic approach.
26. The Council is disposed to favour a
pre-funding approach as this will provide certainty to
policyholders that funds are already available to compensate them
in the event of insurer insolvency.
27. However, the Council notes the major
drawback of the pre-funding approach of locking up a huge amount of
levy the initial accumulation of which may in turn put pressure on
the premium levels. Moreover, the Government has indicated that
back-up funding would be provided under the progressive funding
approach to bridge the liquidity gap to ensure the prompt
reimbursement of policyholders' claims in case funds are not
sufficient to meet liabilities in the event of insurer insolvency.
The Council therefore accepts the progressive funding
approach.
28. Apart from the provision of back-up
funding, the Council suggests that there should be a mechanism for
triggering reinstatement or suspension of the levies when the PPF
falls below a minimum prudent level or exceeds the self-funding
level. A similar mechanism can be found with the Deposit Protection
Scheme in which a target range with upper and lower limits is set
up to provide an adequate buffer to the scheme.
29. From the perspective of policyholder
protection, the Council considers that a re-instatement mechanism
is of particular importance in ensuring that there is no
significant reduction in the funding level below what is required
to provide sufficient protection to policyholders.
Collection of
levy
30. The Council strongly supports that
the cost of financing the PPF should be borne by insurers. The
Council is of the view that industry participants should have the
responsibility of contributing to the PPF in case of insurer
default, instead of having compensation funded by
policyholders.
31. As for other protection schemes, the
Council believes that the main intention of the PPF regulation
should be to have insurers accountable for problems associated with
their own industry. Insurers are experts in assessing risks and
they should be knowledgeable to avoid undue risk-taking. On the
other hand, raising levy directly from policyholders would not pose
an incentive to or have any impact on reducing insurer
default.
32. The Council is aware that the source
of compensation funding for similar local protection schemes is
mainly industry-based. For example, funds under the Deposit
Protection Scheme are collected from banking
institutions.
33. For an industry-funded compensation
scheme, some may argue that the costs of the levies although
initially borne by insurers, are likely to be passed on to
policyholders through higher premiums. As a result, the benefits of
not requiring direct payment from policyholders may be partially
reduced through the transfer of costs by insurers.
34. In this regard, the Council
considers that the PPF Board has a role to play in monitoring the
situation to prevent unreasonable cost transfer to policyholders
upon the inception of the PPF, given that the impact on the premium
levels would be minimal as remarked in the consultation
paper.
35. With regard to the method of levy
assessment, the Council notes the Government proposal of using
premiums as the calculation basis on which levy can be
assessed.
36. Under this assessment method,
insurers make contribution in proportion to the amount of premiums
they receive. The Council considers that imposing levy based on
liabilities, instead of basing levy for PPF on premium, would be
more reflective of the exposure of the PPF to each insurer as it is
more directly linked to the amount of payouts that will need to be
made by the PPF in the event of insurer default.
37. In considering the method of levy
assessment, the Council urges the Government to ensure that it is
appropriately set and that the approach to be adopted will not
materially affect the effectiveness of the PPF.
Initial target fund
size
38. The Council understands that there
is no single answer to the question of what the appropriate initial
target fund size should be, because a trade-off is involved. That
is, too large a fund implies a higher levy rate which may affect
the financial integrity of the insurance industry with cost
implications to policyholders, whereas too small a fund may provide
inadequate funding in meeting claims from policyholders in case of
insurer default.
39. The Council therefore considers that
smaller starting fund sizes of HK$1.2 billion for the Life Scheme
and HK$75 million for the Non-life Scheme, are acceptable in the
early stage of development. However, it is necessary to regularly
review the fund sizes in the light of market developments and the
changes in the risk profiles of insurers.
40. The Council is of the view that as a
small target fund size is set on the assumption that the PPF would
be able to recoup against the assets of insolvent insurers, it is
important for the PPF Board to work closely with the regulatory
authority to ensure that any insolvent insurers would be prohibited
from transferring assets overseas (asset flight) in case of
cessation of their business.
41. The consultation paper has not
provided supportive information or scenario analysis on how the
Government has come up with the estimation of the target fund size
and the fund build-up period which would be able to provide
adequate protection to policyholders. The Council suggests that
detailed information on such estimation should be disclosed to the
public for the sake of transparency.
Levy rate
42. The consultation paper suggests that
the initial levy rates for both the Life Scheme and the Non-life
Scheme should be 0.07% of the applicable premium. The Council
accepts the proposed introduction of a levy rate of 0.07% at the
early stage of the PPF, but an annual review should be conducted to
check whether it remains appropriate, or whether the rate need to
be increased or reduced. This is important to ensure the PPF has
sufficient resources to meet claims; and that the levy is not
excessive resulting in a financial burden for insurers which might
ultimately be passed on to policyholders, notwithstanding the
competition among insurers.
