11 May The Blurring of Banking, Insurance & Securities. Good Morning, Dr. Pontes (Felix), Distinguished guests, Ladies and Gentlemen,

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1 Speech by Mr. Richard Yuen, Commissioner of Insurance, Hong Kong SAR Government at the Annual Meeting of International Association of Insurance Fraud Agencies Macau 11 May 2005 The Blurring of Banking, Insurance & Securities Good Morning, Dr. Pontes (Felix), Distinguished guests, Ladies and Gentlemen, Thank you for inviting me and my colleagues to join this Annual Meeting. This is the second time I attended the Annual Meeting and I am delighted to have the opportunity to speak here. This morning, I hope to share with you the trends on the convergence of the banking, insurance and securities sectors in Hong Kong and the relating regulatory issues. In particular, I will focus on the emergence of bancassurance business and sale of investmentlinked products. Convergence of the Financial Services Sectors It is a global trend that more and more financial one-stop shops have been set up, offering a full range of banking, insurance, pension and investment products. Hong Kong is no exception. Banks, insurers and securities houses formed strategic alliances to explore each other s markets. The demarcation among the traditionally distinctive financial service sectors has become blurred.

2 - 2 - The transformation of financial products is also dramatic. Apart from the traditional life insurance policies which offer pure protection cover, more and more life insurance policies are now offering also investment opportunities that compete with unit trusts and mutual funds, i.e. investmentlinked insurance products. Apart from product transformation, the distribution channels of financial products are also shifting from the traditional agency network towards: (a) bancassurance as a cost effective means of distribution; and (b) direct sales through E-commerce with increasing use of Internet in household and business. Besides, tele-marketing and direct mails are frequently employed for sales to potential clients. At the same time, marketing through a new breed of independent financial advisors, who are able to provide a full range of services, including financial planning, fund management and insurance, is becoming more and more popular. Bancassurance in Hong Kong The development of bancassurance business in Hong Kong can trace its history back to the early nineties when a major banking group commenced to use bank branches as new distribution channel of insurance products. Over the years, bancassurance has gained momentum and has been widely engaged by banks in Hong Kong. The spectacular growth in bancassurance is mainly attributable to the greater business potential and higher profit margins compared to the traditional banking business. The general economic slowdown in recent years has also added impetus to its growth.

3 - 3 - I have the following statistics on the market participants of bancassurance locally. Around 44 banks, including most major banking networks locally, are registered as insurance agencies and selling insurance to their clients. On the other hand, 58 insurers, representing nearly one third of the authorized insurers in Hong Kong, are involved in the bancassurance business. In general, bancassurance in Hong Kong tends to focus on personal lines insurance products such as travel, fire, household, motor, personal accident and medical insurance. As these insurance products can easily be sold through banks as pre-packaged products, they are the most popular bancassurance products in Hong Kong. Nevertheless, more life insurance products, such as term, whole life, endowment, investment-linked insurance and Mandatory Provident Fund ( MPF ) schemes are becoming available in local banks. Turning to the forms of bancassurance in Hong Kong, the most common form is a bank acting as an agent of the insurer. In most cases, the bank and its appointing insurer are companies within the same financial conglomerate. However, it is not uncommon that the bank and the insurer may come from different financial groups but join together to form strategic business alliance. For instance, a number of banks may join together to set up a life insurer, or an insurer teams up with a banking group to market certain customized insurance products. Investment-linked Products On the development of investment-linked long term insurance products, they gained popularity over the past few years because of the increasing demand of products with higher returns, particularly in the low interest rate environment, accelerating speed of financial service integration and

