Robust enough to withstand a once-in-200-year financial crisis - Industry leader Sun Life is ready for the 2024 RBC regime

With a wide variety of insurance products available, when it comes to choosing insurance companies, stability and reputation are important considerations for policyholders. The insurance industry in Hong Kong is gradually implementing the Risk-based Capital (RBC) regime, a bill that was passed by the Legislative Council in early July this year and is set to roll out in 2024. The RBC regime is hailed as significant legislation in the industry. Under the new regime, insurance companies are expected to be able to withstand even a once-in-200-year financial crisis. Some insurers have already gained approval to adopt RBC one year ahead of schedule, and Sun Life Hong Kong is one of them.
Unlike the current regulation that determines capital requirements based on a uniform ratio, under the upcoming RBC regime, insurers will be required to conduct stress tests in four major risk areas, including market risk, insurance risk, counterparty risk, and operational risk exposures. Insurance companies will need to calculate the capital reserves required in each area for a once-in-200-year rare crisis scenario.

Taking Sun Life Hong Kong as an example, they have calculated potential major crises in various risk exposures based on the HK RBC framework, which are with reference to some historical data and statistical concepts. Brian Chan, Chief Risk Officer and Chief Actuary of Sun Life Hong Kong Limited, explained that a 40%-50% crash in the stock market, a significant drop in interest rates, or a sudden 30% policy surrender rate can all be defined as once-in-200-year events. “We will calculate the capital needed to cope with such crises, risk by risk, area by area.”

The RBC regime can bring win-win outcomes.

The RBC regime has been implemented in many countries in Europe and America for many years. Brian believes that introducing the regime into the insurance industry in Hong Kong at this time is “definitely keeping up with the trend and a win-win situation.” He thinks that the new regime will help create a level playing field for insurers, bringing new ambience to the insurance market. “RBC is not about bringing more fancy high-risk products to the market, but more reasonable high-quality products will emerge out of this.”
There are many insurance products labeled as “high guaranteed benefits” and “high dividends” in the market right now. However, under the RBC regime, insurers will need to increase their capital accordingly when launching high risk products. Brian believes that it will serve as an incentive for insurance companies to design more diversified products, thereby diversifying risk exposures. Ultimately, policyholders will definitely benefit from this.

New regime will reduce the risk of insurer default.

“After implementing RBC, there should be a much smaller chance of insurance companies being unable to provide claims due to insufficient financial resources.” Brian expects that RBC will prompt the industry to become more conscious when examining investment strategies and properly manage the potential risks brought by their products and investments. In other words, under such a comprehensive risk assessment of RBC, the risk of default will be significantly reduced for insurers, and they will be better able to fulfill their commitments to policyholders.

RBC is said to have originated in the 1980s and was first implemented in the United States. After many years of evolution, the RBC to be implemented in Hong Kong today, however is quite different. Also, due to different standards in the past, it was difficult to compare disclosed capital ratios between countries. For example, the solvency ratio of insurance companies on the verge of liquidation can exceed 400%, while for a well-established insurance company, it is only 130%.

Brian reminds that under the old regime, a higher ratio does not necessarily mean better. The key is a reasonable ratio, as a high ratio may indicate that the company is holding too much cash and is afraid to invest. To some extent, this reflects the company’s ability to generate returns. In terms of the standardization of capital adequacy ratios, it is reported that the Insurance Authority (IA) will commence preparatory work on detailed requirements for the RBC regime, followed by public consultation on subsidiary legislation, making it easier for the public to compare the financial conditions of various insurance companies.

Sun Life has completed the requirements one year ahead, the process was filled with hardship.

It is certainly not an easy task to meet the RBC standards, and being able to complete the requirements of the IA one year in advance demonstrates Sun Life’s efficiency in preparation. Brian described this as one of the largest one-year projects in the history of the group, and the preparation process was truly challenging, even “filled with tears and blood”. Besides hiring more actuaries to handle risk assessments at a higher cost, there was also a need for hardware and software coordination for cross-border data. He expressed special thanks to the team’s efforts over the past year, which have enabled Sun Life to be one of the first insurance companies to implement the new regime. It has proved their capabilities, as well as their solid financial strength and risk management level. “We have a good foundation, which has given us a head start to win.”

Under the new RBC regime, insurers will be required to disclose information to the IA and the public regularly, while the authority will review the companies’ operational status based on the data. When the capital ratio shows an unusual downtrend, the authority will step in, and if the situation does not improve, there may be a possibility of intervention to avoid default risk.