Our latest insurance update from the Asia Pacific region includes articles from Australia, China, Hong Kong and Singapore.
Product governance and intervention powers: the birth of a new regulatory regime
While the focus of Treasury has been on the 2015 Federal Budget and the imminent Tax White Paper, the wait continues for the Government’s response to the Financial System Inquiry’s final report delivered in December last year. The latest indication from Assistant Treasurer Josh Frydenberg has only committed the Government to a response ‘over the course of 2015’; and the lengthy wait has left a wide berth for speculation (and sustained lobbying) over which of the FSI’s recommendations will receive Canberra’s approval.
We have been reporting on two of the FSI’s recommendations that, if adopted, will signal a real change to the regulatory landscape in Australia. The introduction of a product design and distribution obligation (recommendation 21) and granting the Australian Securities and Investments Commission (ASIC) intervention powers (recommendation 22) will represent a philosophical shift from a regime based on ensuring consumers have sufficient information to make informed investment choices, to one aimed at ensuring that the consumer environment is one that promotes good investment decisions. That description might suggest a subtle change, but for product issuers and distributors, the change will be profound – it represents a move away from personal responsibility for investment decisions and towards a regime in which product providers bear the responsibility of ensuring products are targeted and purchased by consumers to whom they are appropriate.
The influence of the UK’s Financial Conduct Authority (FCA) in this area cannot be understated. The FCA has become increasingly proactive and interventionist since the global financial crisis and the payment protection insurance (PPI) ‘scandal’, and it’s representatives have been frequent visitors and presenters at ASIC functions over the last 18 months.
Current disclosure regime
The existing regulatory framework is based on the adequacy of disclosure, the competency of financial advisors and the financial literacy of consumers. This framework was founded on the recommendations in the 1997 Wallis Inquiry and the idea that disclosure ought to be the primary focus of financial services regulation.
The disclosure regime is based on the assumptions that financial investments involve risks and consumers need adequate information in order to make appropriate decisions about the level of risk they will accept. Underpinning the regime is the philosophy that so long as the consumer has the appropriate information, is given competent advice and has adequate financial literacy, the consumer should be responsible for the outcome of their investment decisions.
However, disclosure can be ineffective for a number of reasons. Financial products have become increasingly complex and there can be a misalignment of interests between consumers and those providing financial products and/or financial advice.
The FSI report suggests that current industry-led standards have not been sufficient by themselves to address such serious conduct issues.
The FSI recommendations
The relevant recommendations are aimed at addressing these inadequacies in the disclosure regime.
The FSI has recommended introducing a principles-based regulatory obligation that would require product issuers and distributors to consider a range of factors when designing and distributing products. This will include taking into account the product’s intended risk/return profile, how consumers are affected by the product in different circumstances, implementing controls to ensure the issuer’s expectations for distribution are met and periodically reviewing whether the product still meets the needs of the target market. It means monitoring and overseeing a product throughout its life cycle – and having systems in place to enable such product governance to occur.
It is also recommended that ASIC be empowered in the same manner as the FCA through a broader regulatory ‘toolkit’ of product intervention powers. This would include, among other things, the ability to require providers to issue consumer or industry warnings, prevent marketing of a product to some types of consumer and/or ban or mandate particular product features. The power would be exercisable before any breach of law or regulation has occurred and where ‘there is risk of significant consumer detriment’.
The shift from disclosure to consumer suitability
The FSI’s recommendations clearly indicate a view that it is not sufficient to regulate disclosure alone.
This new approach has its foundations in the study of behavioural economics. Behavioural economics is a method of economic analysis that applies psychological insights into human behaviour to explain decision-making. The FCA has continued to point to a range of studies in which fully informed individuals make poor consumer choices because of a range of other factors, such as personal preferences, the manner in which information is presented or the consumer’s environment. Regulators are therefore not simply grappling with the need to ensure that products are understood by consumers, but the reality that consumers sometimes make irrational choices regardless of the information they possess.
Reading any recent ASIC publication will reveal how the regulator has been heavily influenced by behavioural economics. Whether or not these recommendations are adopted, ASIC has made it clear that it is committed to applying behavioural economics insights to identify consumer problems and to detect when organisations take advantage of consumer biases.
