Our latest insurance update from the Asia Pacific region considers a new disclosure rule in the Western Australia Supreme and District Courts which could have unwelcome consequences for insurers and reinsurers. We continue our series of reports from China on the liberalisation of the insurance market and also provide an update on how Hong Kong’s new competition law might affect insurers. Our consultant, Professor Robert Merkin, provides us with two case summaries from Hong Kong on non-disclosure.
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Who pays to be the puppet master? – Disclosure novelties for insurers in Western Australian courts
The rules governing civil procedure in the Western Australian Supreme and District Courts were recently amended by adopting a new Order 9A. Order 9A imposes an obligation on parties to disclose the identity of persons who have control over, and who are funding the party’s involvement in a court proceeding (Interested Non-Party).
At first glance this appears to be aimed at litigation funders, but the net is wide enough to extend to insurers (and perhaps reinsurers).
After being gazetted on 12 June 2012, Order 9A came into effect two weeks later on 26 June 2012 and compels parties to notify the Principal Registrar and each other party of the identity of any person who:
- provides funding or other financial assistance to the party for the purposes of conducting the case; and
- exercises direct or indirect control or influence over the way in which the party conducts the case.
There seems to have been no parliamentary discussion or published policy as to the rationale supporting Order 9A’s enactment, and practitioners and insurers alike currently find themselves in a maze of uncertainty brought about by this novel development. We explore below a few of the most prominent issues arising from the new order.
Who has a notifiable interest?
The Courts have not yet provided any guidance or explanatory memoranda and until a practice direction is published the parties are burdened with having to assess whether there are external interests which must be disclosed. Notwithstanding this, it is paramount that both the elements of funding and control must be present to meet the threshold of an interest being considered notifiable.
Order 9A seems to be wide enough in scope to apply to insurers who assume the defence of policyholders, having granted indemnity under a policy. In simple scenarios where there is a single underwriter, notification will be a straightforward process. However, in scenarios with a more complex matrix of interests of insurance, reinsurance and co-insurance structures, the identification of notifiable interests might prove challenging, and involve commercial sensitivities and reluctance to notify.
Whilst an insurer might have assumed the conduct of a case, if a costs inclusive excess is yet to be exhausted it cannot be said to be funding it. Underwriters’ interest will only become subject to disclosure when the deductible has been eroded fully.
Duties owed by Interested Non-Parties
Interested Non-Parties now owe duties to the Court under Rule 3 of Order 9A:
- neither to engage in conduct which is misleading or deceptive, nor to aid, abet or induce such conduct, in connection with the conduct of the case;
- to cooperate with the parties and the Court in connection with the conduct of the case; and
- to use reasonable endeavours to ensure the goals in relation to eliminating delays and the use and objects of case flow management are attained.
The issue of non-compliance with disclosure obligations by parties has not yet been addressed in rules or regulations underlying Order 9A. It seems likely, however, that non-compliance will incur the imposition of usual sanctions such as adverse costs orders or even injunctive relief.
Timing of Notice
Pursuant to Rule 2(b) of Order 9A, parties need to discharge their disclosure obligations in accordance with the rules as soon as is reasonably practicable after the person becomes an Interested Non-Party in relation to the party to a proceeding. This means that within the limits of reasonable practicability, Interested Non-Parties need to be identified in relation to litigation presently on foot. There is no suggestion or reference to Order 9A having any retrospective effect.
Implications of Order 9A
The introduction of the new order will invariably cause underwriters’ interest in the subject matter to be exposed. This, in turn, might pave the way for the ‘deep pockets’ perception of defendants to come to fruition to the likely detriment of underwriters. It also follows that in deciding whether to settle matters prior to proceedings becoming litigious, underwriters should bear in mind the real likelihood of having to disclose members of a following market in excess layer arrangements.
Fortunately, nothing in the current wording of Order 9A compels Interested Non-Parties to disclose the basis upon which they operate as such. Consequently, issues such as policy wording, extent of indemnity and limits of cover do not fall within the ambit of the disclosure obligations.
