A medical check-up or a free consultancy?
The Insurance Authority’s on-site inspections of licensed insurance broker companies
In our circular of 30 November 2022, the Insurance Authority (“IA”) published its common findings from the inspections we have carried out on licensed insurance broker companies as part of our ongoing supervision work. But what exactly is an “on-site inspection” and what can broker companies expect when they are selected for inspection by the IA? We seek to answer these questions here:
What is an on-site inspection?
Hong Kongers are pretty good about going for regular medical check-ups and it is a really good habit to have. Sure, you may have no symptoms or issues, but going for a medical-check-up is a means of making sure you stay on the right track. If the cholesterol levels are starting to creep up, the doctor can advise you to make changes to your diet in advance to stop it from becoming a problem.
An on-site inspection is a bit like a medical check-up in this respect. In an on-site inspection, the IA (per section 64ZZF of the Insurance Ordinance (Cap. 41) (“IO”)) checks that the broker company is complying with the requirements in the insurance regulatory framework. These include the requirements set out in the Insurance (Financial and Other Requirements for Licensed Insurance Broker Companies) Rules, the Code of Conduct for Licensed Insurance Brokers, the Guidelines issued by the IA, the anti-money laundering and counter-terrorist financing requirements (if applicable), and the conduct requirements for Mandatory Provident Fund business (if applicable).
There does not need to be any indication that an insurance broker company may be in non-compliance for it to be targeted for inspection (and the fact that a broker company is targeted for inspection should not be taken to suggest that it is in non-compliance in any way). Rather, an on-site inspection is part of the IA’s ongoing monitoring and supervision function to ensure that standards in the market are being maintained. As with a medical check-up, if any issues are found during an inspection that need correction to ensure the insurance broker company remains in compliance, the IA will point it out.
After all, prevention is always better than cure.
Just to be clear, an “inspection” is very different from an “investigation”. To start an investigation, the IA must have reasonable cause to believe that the insurance regulatory framework may have been contravened (i.e. there must be a suspicion that something is wrong). With an inspection, however, no such reasonable cause is needed because, as stated, the inspection process is about maintaining standards and correcting problems before they arise.
How do we choose which licensed insurance broker companies to inspect?
With over 800 licensed insurance broker companies in Hong Kong, we select companies to inspect based a risk-based approach. This approach takes into account numerous quantitative and qualitative factors such as: type of business being carried on (long-term business is deemed higher risk than general business, in terms of regulatory requirements that need to be complied with); business volume (e.g. revenue); number of technical representatives; turnover of responsible officers; consumer versus commercial business; and key ratios (such as the ratio of technical representatives to revenue and ratio of expenses to revenue).
We do also select a different variety of broker companies to ensure that we have insight to the full diversity of business models that broker companies across the market are adopting.
How is an inspection conducted?
There are usually three-phases to an inspection: (i) before the IA comes onsite to inspect; (ii) the on-site inspection phase; and (iii) the completion phase. An outline of each of the stages is set out below.
What happens before the IA comes on-site?
The IA will contact the relevant licensed insurance broker company about the inspection around one month prior to the intended on-site stage of the inspection, so that a mutually convenient period for the IA to come on-site can be arranged.
After fixing this date, the IA will issue a formal inspection letter confirming the date and to request certain information to be submitted for the IA’s review prior to it coming on site so that it can prepare. In general, the licensed insurance broker company would be requested to provide the following:
- background information on the management structure of the broker company (e.g. shareholding and organization chart);
- financial and accounting information (e.g. monthly management accounts, general ledger, bank statements and list of insurance applications handled in the past two years); and
- corporate governance related information (e.g. internal policies and procedures, training records and complaint records).
To assist the broker company to prepare for the inspection, the IA has also developed a series of self-assessment checklists, which are provided to the broker company with the formal inspection letter.