The impact on the insurance industry
A key focus for ASIC in the insurance sector appears to be on add-on insurance products. Add-on insurance products are those sold in conjunction with another primary product (for example consumer credit insurance sold with loans and insurances sold with motor vehicles such as GAP or tyre and rim cover). In a speech to the Insurance Council of Australia as far back as February 2014, the Deputy Chairman of ASIC, Peter Kell, said ASIC would focus on these areas because the products were a perennial source of complaints from consumers, and importantly, because selling practices appear to be ‘exploiting consumer behavioural bias’.
Mr Kell explained that add-on insurance products are not the consumer’s focus at the time of purchase, the consumer has little or no information about the products and therefore they rely heavily on statements made by sales representatives to inform their decision to buy. Drawing comparisons with recent UK experience with PPI, Mr Kell noted how badly things can go wrong with add-on products, highlighting that the enormous capital return on PPI products, along with very low claim ratios, suggested a product offering little value to consumers. These comments about PPI should not be ignored by underwriters and distributors of consumer credit insurance in Australia.
There is a growing global trend towards this shift in regulatory thinking, with the EU close behind the UK in adopting similar measures.
Much attention has been given to the proposed intervention power, but we would urge insurers and distributors to consider the product governance obligation closely. The UK regulator has only used its intervention powers once (to ban the retail distribution of Contingent Convertible Capital Interests or CoCos as they are commonly known) and the way it has been framed in the FSI report suggests it will be a tool of last resort. The product governance obligation on the other hand lacks any real definition and as described potentially has wide ramifications for boards and senior executives, or whoever it is within the organisation that has responsibility to ensure that the obligation becomes part of the culture of the organisation.
These two recommendations are being championed by ASIC and roundly supported by a number of consumer affairs advocates; but they are also among the only recommendations that Mr Frydenberg has indicated are under the Government’s active consideration. The sceptics might consider regulatory change unlikely under a Government managing budgetary pressure and that has espoused a clear inclination for deregulation – but it seems equally implausible that the FSI (which was commissioned by this Government) will be ignored. The attention these two recommendations have received is difficult to ignore, and if the Government is considering an industry funding model for ASIC, it is difficult to see any real impediment to their adoption.
For further information please contact Matt Ellis.
Digital disruption in insurance
Innovation and disruption are in reality two sides of the same coin (or Bitcoin, if you will). On one side, innovation may describe the driver of change, the creative thinking and ideas that lead to new technology, new methodologies and new approaches. On the other side, the by-product or necessary consequence of innovation is change to the status quo, the uprooting of traditional models and incumbents and the disruption of markets. And so in one sense, the much hyped concept of ‘disruptive innovation’ might be seen as no more than a descriptor of human advancement. But there is a reason the expression has become the catchphrase of this generation of tech-savvy organisations; and that is because organisations are seeing disruption not merely as the consequence, but as itself a driver of innovation. Where markets can be disrupted, there is opportunity; and so organisations these days are quite proudly identifying themselves as disruptors as much as they are innovators.
The insurance industry is not shielded from disruption, and in fact has been subject to significant disruption in a number of forms already. In this age of the digital economy, it may be that the insurance industry is on the brink of even more seismic change. This article identifies current disruptive innovations affecting the global arena and discusses some potential areas where disruptive innovations have the potential to reshape the industry.
The key to digital disruption
The term ‘disruptive innovation’ has only gained popularity since it was used by a Harvard Business School Professor, Clayton Christensen in his book called ‘The Innovator’s Dilemma’. Disruptive innovation is described as innovation that creates new markets by appealing to new categories of consumers. One aspect of disruptive innovation is the implementation of new technologies, but alternatively, it may involve the development of new business models and exploiting old technologies in new ways.
A major difference between innovation historically and disruptive innovation, as the expression is used today, is the digital aspect of the current surge of innovations. Innovators have capitalised on the availability of mass marketing through the ‘Internet of Things’ and global connectivity and the collection and use of massive amounts of data and information stored on the internet. The expression digital disruption has been coined to describe this most recent movement.
Disruption in the insurance industry
Disruption has been occurring at pace in different forms in insurance. Alternative capital models have encroached on traditional reinsurance markets and are growing ever more popular. Technological advancements such as the use of telematics have encroached into traditional underwriting processes. Online platforms have encroached upon traditional broker-led distribution channels. Nevertheless, it feels as though we are on the cusp of much bigger and more significant change.