This is the first of such rules to be implemented in Australia and it remains to be seen if other states and territories will follow suit. Time will tell what benefits will conceivably be achieved by this development, and whether there is a case for limiting its application for insurers.
For further information please contact Riaan Piek or Rachel Page in Perth.
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Measures to liberalise the insurance asset management sector in China
With the rapid development of the insurance industry, China’s insurance asset management industry has experienced considerable growth over the past decade. Since the first insurance asset management company (insurance AMC) was approved in 2003, a further 17 insurance AMCs have been registered. However, for a period of almost four years, the China Insurance Regulatory Commission (CIRC) did not grant approval to any new insurance AMCs. Last year CIRC started approving applications again, albeit with higher entry thresholds than before the hiatus.
Since 2010, CIRC has been dedicated to reforming the insurance sector, with the chief objective of improving cooperation between insurance and other types of financial institutions. In late 2010, CIRC issued the Interim Measures on Management of Use of Insurance Funds, which permit insurance AMCs (who could previously only provide asset management services to their affiliates) to act as professional third party asset managers.
In July 2012, in view of low investment returns and asset depreciation suffered by insurers, CIRC issued the Interim Measures on the Management of Investment of Entrusted Insurance Funds. The measures, for the first time, allow qualified fund houses and securities firms to manage entrusted insurance funds by investing them domestically in mutual funds, listed bonds and stocks.
CIRC has taken further steps to liberalise investment restrictions on insurance funds and provide greater flexibility in asset allocation. In July 2012, CIRC issued three new regulations: the Interim Measures on Investment in Bonds by Insurance Funds, the Circular on Certain Issues Regarding the Investment in Equities and Real Estates by Insurance Funds, and the Interim Measures on Management of Insurance Funds Allocation. Under these regulations, CIRC has implemented the following changes:
- Insurers are now allowed to invest in hybrid and convertible bonds.
- The ceiling on investments by insurance funds in unsecured bonds is raised from 20 to 50 per cent of the total assets of any single insurer, calculated at the end of the preceding quarter.
- Insurers are no longer required to meet annual profit making requirements for equity or real estate investment.
- Caps on aggregated investment by insurance funds in unlisted equities and equity investment funds are raised from 5 to 10 per cent of the total assets of any single insurer, calculated at the end of the preceding quarter.
It is anticipated that more regulations will be introduced either later this year or early next year to further liberalise restrictions on both domestic and overseas investments by insurance funds.
CIRC began this liberalisation process in June 2012 when it published discussion papers on 13 regulations on domestic and overseas investments by insurance funds for public comment. Under the draft regulations (three of which were issued in July 2012), more categories of investment products, such as unlisted equities, real estate and investment funds linked to securities or real estate investment trusts, and multiple jurisdictions (other than Hong Kong and US) will be available for investment.
CIRC encourages private capital investment in the insurance industry
On 15 June 2012, CIRC issued the Implementation Opinions on the Encouragement and Support of the Healthy Development of Private Investments (the Implementation Opinions), which took immediate effect.
The Implementation Opinions implement the State Council’s policy to encourage and introduce investment by private capital in China’s key industries. According to the Implementation Opinions:
- Private capital investment will be encouraged in insurance companies through various means including, but not limited to, new establishments, acquisitions and subscriptions. In addition, single qualified private shareholders may hold more than 20 per cent stake in an insurance company.
- Qualified private shareholders are also encouraged to invest in insurance intermediaries, such as agents, brokers, loss adjusters and asset management companies.
- Private capital will be allowed to participate in the development of IT systems and the provision of outsourcing services (such as data maintenance, software development, translation and consultation) to insurers and insurance regulators.
The issuance of the Implementation Opinions reflects the authorities’ intention to break the current monopoly of state capital in the insurance industry and revive a slowing economy.
CIRC publishes administrative measures on controlling shareholders of insurers
On 10 July 2012, CIRC published the Administrative Measures on Controlling Shareholders of Insurers, which will take effect on 1 October 2012. We previously reported on this development (for further information please refer to Asia Pacific - focus on insurance September 2011), when the CIRC published a draft version of the measures for public consultation.
