BEST’S SPECIAL REPORT

Global Life

Our Insight, Your Advantage.

Market Review June 10, 2015

While the broad principle observed from most companies to reserve with prudent assumptions, exactly how much prudence has been assumed is usually not disclosed in companies’ statements.

Hong Kong Life Insurance Industry Moving Toward Risk-Based Capital Regime The Insurance Authority (IA) of Hong Kong issued a Consultation Paper on a “Risk-Based Capital Framework for the Insurance Industry of Hong Kong” (RBC Consultation Paper) in 2014, which introduced broad principles and the key approaches in developing a RiskBased Capital (RBC) framework. After receiving the first round of commentaries, IA began to develop detailed rules, including calibration of the regime, assessing the adequacy level of capital supporting the Hong Kong Insurance market. Legislation needs to be amended to provide sufficient time for the Hong Kong insurance industry to adapt to the new RBC requirements. This is expected to take two to three years. This report aims to present A.M. Best’s research on several key areas proposed under Pillar 1 (quantitative requirements) in two other jurisdictions and comments on the observation on issues that could impact the Hong Kong life insurance industry. Note: For the life insurance sector, we used the Hong Kong insurance industry data published by the Office of the Commissioner of Insurance (OCI). Where information is unavailable in the OCI data (for example, with regard to investment mix and capitalization), the financial statements published by insurance companies were used. The ten largest life insurers in Hong Kong that have made their Hong Kong financial statements available publicly were selected. These companies represent over 70% of total inforce premium and net liabilities of the Hong Kong life insurance market as of 31 December 2013 based on OCI statistics.

Life Insurance Sector A. Key points as proposed by the Insurance Authority in its RBC consultation paper Key principles proposed by the IA are outlined below: Origination: The fundamental ideas are based on ICPs (Insurance Core Principles) issued by IAIS (International Association of Insurance Supervision) Capital Resources (Pillar 1) • Moving toward standardizing the method of valuation on insurance liabilities (E.g. different valuation basis of Hong Kong life companies, different basis by products currently exists); • Consistent assets and liabilities valuations using economic principles. Capital Requirement (Pillar 1) • Relating it to the risk exposure and make it more sensitive to the level of risk; • Prescribed Capital Requirement (PCR) determined as 99.5% VaR over one-year period; • Minimum Capital Requirement (MCR) will be defined post-QIS; • Key risks will be handled by models (underwriting, credit, market and operational risks) and other material risks (liquidity, legal, strategic, reputational) will be dealt under ERM respectively.

Analytical Contact

Ken Chow, Hong Kong +852 2827 3426 [email protected] SR-2015-516-L

On top of quantitative aspect (Pillar 1), additional qualitative (Pillar 2) and disclosure (Pillar 3) requirements apply. Pillar 2 includes corporate governance, ERM, Own Risk and Solvency Assessment (ORSA), asset-liability management (ALM) and discretionary capital-add-ons by IA. Pillar 3 includes periodic reporting of capital resources and capital requirements by local entities and branches of non-local entities. Assessment of companies on both legal entity and group-wide levels will also be required.

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Special Report

Global Life

In principle, the new framework is expected to provide greater awareness of the financial strength of insurers for the policyholders and the general public. B. Pillar 1 Quantitative Requirements - References to Australia and Singapore and the Observations on the Hong Kong Life Insurance Industry This section describes the Pillar 1 quantitative requirements practiced in jurisdictions, including some technical details, which may be helpful for Hong Kong life companies in preparing for upcoming quantitative impact studies. The following tables summarizes the quantitative requirements in two country risk tier 1 countries: Australia and Singapore. Comments will be made on observations on issues which could impact Hong Kong life companies. Note that Singapore RBC2 is undergoing industry consultation on Pillar 1 requirements and is thus not yet finalized The approach described here is as proposed under its Quantitative Impact Study 1 (QIS1).

Capital Resources Tier 1 Capital

Tier 2 Capital

Australia

Singapore (QIS 1 of RBC2)

Min. Tier 1 Capital >= 80% of prescribed capital amount

Min. Tier 1 Capital >= 80% of total risk requirements excluding Par fund

Min. CET 1 Capital >= 60% of prescribed capital amount

Min. CET 1 Capital >= 65% of total risk requirements excluding Par fund

Additional Tier 1 Capital is recognized

Additional Tier 1 Capital is recognized

In the last 4 years to maturity, the amount eligible for inclusion in Tier 2 Capital is amortized on a straightline basis:

In the last 4 years to maturity, the amount eligible for inclusion in Tier 2 Capital is amortized on a straightline basis:

>4 years: 100% >3 years and 2 years and 1 year and 3 years and 2 years and 1 year and