There are countless articles on the news every day about new innovation ‘disrupting’ a myriad of service and product based industries including Uber, Groupon, Airbnb, Netflix, iTunes or Spotify, Skype and more recently, ‘Driverless’ or autonomous cars. What these players have been able to capitalise on is the ability to reach the mass market, process sales quickly and target sales to appropriate markets. It may seem that these innovations are far removed from the insurance industry; but when you imagine targeted distribution of insurance products on the scale that the above players have achieved through digital markets, it is easy to see the opportunity and the potential scale of disruption.
Aggregator or price comparison websites
Price comparison websites allow consumers to filter and compare products based on price and other features. These websites have penetrated various markets worldwide. In Australia, websites such as iSelect, comparethemarket.com, Choosi and Canstar are providing comparison data for health and life insurance and motor vehicle insurance. Although they have been resisted by the large insurers and have therefore caused less disruption in Australia than in other markets, they continue to pose a threat to the status quo.
Aggregators have broad appeal due to the perception that they offer consumers the ability to compare products and identify the cheapest insurance option. That appeal means aggregators are becoming the consumer’s first port of call on insurance purchases and as a consequence, in international markets we are seeing aggregators become significant competitors to traditional intermediaries.
This distribution channel is one that is now attracting the biggest digital disruptors. In 2012, Google entered into the insurance industry in the UK by launching a price comparison site, providing comparisons on car insurance, travel insurance, credit cards and mortgages. In March this year, Google entered the insurance industry in the US by introducing ‘Google Compare for Auto Insurance’.
Where else for Google and other disruptors?
It is unsurprising that a great disruptor like Google is seeing the opportunities in insurance. It has the scale and the connection to customers to achieve mass distribution of insurance products.
However, intermediating insurance may only be the start. It can be said that the success of an insurance carrier depends on the skill of its underwriters. An underwriter’s skill is in identifying and pricing risk based on the information provided by its prospective clients. The amount of data collected by the big digital disruptors is staggering. Their ability to filter and utilise that data to personalise and direct marketing is well known. If they are able to utilise information on which sophisticated and automated underwriting could be performed, then the next disruption will impact insurance carriers directly.
Maybe the slogans of disruption and innovation are starting to sound more like spin than substance; but it would be unwise to be dismissive. Digital innovation is quietly, and quickly, shaping the insurance market globally. Insurance CEOs around the world are talking up the importance of keeping ahead of technology and abreast of developments in disruptive innovations. It is therefore vital for current players in the insurance industry to remain aware of potential disruptors and plan ahead to adapt to the inevitable changes the digital market will bring.
For further information please contact Matt Ellis.
CIRC strengthens corporate governance requirements on new insurance entities
On July 7, the China Insurance Regulatory Commission (CIRC) published the Notice on Several Issues regarding Strengthening the Governance Mechanism of Insurances Companies during Establishment Preparation Stage (the Notice), which took immediate effect. The Notice applies to all insurance companies, insurance group companies and insurance asset management companies.
The Notice sets forth the following major corporate governance requirements on new insurance entities:
- During the establishment preparation stage, any change to the shareholders, proposed chairman of the board or general manager of the new insurance entity is prohibited without prior approval from CIRC.
- Board members of the new insurance entity must comprise personnel specialising in finance, investment, actuarial and legal matters.
- Proposed chairman of the board and general manager of the new insurance entity must not concurrently take other positions.
- Unless assuming management positions in insurance group companies, senior management personnel of the new insurance entity must not concurrently take positions other than directors or supervisors in other entities.
- The establishment preparation team of the new insurance entity submit a monthly written progress report to CIRC during the preparation stage.
CIRC approves specialised internet-based insurance companies on a trial basis
Two years ago, CIRC approved the first specialised internet-based insurance company on a trial basis. Following the company’s strong performance, CIRC approved another three specialised internet-based insurance companies in July. CIRC is also in the process of formulating appropriate measures to formally regulate internet-based insurance companies.
CIRC’s recent focus on internet-based insurance companies is in response to the latest nationwide strategy on the development of internet-based business. CIRC and nine other ministries and departments jointly issued the Guideline Opinions on Promoting the Healthy Development of Internet-based Finance in mid July 2015, which encourage traditional insurance companies to develop online business and require specialised internet-based insurance companies to provide suitable insurance services.
In respect of the distribution of insurance products online, the Guideline Opinions require insurance companies not to make misleading statements (including false, incomprehensive or exaggerating publication of previous performance), nor to provide warranties on profits and gains or indemnification for online distribution of insurance products.