The final version of the measures retains much of the same wording, including:
- the personnel of a controlling shareholder of an insurer may not concurrently assume the position of an executive director or a role in the senior management of the insurer (with the exception of the role of chairman of the board);
- the controlling shareholder of an insurer shall ensure that the assets of the controlled insurer remain independent and the controlling shareholder may not hold the funds of such insurer through loans or any encumbrances; and
- an insurer (or any of its controlled subsidiaries) may not make equity investments in the controlling shareholder.
The final measures include two major changes from the earlier draft. The draft provided that insurers are not permitted to purchase bonds issued by a controlling shareholder. In the final measures, however, this will be permitted, as long as the aggregated bonds purchased are no more than 10 per cent of the total bonds issued by the controlling shareholder. Further, the draft expressly prohibited the engagement of its controlling shareholder by an insurer to conduct any investment activities. This prohibition has been abolished in the formally issued measures.
CIRC implements trial remuneration administration mechanism in insurance sector
On 19 July 2012, CIRC released the Guidelines on Remuneration Administration Regulations for Insurance Companies (the Guidelines) for trial implementation, which will take effect from 1 January 2013. This is the first time that CIRC has tried to administrate the remuneration mechanisms of insurance market participants. According to CIRC, improper remuneration mechanisms leading to excessive risk taking of financial institutions is considered one of the major factors contributing to the financial crisis in 2008.
In fact, CIRC is not the first financial regulator in China to propose remuneration controls, with the China Banking Regulatory Commission previously issuing a similar policy for banks.
The Guidelines will apply to insurance market participants such as insurers, insurance group companies, and insurance asset managers registered in China. CIRC has stated that the main objective of the Guidelines is to administrate the remuneration of senior management and those in key positions in the insurance market. This has raised major concerns in the market, in particular amongst foreign invested insurance companies. The key terms include:
- the performance related pay of directors and senior managers shall be determined on the basis of the outcome of their performance appraisal for the current year, and any performance related element of pay shall be no more than three times their basic salary;
- the cash benefits, allowance and subsidies offered annually by firms to directors and senior managers shall not exceed 10 per cent of their basic salary;
- the performance related pay of directors and senior managers (in addition to other key personnel in firms) shall be deferred. The proportion of deferred performance related pay shall be at least 40 per cent of the overall amount. For the chairman and general manager the proportion of such deferred payments shall be at least 50 per cent; and
- firms shall determine the payment period of performance payments according to the duration of the risks, and in principle such period shall be at least three years.
For further information, please contact Lynn Yang and Tong Ai in Shanghai.
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Hong Kong enacts Competition Law
The Competition Ordinance was enacted in June 2012; however, it is not expected to come into force until 2014. This will allow time for the Competition Commission and the Commission Tribunal to be established and implementing guidelines issued.
The Competition Ordinance introduces two broad prohibitions for companies conducting business in Hong Kong. The first conduct rule prohibits anti-competitive agreements and concerted practices among two or more businesses. Examples of serious infringements cited in the new rule include price fixing, market sharing, output limitation and bid-rigging practices.
The second conduct rule prohibits anti-competitive conduct by a single business with market power. It is not clear what market power means in terms of market share, but businesses with a significant market position should not abuse their position by, for example, pricing below cost or bundling products to exclude a competitor. Competition authorities elsewhere have traditionally adopted a narrow view on market definition in the insurance sector, leading them to consider that each separate risk constitutes a separate market.
The new rules will apply to any pre-existing agreements, arrangements and conduct that continue to have effect after the Competition Ordinance comes into force. As a result, entities active in Hong Kong will not only have to ensure that new agreements and practices are compliant, but also that existing agreements and practices are consistent with the new law. Commercial practices that must cease before the law becomes effective would include any ongoing coordination and exchange of information among competitors in respect of pricing, market allocation, production or sales capacity, and bid-rigging. Similarly, trade association activities involving these practices must also come to an end.
Entities found to be infringing these rules could face a fine up to 10 per cent of their group Hong Kong turnover for the duration of the infringement (with a three-year cap). Holding companies and ultimate controllers will most likely be held jointly and severally liable for the behaviour of their subsidiaries. Infringing entities may also be ordered to refund illegal profits to the government and pay damages to any third parties that suffered loss due to the infringement.