4 - 4 - the increasing familiarity of Hong Kong customers to investment funds especially with the introduction of the Mandatory Provident Fund Schemes in There are now around 30 insurance companies offering some 180 investment-linked insurance products in Hong Kong. Investment-linked insurance policies are now one of the fastest expanding life insurance products in Hong Kong. According to the latest provisional statistics, office premiums of new business of investment-linked business increased by over 110 per cent to HK$18.5 billion in It accounts for about 50 per cent of the total individual life new business. Bancassurance Level Playing Field Under our supervisory regime, a bank is supervised by the Hong Kong Monetary Authority on its banking and securities business while an insurer is required to be authorized by us, the Insurance Authority. To ensure a level playing field among all market participants, a bank acting as an insurance agency is also required to be registered with the Insurance Agents Registration Board ( IARB ) established under a self-regulatory system monitored by us. This requirement will ensure that the insurance agency business undertaken by a bank is subject to proper regulation and that there will be a locus for handling customer complaints. To satisfy the registration requirement of the IARB, a bank is required to comply with the Code of Practice for the Administration of Insurance Agents ( the Code ). In particular, it should appoint a senior officer as Responsible Officer ( RO ) who is responsible for the conduct of the insurance agency business. For bank staff with responsibilities to advise / sell insurance, they should be registered as Technical Representatives ( TRs ) of the

5 - 5 - insurance agency. In addition, the bank must ensure its RO & TRs meet the requirements of the Insurance Intermediaries Quality Assurance Scheme ( IIQAS ) imposed by us. Under the IIQAS, all ROs and TRs of banks and also insurance intermediaries selling investment-linked products are required to pass specified examination and satisfy the continuing professional development requirement as a condition for renewal of their registration. Investment-linked Products Level Playing Field In Hong Kong, any person dealing in or advising on investment or securities is required to be licensed by the local securities regulator, the Securities and Futures Commission ( SFC ). An insurance intermediary intending to sell investment-linked policies in Hong Kong should be registered with one of the approved self-regulatory bodies such as the Insurance Agents Registration Board, the Hong Kong Confederation of Insurance Brokers or the Professional Insurance Brokers Association Limited as appropriate. An insurance intermediary is required to meet the requirements of the IIQAS. To ensure a level playing field and to better protect the insuring public, an insurance intermediary intending to sell investment-linked policies is required to pass a paper on Investment-linked Insurance, in addition to the insurance fundamental papers under the IIQAS. The marketing materials of investment-linked policies are also required to be authorized by the SFC, as is the case for investment products.

6 - 6 - Bancassurance Issues As the regulator of the insurance industry in Hong Kong, what are the main issues for bancassurance business? In the case of a bank acting as a distributor of insurance products, our first concern would be the potential mis-selling of insurance by a teller or a member of bank staff who has not been registered as an insurance agent. This may happen in a number of ways. For example, a member of bank staff may market a new savings plan to a bank client without explaining that the plan is in fact an insurance product with some savings features. There will be complaints and dissatisfactions when it was later discovered that the savings plan was actually an insurance policy. Secondly, there is a general lack of professional after sale service from bank staff, as compared with traditional life insurance agents. There is also allegation of policy replacements using the privileged bank clients information. Investment-linked Products Issues The investment-linked products are particularly prone to misselling. As the unit values of the investment-linked policies are not guaranteed and can rise or fall with their underlying investments, there is a risk that poor performance of the chosen investments will greatly reduce the values of these policies. Moreover, many investment-linked policies provide relatively low protection for mortality risk. The life insurance benefit is usually a fixed percentage of the value of the underlying investments. For example, the amount payable upon death of the life assured under a typical 101 Plan is only 101% of the account value of the underlying investments. If the value of such

7 - 7 - investments drops, the sum assured will decrease accordingly and such reduced amount may not be able to meet the life insurance needs of a policyholder. Another inherent risk lies in the high costs for early redemption. Investment-linked policies are usually established for a period of over 5 years where fees/charges are heavily stacked at the beginning of the policy period. Therefore early redemption will be subject to very high encashment charges, compensating for an insurer s upfront expenses. Insurance Fraud Case To tap the growing potential of the investment-linked insurance products, insurers are rigorously promoting the products through different channels. Taking this opportunity, some fraudsters tend to play tricks with these insurers. Here I would like to share with you a syndicated insurance fraud case mounted by the Police in November last year. Between 2001 and 2004, a number of insurance brokerage firms were set up to introduce clients to a few well-known insurance companies. In return for the introduction of new clients, these insurance companies would pay the brokerages lump sum commissions ranging from 100 to 138 percent of the annual premium. The brokers were under a written contractual obligation to return or clawback specified percentages of these commissions if the new policyholders stopped their monthly premium payment instalments within certain specified periods of time.