The implications of Contract (Rights of Third Parties) Ordinance on supplemental or renewable contracts after its commencement on January 1, 2016
The doctrine of ‘privity of contract’ establishes that a party cannot acquire or enforce rights under a contract to which it is not a party. In our November 2014 edition of Asia Pacific – focus on insurance, we discussed the impact of the proposed reform of the doctrine as set out in the Contracts (Rights of Third Parties) Bill. TheContracts (Rights of Third Parties) Ordinance (Cap. 623) (the Ordinance), which largely resembles the Bill, will come into effect on January 1, 2016. In this update, we set out the key implications of the Ordinance, in particular in relation to supplemental and renewable contracts.
Most contracts will fall under the scope of the Ordinance. The only excluded contracts are: bills of exchange; promissory notes or any other negotiable instruments; deeds of mutual covenant; covenants relating to land; contracts of carriage of goods by sea or by air, letters of credit; companies’ articles; and contracts of employment (insofar as they can be used against employees).
The Ordinance adopts a two-limb test, which is similar to that applied under English law. A third party may enforce a term of a contract if either of the following two limbs are satisfied:
- the contract expressly provides so; or
- the term purports to confer a benefit on the third party, unless on a proper construction of the contract, the parties to the contract do not intend the terms to be enforceable by the third party.
Contracting parties are free to contract out of the Ordinance if they do not wish to extend the benefit to any third party.
In the event that the Ordinance is not contracted out of by express terms, if a third party is expressed or implied to have rights under a contract:
- the third party will have the same remedies as those available to a contracting party who brings an action in breach of the term, and may rely on any arbitration agreement and/or jurisdiction clause contained in the contract;
- the third party’s consent may be required for rescinding or varying the contract which has the effect of altering or extinguishing the third party’s right under the contract by agreement; and
- the third party’s right is assignable.
It is worth noting that pursuant to the Ordinance, the third party will have to be expressly identified by name, as a member of a class or as answering a particular description, but need not be in existence when the contract is entered into. Accordingly, if the Ordinance is not contracted out of in the contract, this can potentially lead to increased exposure to liability to unknown or unforeseen third parties. It may also become impractical to obtain all third parties’ consent for varying or rescinding the contract.
Supplemental and renewable contracts
The Ordinance will only apply to a contract entered into on or after January 1, 2016. It is not clear whether it also applies to (i) a supplemental contract entered into after January 1, 2016 and (ii) a contract that is entered into before January 1, 2016 but renewed thereafter.
In respect of supplemental contracts, it has been suggested in the Report of the Bills Committee on the Contracts (Rights of Third Parties) Bill that a third party will have the right to enforce the terms of the supplemental contract, unless the original contract expressly excluded the Ordinance and this has not been altered in the supplemental contract.
In respect of renewable contracts, while the position in Hong Kong is yet to be tested, this issue has been discussed by the English court in Mulchrone v Swiss Life (UK) Plc  EWHC 1808 (Comm). In England, the Contract (Rights of Third Parties) Act 1999 (the Act) applies to contracts ‘entered into after 11 May 2000.’
In that case, one of the issues was whether a contract of insurance which was entered into before the effective date of the Act, was subsequently renewed in October 2000 (i.e. after the effective date) could be said to have resulted in a new contract. If the answer is yes, the Act will be applicable and the third party beneficiary (i.e. the claimant thereunder) would have remedies against the insurer under the insurance policy.
Confining himself to the construction of the particular policy, the judge held that a new contract had not been made upon its renewal in October 2000. Upon the expiry of the first policy period, the insurer did not appear to ‘have available to it the exercise of a relevant discretion whether to grant or decline another year of insurance from that date.’ Further, the judge considered that the contracting parties were ‘equating renewal with the beginning of a new Policy Year under an existing and continuing contract of insurance, and that they were not thinking in terms of the entering into of a new contract.’
On the other hand, in relation to a subsequent renewal in October 2001, when the rate was reviewed and a new unit rate was quoted by the insurer, and the insured expressly notified the insurer that it would remain insured, the Judge held that ‘what happened…was redolent of a fresh contract being entered into.’
The case is far from setting out clear rules to decide whether a renewal of a contract constitutes or does not constitute a new contract entered into after the Act came into force. It appears from the decision that if the renewal does not involve any revision of the terms of the existing contract, one may argue that such renewal is merely a continuation of the existing contract but not a new contract being entered into and that therefore the Act does not apply to the renewal. Whether or not the Act applies, however, will largely depend on the facts of each case. Since this position has not been tested in the Hong Kong courts, contracting parties should make sure their contractual intention is clearly expressed in any of their supplemental or renewable contracts to avoid dispute in this regard.