Enforcement trends in the insurance industry in Asia
In the absence of implementing guidelines, it is too early to tell how the new competition law will affect the insurance industry in Hong Kong. However, enforcement trends in the industry elsewhere in Asia may provide some guidance.
Asian competition authorities have so far focused on relationships between competing insurance companies rather than on their relationships with distributors, agents or customers. This focus on competitor-to-competitor (or “horizontal”) relationships can also be expected in Hong Kong. The Administration explained during the legislative process that supplier-to-reseller (or "vertical") relationships would be less likely to raise concern - the only exceptions being when competitors enter into a supply relationship, or when the supplier has a substantial degree of market power.
Given the nature of the industry, there is significant interaction among competing insurers in Asia for many legitimate purposes, for example, reinsurance, mutualisation of risks, common industry standards, statistics and actuarial studies. These activities, however, should not give rise to agreements or common practices in terms of pricing or to market allocation among insurers, as the following situations demonstrate.
In Korea, the competition authority has repeatedly sanctioned insurance companies for price-fixing practices. Last year, it imposed fines in excess of US$300 million on life insurers for conspiring to fix interest rates applied to client deposits – a key factor in determining insurance premiums. The investigations took place between 2001 and 2006 through regular communication and exchange of information. In 2008, twenty five insurance companies were fined collectively more than US$23 million for allegedly fixing the price of certain types of insurance, an activity the defendants said came at the request of the government.
Similar conduct was also challenged under competition laws in Vietnam and China. In 2011, Vietnamese competition authorities fined nineteen insurers, which together account for 99 per cent of the country’s motor vehicle insurance sector, for premiums fixing arrangements. In China, a trade association representing local insurers was sued in the civil courts for price fixing in 2009. The association had adopted a decision requiring members to follow its guidance on the level of premiums that should be charged for automobile insurance. Ultimately, the case was settled following the association’s decision to stop requiring adherence to its pricing guidance.
The introduction of competition laws has also informed the way insurance regulators exercise their prudential powers. In 2008, for example, eighteen local insurers entered an agreement requiring clients to purchase insurance exclusively through a “New Vehicle Insurance Service Centre”, which then allocated the clients among the insurers within Hong Kong. The practice was prohibited by China’s Insurance Regulatory Commission as it amounted to an illegal market allocation and a boycott of non-participating insurers.
What steps need to be taken in order to ensure compliance?
There is no one-size-fits-all compliance scheme, therefore, it is always advisable to implement a programme that is suitable for the business and resources of the company concerned.
In general, a four-step compliance approach should be adopted:
- Awareness: spread understanding of the basic features of the Competition Ordinance and its relevance to your business through introductory face-to-face or online workshops.
- Assessment: conduct internal business audit and risk assessment to identify high-risk areas.
- Competence: based on priorities identified during the risk assessment process, and under the leadership of senior management, implement a corporate compliance programme consisting of staff training, internal guidelines and circulars on sensitive topics, with a view to communicating to staff what is expected from them.
- Commitment: implement appropriate disciplinary and reporting procedures, and obtain staff commitment to compliance.
For further information, please contact Marc Waha or Marie Kwok in Hong Kong
Update on the Employees’ Compensation Insurance Residual Scheme
Pursuant to the Employees' Compensation Ordinance, employers are required to take out employees' compensation insurance policies to cover any liabilities arising in respect of their employees who suffer injuries at work. At present, there are around 50 insurers that can underwrite employees' compensation insurance.
To assist those employers who encounter difficulties in taking out insurance policies in accordance with the Employees' Compensation Ordinance, the Employees' Compensation Insurance Residual Scheme (ECIRS) was launched in 2007. Under the ECIRS, appropriate insurance cover is offered to those employers who meet the specified conditions.
Evaluation of the ECIRS
Feedback suggests that the ECIRS has been operating smoothly. Since its establishment to March 2012, the ECIRS Bureau has received 218 applications. Of these 218 applications:
- 50 applicants have been offered employees’ compensation insurance by the ECIRS
- 64 applications are being vetted
- 2 applications have been refused as the cover sought does not fall under any category of employees’ compensation insurance
- the remaining 100 applications have been offered employees’ compensation insurance by other insurance companies.
