18 February 2024
As the Chinese New Year dawn upon us, we at the Insurance Authority (IA) would like to wish you all good health, happiness and prosperity in the coming year.
In the past two years we have seen a surge in interest rates drawing an end to the low rate environment, and with it, also brought severe volatility to the market which impacted both our policy holders and the insurance market. The IA has been closely monitoring the situation, with a strong focus on the premium financing business, which is particularly sensitive to changes in interest rates.
Premium financing is a double-edged sword. In the past era of low interest rates, through premium financing, policy holders may benefit from the spread between their policy returns and bank loans while also amplifying their returns through leveraging. However, this would in turn magnify the risks and potential losses. The current high interest rates have already increased the cost of borrowing, and at the same time possibly decreased the policy returns as the majority of products purchased through premium financing in the market are now participating products, which not only offer non-guaranteed returns that are subject to the investment performance of the insurers, but also have a longer break-even period, further aggravating the risks involved in premium financing.
Being cautious of these risks, the IA and the Hong Kong Monetary Authority (HKMA) jointly issued guidance to the industry in 2022 to clarify the supervisory requirements for premium financing. Targeted at insurers and insurance intermediaries, the new requirements, which took effect in 2023, focus on enhancing disclosure and improving affordability assessment to protect the interests of policy holders. The IA also launched a thematic webpage on premium financing in 2022 to raise public awareness about the risks involved through numerical case studies and smart tips. Through our publication “Conduct in Focus” (Issue 5 – August 2022), we’ve also shared our views with policy holders on the complex nature of premium financing and highlighted the associated risks.
Our latest figures show that premium financing activities have slowed down substantially in 2023, as the relevant business declined from 43% of the total market in 2022 to 21% in 2023, including a multi-year record low of 9% in the 4th quarter of 2023, revealing a relatively conservative attitude in adopting premium financing amid rate hikes.
The IA received 28 complaints about premium financing in 2022 and 50 in 20231. The main issues raised were the lack of disclosure of risks by the intermediaries during the selling process and misrepresentation of information such as policy terms and loan rates.
The market has always been fraught with uncertainty. Policy holders who believe that the rates have peaked and will gradually decline may be eager to adopt premium financing, while others who have already purchased a premium financing policy may consider terminating it in fear of the sustained high rates or the potentially lower-than-expected policy returns. The IA would like to remind policy holders again that when it comes to premium financing, they should fully consider all the factors involved and make wise choices both before and after taking out the policy.
Before taking out the policy: Understand the risks and make a truthful declaration
Under the new requirements, insurance intermediaries must fully explain to policy holders the potential risks involved in premium financing and ask the customers concerned to sign the Important Facts Statement – Premium Financing. Policy holders should sign the document only after fully understanding its contents. We also encourage policy holders to learn about the relevant risks through the IA’s thematic website on premium financing.
In addition, the new requirements require a holistic assessment of a customer’s affordability by the insurance intermediary, taking into account the impact of the loan facilities. The intermediary must refrain from recommending or soliciting premium financing business before obtaining sufficient details about the premium financing facilities, as without it, they are unable to assess the relevant impact. If the affordability assessment indicates that the customer is facing a risk of over-leveraging, the insurer must impose additional safeguards, such as requesting asset and income proof from the customer for verification.
The affordability assessment relies heavily on the information provided by the policy holder in the Financial Needs Analysis (FNA), which must be authentic and accurate. In recent cases reviewed by the IA, some insurers, after identifying certain policy holders as customers with an over-leveraging risk, asked the policy holders concerned to “confirm” whether they had sufficient additional liquid assets or whether they were willing to adjust their affordability level. Policy holders thus revisited their FNA multiple times in their policy applications to increase their proclaimed liquid assets. Repeated amendments raise doubts about the accuracy of the information provided and may result in the recommendation of a policy that is unsuitable for the policy holder. In addition to reviewing the practices of insurers, we would like to remind policy holders to provide truthful financial information and refrain from overstating their income and liquid assets to avoid a mismatch on affordability or the insurance product recommended.
After taking out the policy: review it regularly and think twice before surrendering it
If a policy involves non-guaranteed returns and the premium financing loan involves floating interest rates, policy holders should regularly review the relevant information and take appropriate measures to manage the additional risks caused by the fluctuations (e.g. set aside additional financial resources to repay the premium financing loan) so that involuntary early surrender of the policy can be avoided.
Life policies are often long term in nature, and early surrender will result in a loss. Policy holders should be mindful that purchasing long term policies using premium financing will magnify such losses due to the leverage effect. In one case from our recent inspection, the policy holder, fearing a further interest rate hike, decided to surrender his policy only several months after he purchased it. Most of the policy surrender value was used to repay the loan, so the policy holder could recover only HK$400 in the end, resulting in a net loss of HK$300,000 of the principal. Considering other expenses related to the loan, he suffered a loss of over 100%. In addition to the monetary loss, policy holders will lose their insurance protection after surrendering their policy, and they may not be able to obtain the same insurance coverage later for reasons such as a change in health condition.
The IA and the HKMA joined forces again for another round of inspections related to premium financing since late 2023 to examine compliance with the new requirements and market trends. The regulators will share the observations from the inspection in due course with the industry and continue to urge the cautious use of premium financing to enhance policy holder protection. We will also step up our efforts in public education to remind policy holders of the points to note when using premium financing.
We wish everyone a wise policy holder experience in the Year of Dragon!
Marty Lui
Head of Long Term Business (Acting), Insurance Authority
18 February 2024
Note:
1 Including multiple cases which were also reported in the HKMA’s complaint statistics and jointly followed up by the two regulators.