43. In addition, the Council considers
that a more sophisticated approach should be adopted at a later
stage taking account of experience and the availability of the
insurer's supervisory risk rating. The Council suggests that a
risk-based levy system should be adopted to calculate levies for
individual insurers. Using a risk-based approach would reduce moral
hazard and avoid implicit cross-subsidization among
insurers.
Financial arrangement to bridge
liquidity gap
44. Whilst accepting that the PPF should
not be accumulating assets beyond the amounts it needs, the Council
sees it crucial for policyholder protection to have a mechanism in
place to bridge any liquidity gap so that the PPF will be able to
effect immediate release of funds to affected policyholders at the
time of an insurer failure. The availability of back-up funding is
particularly important at time of failure as there will be
confusion and alarm on the part of policyholders.
45. In this regard, the Council supports
the proposal that the PPF Board may resort to borrowing from a
third party to bridge any liquidity gap, for purposes of protecting
policyholders and maintaining public confidence in the insurance
industry.
Governance
Arrangements
Legal and organizational
structure
46. To safeguard the interest of the
consuming public and the public at large, the Council supports that
the PPF should be established by legislation and be administered by
an independent statutory body to ensure transparency and
accountability of its operation.
47. With regard to the composition of
the PPF Board, the Council supports having a majority of
professionals from various sectors instead of industry
participants, to ensure sufficient independence. The Council
suggests that consumer representation be included on the PPF Board
to speak for the wider community interest.
48. Furthermore, the Council considers
the two industry committees to be set up under the PPF Board should
be of advisory nature and include professional members as
appropriate.
Functions and powers of the PPF
Board
49. The Council suggests that the PPF
Board should have the responsibility of promoting the PPF to the
public.
50. For instance, it should be made
clear to the public what rules and procedures will be used when the
PPF is applied in case of insurer insolvency to reassure
policyholders that at the time of insurer insolvency, the PPF will
be able to effect a speedy and accurate payout to lessen the burden
on policyholders. The PPF Board will also need to give guidance to
policyholders on how to file claims for reimbursements. This will
be important in helping to avoid potential financial hardship for
policyholders and maintain public confidence in the insurance
industry.
Governance
arrangements
51. As regards the proposed governance
arrangements of the PPF Board, the Council supports the proposals
of having annual budgets submitted for the Financial Secretary's
approval, publication of annual reports for vetting of the LegCo,
and appointment of auditor to perform reviews on the
PPF.
52. However, the consultation paper has
not mentioned any interface arrangement between the PPF Board and
the supervisory authority. It is noted that international best
practice seems to be in favour of a degree of separation in terms
of governance between protection fund scheme and supervisory
authority. The Council therefore suggests that the Government
should explore the degree of separation in terms of governance
between the PPF Board and the supervisory authority, with a view to
avoiding conflict of interest and providing greater accountability
and transparency to the public.
Daily
operations
53. Given the comparative rarity of
insurer insolvencies in Hong Kong and the cost saving
consideration, the Council supports that the PPF Board should
maintain a small team of staff for carrying out the daily
operations of the PPF.
Confidentiality
54. The Government proposes in the
consultation paper that confidentiality provisions would need to be
written in the PPF legislation to ensure that the PPF Board
including its staff should be duty bound to keep sensitive
information obtained in carrying out their delegated functions
confidential.
55. The Council understands the
rationale behind keeping sensitive information about insurers
confidential because the disclosure of such sensitive information,
substantiated or otherwise, may put market stability at stake.
However, as a matter of general principle, consumers should have
access to sufficient information in order to make an informed
choice. The manner in which a balance is to be achieved in
maintaining confidentiality and meeting the need for transparency
is a matter that should be addressed by the Government.
56. A searchable database accessible to
consumers would assist them in tracing an insurer in order to
determine its status as participating insurers, its financial
situation and its position relative to other insurers. This may
meet consumers' information needs. In this connection, the Council
recommends that a database containing comparative financial and
non-financial information on insurers should be
provided.
Appeal
mechanism
57. The Council welcomes the proposed
setting up of an Appeal Board to allow policyholders to appeal
against the decisions made by the PPF Board, for instance, about
compensation payment or refusal to make payment. The Council
suggests that the procedures and rulings of the Appeal Board should
be documented and made transparent to the public and consumer
representation should be provided for in the mechanism.
Conclusion
5 8. In regard to the proposed
establishment of a PPF in Hong Kong, the Council's overall stance
is that Hong Kong policyholders should have a protection scheme
that will advance the limited protection currently available, and
having such a scheme will bring Hong Kong in line with the world's
best practice.
59. The Council urges that the future
PPF Board keeps under review the scope and level of coverage, the
fund sizes and levy rates for the PPF, taking into account changes
in the market and the expanding range of products developed by
insurers.
Consumer Council
June 2011
