The Hong Kong Office of the Commissioner of Insurance has set out new rules around insurance risk transfer to the capital markets, which stipulate that approval must be required for capital market risk transfer using an SPV, unless a reinsurance firm is involved.
The Insurance Authority in Hong Kong has had a regime which would allow risk transfer to the capital markets through so-called Special Purpose Entity (SPE) vehicles, but a recent guidance note has brought put into place more stringent rules around this and clarified some issues.
The most important change is the fact that approval must now be sought for any alternative risk transfer transactions to the capital markets, using an SPE.
Hong Kong authorised insurers and reinsurers may leverage alternative risk transfer techniques to migrate risks away, including to the capital markets. The Insurance Authority expects that a “robust framework” for managing and monitoring any alternative risk transfer arrangements be put in place by the re/insurer, comparable to those required to be in place for any reinsurance arrangement.
In the case of a capital market reinsurance transaction using an SPE, which should be fully funded and bankruptcy remote by nature, the re/insurer has to ensure that it has “sound investment and strategies on its underlying risks.”
Re/insurers using an SPE for risk transfer to the capital markets should also ensure that:
- Investment restrictions are adhered to.
- Proper accounting takes place on interest, dividends etc.
- Collateral and asset movement is properly reported.
- Collateral assets are legally existent and technically identifiable.
- Liabilities can be determined on a timely basis, with obligations satisfied in accordance with underlying risk transfer contracts.
The Insurance Authority will consider a number of items, to ensure that an SPE for risk transfer to the capital markets is fully-funded, including how collateral is held, whether diversified, the use of derivatives and liquidity or investment strategy, among others.
Clearly this is not exactly like collateral arrangements seen in ILS markets, but we’d imagine the main use-case for these SPE’s would be for a typical ILS, collateralised reinsurance or catastrophe bond style risk transfer to third-party capital market investors, so more typical collateral would be seen to be used. The Authority in Hong Kong appears to be covering all bases with its guidance note.
There must be a legal opinion as to the bankruptcy remoteness of the SPE, according to the Insurance Authority, including full disclosure in any prospectus or offering circular involving a transaction from the SPE.
Authorised insurers have to seek written approval from the regulator before entering into an insurance risk transfer to the capital markets through an SPE, however a professional reinsurance firm does not.
The regulator likely wants to ensure that insurers are not acting as reinsurers, and are truly achieving risk transfer with these transactions.
In order to establish an SPE in Hong Kong for use in a transaction involving insurance risk transfer to the capital markets, details need to be provided on the structure including fully-funded features, the legal opinion on bankruptcy remoteness, details of the transaction terms, disclosure information, conflicts of interest, analysis of the sponsors basis risk, management details, third-party analysis of the SPE’s structure, projections (financial and actuarial), outsourcing agreement details and information on any credit risk involved.
Reports must be provided to the regulator during the transaction term, on funding levels, capital and the ability to respond to any covered events, which is to ensure that the SPE can continue to meet its obligations under the risk transfer or reinsurance contract.
This new set of guidance rules came into force at the start of 2017 and does make Hong Kong a viable location to transact a capital market risk transfer. At this time it seems only applicable to locally authorised insurance and reinsurance firms, but the regulator may look to open that up, as other domiciles have done as they attempt to attract cat bonds and the like to their shores.
For Hong Kong though, the guidelines on insurance risk transfer to the capital markets using a Special Purpose Entity (SPE) could be attractive to Chinese insurers to use, as the regulator establishes a regime that might open up capital market options to the China market as well.