On the basis of the information provided by the Labour Department, the ERICS Bureau has initially identified 19 High Risk Groups (HRGs) within which employers are more likely to encounter difficulties in obtaining employees’ compensation insurance. Most of the HRGs are related to the building and construction industries. Recently though, employers in the transport/logistics, cleaning and recycling industries have reported experiencing difficulty in obtaining employees' compensation insurance and requested assistance from ECIRS. Following consultation with the relevant industries, the ECIRS revised the list of HRGs with effect from 1 April 2012. The updated list now includes 22 HRGs:
- Air conditioner installation worker/repairer
- Crane operator
- Demolition work
- Drain repairer
- Earth removal
- Filling & reclamation
- Gondola worker/Window Cleaner
- Neon light signboard installation worker/repairer
- Ship repairer
- Steel bending & erection
- Well sinkers & borers
- Worker on board launch/river trade vessel
The ECIRS Bureau also agreed to issue short-term insurance policies ranging from 3 to 6 months to allow employers more time to discuss policy terms and premium rates with individual insurance companies.
Additionally, the Hong Kong Federation of Insurers and the ECIRS Bureau have been in discussion with representatives from various industries (including scaffolding, cleaning and recycling industries) over the past year in order to better understand the particular needs of each industry.
It is anticipated that the ECIRS will continue to fulfil its role of providing assistance to those employers who have difficulty obtaining employees' compensation insurance. Long term, the Labour Department will continue to improve occupational safety awareness through better enforcement and training with a view to preventing, or at least reducing accidents. It is hoped that this will in turn lead to a reduction in the number of insurance claims, and ultimately lower premium rates.
For further information, please contact Winnie Lee in Hong Kong
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Ma Kim Ying v Manulife (International) Ltd  HKCFI 941
Mr Wong Shiu Tong applied for a life policy on 12 July 2004, and a policy was issued backdated to 1 July 2004 with Mr Wong as policyholder and his wife as sole beneficiary. The policy contained an incontestability clause which stated: "The Owner's or the life insured's failure to disclose any fact or their misrepresentation of any fact within their knowledge that is material to the insurance (and it is not disclosed by the other party) will not, in the absence of fraud, render this policy voidable by the company after it has been in force during the life insured’s lifetime for 2 years from its date of issue or date of reinstatement …". Mr Wong died on 14 May 2007 from a condition which he had not disclosed to the insurers. The Court held that the non-disclosure had been fraudulent, that the facts withheld were material, that the underwriter had been induced to write the policy when it would otherwise have not been written and that the incontestability clause did not provide a defence. In addition, the assured was in breach of a warranty stating that the answers had been given to the best of his knowledge and belief.
Cheung Kwan Wah v China Ping An Inusrance (Hong Kong) Co Ltd, HKDC
Cheung Kwan Wah (CKW) was the owner of a Porsche. On 22 January 2010, he completed a motor insurance proposal form issued by the defendant insurers. The proposal asked a series of questions which were to be answered by ticking "yes" or "no" boxes. Question 3 asked whether any person who may drive the car had been convicted of any driving offences during the last 3 years, to which CKW answered in the negative, CKW also declared that the vehicle would not be driven by any person who “has been disqualified from holding [a] driving licence”. The Porsche was involved in an accident, and the insurers denied liability on the grounds that CKW had not disclosed that he had been disqualified in 2003 and 2005 and had, in 2008 and 2009, a total of three fixed penalties for speeding. The court gave summary judgment for CKW.
- The facts were not material: the insurers were not interested in any offences more than three years earlier; and there was no evidence that they regarded the fixed penalties – which were not convictions – as material, given that they were only minor transgressions and had not involved injury or damage.
- The declaration applied only to drivers who were currently disqualified, not those who had earlier been disqualified
- Even if the facts were material, their disclosure had been waived. Limited questions waived disclosure of related material, and in any event there was no space on the form for further disclosure.
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