In light of the far-reaching implications of the Ordinance, contracting parties should start considering its application to their businesses. In particular, when drafting a contract and considering renewal/supplementation of existing contracts, they should:
- consider whether they want the contract to be extended to any third party;
- if so, define the third party clearly; or
- if not, expressly say so and opt out of the operation of the Ordinance (in its entirety or in part) in the contract.
Passing of Insurance Companies (Amendment) Bill 2014
The Hong Kong Legislative Council passed the Insurance Companies (Amendment) Bill 2014 on July 10. The Bill will need to be gazetted before it becomes law. The Secretary for Financial Services and the Treasury, Professor KC Chan, indicated that the Ordinance will be brought into force in three stages. This is to facilitate the transition from the existing Office of the Commissioner of Insurance (OCI) and the self-regulatory regime for insurance intermediaries to the Independent Insurance Authority (IIA), which will be established under the Ordinance.
- Stage 1: a Provisional Insurance Authority (PIA) is expected to be set up by the end of 2015. The PIA will be given certain administrative powers to undertake key preparatory work, such as recruitment of senior executives. The self-regulatory system for insurance brokers and insurance agents will continue.
- Stage 2: The IIA will take over the work of the OCI, starting approximately one year after the PIA is set up. The IIA will carry out preparatory work for regulating insurance intermediaries, including subsidiary legislation, codes of conduct for insurance intermediaries, and regulatory guidelines. It is expected that there will be public consultations.
- Stage 3: Introduction of the statutory licensing regime for insurance intermediaries to replace the existing self-regulatory regime.
The three-stage process is expected to take two to three years.
The text of the Bill as passed is not yet available. We understand that following the Bills Committee stage there may be various amendments to the version introduced into the Legislative Council in April 2014. The Bill provides for, among other things, the establishment of the IIA and a statutory licensing regime for insurance intermediaries to replace the existing self-regulatory system.
Focus on product disclosure for Singapore insurance industry
Disclosure is a common thread that runs across three consultation papers issued by the Monetary Authority of Singapore (MAS) from May to July 2015. These disclosure enhancements appear to be timely when looking at the statistics provided by the Life Insurance Association (LIA) which point to:
- Approximately one in two individuals in Singapore (2.78 million lives) having health cover with total premiums amounting to S$1.62 billion as at March 31, 2015.
- Investment-linked products making up 20 per cent of new sales.
- Distribution via representatives (such as banks, tied agency, financial advisers representatives) collectively contributing to 84 per cent of new policies.
The three consultation papers and highlights are:
This consultation paper applies to all insurance policies (life insurance and general insurance including accident and health insurance). It proposes to implement Market Conduct Guidelines that set out controls and safeguards that financial institutions (FIs) should put in place when conducting retail marketing and distribution activities (Activities). These measures are aimed at mitigating the risks of FIs engaging in improper practices such as pushing products and aggressive selling.
We have listed the following safeguards (of 15 safeguards suggested by MAS) which may require a FI to allocate more resources to ensure compliance:
- FIs should conduct call-backs to all customers prospected from such Activities within the free-look or cooling-off period of 14 days.
- FIs should conduct regular mystery shopping and site visits.
- FIs should track and monitor complaints.
- FIs should maintain a register containing information on Activities that are planned and have been undertaken.
FIs will also be required to notify MAS of their plans to conduct marketing and distribution activities at retailers and public places, as well as provide MAS with information on the actual activities conducted. The type of information and frequency of MAS reporting will differ depending on the duration of the marketing and distribution arrangements.
Consultation Paper on the Review of Accident and Health Regulatory Framework (targeted effective by Q4 2015) which applies to all accident and health products. The proposals include:
- Standardised disclosure statements.
- A minimum 14 days free-look period.
- Responsibility for training, competency and conduct of intermediaries lies with the insurer.
- Assessment of the policyholder’s financial commitments and affordability consideration.
Consultation Paper on proposed Enhancements to Disclosure Requirements for Sale of Investment Linked Policies (effective date to be determined).
Among other things, this consultation paper proposes that all fees and charges are categorised and disclosed individually in a separate Product Highlights Sheet.