8 - 8 - Since the commencement of the scam in 2001, over 10,000 new clients had been introduced through the brokerage firms with total sum of HK$166 million being paid. Since 2003, the proportion of these clients who stopped paying the premiums began to increase, leaving the brokerages liable to pay the clawback percentage to the insurance companies. Between June and September 2004, the brokerages began to close down, and the insurance companies were left with outstanding clawback fees of HK$48 million owed to them by the brokers. Police investigation revealed that the brokers were linked behind and it was also discovered that such insurance policies were mainly investmentlinked in nature. They were often given as prizes in lucky draws, or as staff benefits in attracting employees to various related firms. To this end, the premium of the clients was in majority settled by the brokerages and the insurance companies were kept in the dark. The Police has arrested 11 persons for conspiracy to defraud and our Office has been working closely with the Police in investigating the case. So, what are the lessons that we have learned? Although the incidents have affected only individual insurers, if we do not nip it from the bud, it would undermine public confidence in the insurance market and insurance products. The commission system practised by some aggressive insurers provides a huge temptation for the unscrupulous intermediaries to take advantage of the insurers. While we respect that credit policy is a commercial decision of individual insurers, we will take the management of the insurer to task if they do not have an effective internal control system in place to monitor the credit extended to the intermediaries and identify any early sign of trouble.

9 - 9 - Therefore, the early warning signs like (a) sudden increase in market share, (b) departure of senior personnel in quick succession, and (c) rapid rise in the number of consumer complaints, that have been discussed in last year s Annual Meeting in London are extremely important to us as regulators. Not to forget an important element of regulation share of market intelligence. Regulatory Measures Closing to the final part of my speech, I wish to sum up the regulatory measures which have been made to meet with the trend of convergence of the financial services sectors. In the first place, customers complaints must be monitored closely. As I have just mentioned, one of the early warning signs is the rapid rise in the number of complaints. Secondly, in meeting the challenges of an increasingly complex and dynamic marketplace, there is an urgent need to enhance the professional standard and quality of service of insurance practitioners. As I mentioned earlier in this presentation, through the IIQAS, we have made sustained efforts in this regard. Thirdly, criminals have tremendous creativity in abusing a transaction of insurance and there is a trend of increasing complexity in their illicit exploits. We will work closely with law enforcement agencies, international organizations and other financial regulators to facilitate reporting of any suspicious transactions in building up a robust cross-functional regulatory regime.

10 Fourthly, it is a global trend for insurance service providers to expand and enhance their services by marketing and selling their products online. As more and more insurance websites are emerging in the local market, we have formulated the guidelines on the use of Internet to conduct business by insurance service providers. Finally, as a result of globalisation, multi-national insurers will dominate global insurance market and insurance operations across borders are becoming more closely linked. Greater cooperation among the financial regulators, both locally and internationally, is not just desirable but necessary. We are actively participating as a charter member in the International Association of Insurance Supervisors. Besides, we maintain close liaison with local regulators. We have signed MOUs with local and overseas regulators to promote closer cooperation and exchange of information between regulators. We will, of course, keep up our liaison with the local securities and bank regulators on matters of common concern. Looking Forward Looking ahead, accelerated pace of convergence of financial services will continue to pose new challenges and opportunities to the insurance industry. We will keep track of the dynamic market developments and do our best to maintain an open, transparent and business-friendly environment. Thank you. [PA-Speech(16)/WH/CI speech ( )-IAIFA(rev)/ss]