Upon receiving the information, the IA would then select from the bank statements and the list of insurance applications provided, certain sample transactions for detailed review and will notify the broker company of these selected transactions. For the transactions selected from the bank statements, the broker company should then collate and prepare the supporting documents (e.g. invoice, debit note, cheque copy, remittance slip) for each transaction selected which can sufficiently explain the nature of transaction. The broker company should do the same for the transactions selected from the list of insurance applications – in this regard the broker company should collate and prepare supporting documents such as the copy of the application form signed by the client, client agreements, remuneration disclosure, policy delivery records, customer due diligence documents, AML customer risk assessment records etc. All these supporting documents should be prepared and ready for review by the IA on or before the commencement of the on-site inspection period.
What happens during the on-site inspection stage of an inspection?
At the beginning of the on-site inspection stage, the IA would have an opening meeting with the senior management of the licensed insurance broker company at the broker company’s office, during which the management team would be invited to present an overview of the broker company’s business operations and internal controls. Thereafter, the inspection team (usually 2 to 3 IA staff) would stay in the broker company’s premises for around two to three weeks. During the on-site period, the IA inspection team would review supporting documents provided by the broker company, raise written and verbal enquiries, and discuss with various staff of the broker company (e.g. responsible officer, technical representatives, compliance officer, accountant etc.) to understand the broker company’s operations and major workflow for selling insurance policies. If necessary, additional samples would be selected for review and the on-site period may be extended accordingly.
What happens after the on-site stage of the inspection through to completion of the inspection?
After the on-site stage is finished, the IA would continue to follow up any outstanding questions by email or telephone calls with the licensed insurance broker company. Where necessary, the inspection team may also pay an extra visit to the licensed insurance broker company.
After all outstanding issues and enquiries are cleared, the IA would wrap up the case and invite representatives of the broker company to have an inspection closing meeting in the IA’s office. During the closing meeting, a draft management letter (with intended inspection observations and findings) would be tabled for discussion. Along with observations and findings, the IA would also provide the licensed insurance broker company with comments and suggestions on improvements and rectifications to its controls and governance. The final management letter would be issued to the licensed insurance broker company taking into account any feedback that the broker company may raise during the closing meeting.
Upon receipt of the management letter, the licensed insurance broker company should provide the IA (usually within three weeks of the management letter) an action plan to address the issues cited in the management letter. Detailed proposed actions and the relevant timeline for implementation are expected to be included in the action plan. The IA would then follow up with the licensed insurance broker company in accordance with the respective milestones stated in the action plan to ascertain if the proposed actions have been implemented satisfactorily. The implementation of all the actions marks the end of the inspection.
That all sounds pretty intrusive, doesn’t it?
True, and we do not pretend it to be otherwise. But think of it this way. No medical check-up is worth anything if it isn’t sufficiently intrusive to assess one’s inner-workings. Further, think of the relief you feel when it’s all over! Indeed, we have had comments from certain broker companies who felt like an IA inspection was the equivalent of getting an external consultant to do a full review of their operation, only completely free of charge!
The point is this: we do inspections to ensure that the standards demanded by the insurance regulatory framework are being maintained. And this is vital to ensuring that policyholders can have trust and confidence in the licensed insurance broker companies they use for their insurance needs.
What if the IA finds significant non-compliance during an inspection?
As indicated, the IA generally adopts a “prevention is better than cure” approach in its inspection of licensed insurance broker companies.
However, if the IA does find something badly wrong in an inspection (where cure is the only option because prevention has not been forthcoming), then we have to act. In this regard, we have been very transparent on the matters for which we have zero-tolerance. The biggest red-flag for the IA is if it finds a business model which involves a broker company relying on (or even incentivizing) unregulated sales activities by third party referrers (rather than carrying on substantive regulated activities itself), as indicated by the broker company driving such unregulated sales activities by paying virtually all its commission to third party referrers in referral fees. Where we see this, the matter is likely referred to our enforcement division for investigation so the appropriate cure (in the form of enforcement and disciplinary action) can be meted out.
For the most part, however, in our inspection work we are like a doctor or a cost-effective consultant that aims to leave a broker company after an inspection, in a better place than where it started before the inspection was commenced.