The Hong Kong Office of the Commissioner of Insurance (OCI) is currently in the process of developing a risk-based capital regime for the Hong Kong insurance industry. The current regime has been in use since the 1980s and so significant changes abound, with the OCI’s stated intention being to align Hong Kong’s regime with international requirements and make capital requirements more sensitive to the levels of risk that insurance companies are bearing.

A Consultation Paper, which informs the development of a framework and key approaches, was published on 16 September 2014 and is open to submissions until December 2014. Following this, detailed rules will be proposed followed by a second consultation, with amendments to legislation expected to take at least 2-3 years. The OCI has not commented extensively on the EU’s Solvency II Directive as part of the reforms; however, while it has indicated that it may not attempt to replicate Solvency II it has nevertheless expressed interest in complying with the “temporary equivalence regime”, which is available in relation to the treatment of reinsurance activities and group supervision.

The proposed risk-based capital framework set out in the Consultation Paper comprises three Pillars to be adopted by the Hong Kong insurance industry.

Pillar 1 (Quantitative aspects) suggests a number of changes, including the proposal to replace the existing minimum solvency requirements for long term and general insurers with new capital adequacy requirements. The key features of this would be:

  • a Prescribed Capital Requirement (PCR) aligned to a minimum investment grade level, whereby value-at risk is calculated at a confidence level of 99.5% over one year; and
  • a Minimum Capital Requirement (MCR) to be defined after completion of an industry quantitative impact study.

It is initially proposed that the PCR and MCR should be calculated using a standardised approach rather than using insurers’ internal models. A stress-test based approach is proposed to be adopted for assessing the underwriting risk of long-term business and the market risk of all insurers, while a risk factor based approach is proposed for all other risks.

Pillar 2 (Qualitative aspects) includes a number of proposals for increased standards of corporate governance of insurers including in relation to:

  • controls to be put in place to deal with day-to-day business to be built into systems and processes;
  • insurers being required to put in place an effective enterprise risk management framework;
  • the adoption by insurers of an Own Risk and Solvency Assessment to include continuity analysis, stress and scenario testing and reverse stress testing;
  • a requirement for insurers to adopt investment policies which include security, liquidity and diversification perspectives; and
  • the proposed ability of the OCI/Independent Insurance Authority (a new authority which will replace the OCI, to be established in 2015) to have the power to apply capital add-ons.

Pillar 3 (Disclosure) proposes a requirement for the periodic public reporting of capital resources and capital requirements, in addition to the current statutory reporting to the OCI.