Paper V - Investment-linked Long Term Insurance

Under the Securities and Futures Ordinance (SFO) in Hong Kong, when an intermediary firm ceases to carry on regulated activities, it must promptly notify the Securities and Futures Commission (SFC). This notification ensures that the SFC is aware of the firm’s status and can take appropriate regulatory actions, such as removing the firm from the register of licensed corporations or registered institutions. This requirement helps maintain the integrity and transparency of the financial market. The notification should include details about the cessation, such as the effective date and the reasons for the cessation. This is important for the SFC to monitor and regulate the market effectively. Therefore, informing the SFC is a mandatory step to ensure compliance with regulatory requirements.

Bond investments, while generally considered safe, do come with certain disadvantages. One key risk is the potential for price fluctuations due to changes in prevailing interest rates. If interest rates rise, the value of existing bonds with lower fixed interest rates may decrease, leading to a capital loss if the investor needs to sell the bond before maturity. Additionally, bonds typically do not offer participation in the profits of the issuing company, limiting potential upside compared to equity investments. While some bonds are highly liquid, others may lack a readily available secondary market, making it difficult to sell them quickly without accepting a lower price. Inflation also poses a risk, as the fixed interest rate may not keep pace with rising prices, eroding the real return on the investment. Therefore, statements I, II and III are correct.

Value at Risk (VaR) is a risk measurement methodology used to estimate the potential loss in value of an investment over a specific period, given a confidence level. A stress test assesses the performance of an investment under extreme market conditions, supplementing VaR’s limitations. Option sensitivity measures, like Greeks, quantify how option prices change in response to changes in underlying parameters. Duration measures the sensitivity of bond prices to changes in interest rates. The HKMA’s risk-based supervisory approach assesses whether authorized institutions have appropriate risk management and internal control systems. The CAMEL rating system evaluates Capital adequacy, Asset quality, Management, Earnings, and Liquidity. The SFC adopts risk-based regulation to focus on areas of highest risk in the securities and futures industry. Therefore, all of the above statements are correct.

The Securities and Futures Commission (SFC) is the primary regulatory body overseeing the securities and futures markets in Hong Kong. Its responsibilities include licensing intermediaries, supervising market conduct, and enforcing regulations to maintain market integrity and protect investors. The Hong Kong Monetary Authority (HKMA) regulates banking and deposit-taking institutions, while the Insurance Authority (IA) oversees insurance companies. The Mandatory Provident Fund Schemes Authority (MPFA) regulates the MPF schemes. Therefore, the SFC is the principal regulator for investment-linked assurance schemes (ILAS) that have an investment component linked to securities or futures. Therefore, statement I is correct.

Investment-linked policies in Hong Kong are characterized by transparent fees, investment in segregated funds, fluctuating policy values tied to investment performance, a variety of fund options, policyholder assumption of investment risk, and potential unsuitability for small premiums. These policies contrast with traditional ones by explicitly disclosing all charges. The premium for such policies is based on the cost of insurance, operational expenses, and investment earnings. Therefore, policyholders need to be aware of these characteristics and charges to make informed decisions.

Candlestick charts are a visual representation of price movements over time. The ‘body’ of the candlestick represents the range between the opening and closing prices. When the opening price exceeds the closing price, it signifies a price decrease during that period, and the body is typically filled or blackened. Conversely, when the opening price is lower than the closing price, indicating a price increase, the body is usually hollow or white. The lines extending from the body, known as ‘wicks’ or ‘shadows,’ represent the highest and lowest prices reached during that period. This contrasts with other chart types, such as point and figure charts, which use crosses and circles to represent price movements, or bar charts, which use vertical lines with small horizontal lines to indicate opening and closing prices. Technical analysts use candlestick charts to identify patterns and potential trading signals.

Government bills, such as US Treasury bills and Hong Kong Exchange Fund bills (EFB), are short-term debts issued by governments to finance their expenses. Investing in these bills is akin to lending to the government. Due to the extremely low risk of default, these instruments typically offer the lowest yield among similar instruments. Commercial papers, on the other hand, are unsecured promissory notes issued by top-rated financial and non-financial companies and usually offer higher rates of return than government bills due to higher liquidity and default risks. Short-term certificates of deposit (CDs) are negotiable short-term time deposit certificates issued by commercial banks, and their yields are typically higher than government bills but lower than commercial papers, reflecting the higher possibility of default compared to the government but lower than commercial papers.

The Guidance Note on Product Recommendation for Long Term Insurance Business (Including Linked Long Term Insurance) issued by the CIB (now known as the Insurance Authority) provides guidelines to ensure that intermediaries make suitable product recommendations to clients. A key aspect is understanding the client’s financial needs and objectives. This involves assessing their current financial situation, future goals, risk tolerance, and investment knowledge. Recommending a product without considering these factors would be a violation of the guidelines. The guidance note emphasizes the importance of documenting the client’s needs and the rationale behind the product recommendation. It also covers the need to disclose all relevant information about the product, including its features, benefits, risks, and associated fees. Therefore, a suitable product recommendation should align with the client’s financial needs and objectives, be based on a thorough assessment of their circumstances, and be fully disclosed to the client. Therefore, all of the above statements are correct.

Index funds are designed to mirror the performance of a specific market index, such as the Hang Seng Index in Hong Kong. They achieve this through passive management, where investment decisions are largely automated to replicate the index’s composition. This approach results in a limited number of transactions, keeping costs low. Index funds offer advantages like ease of understanding, lower management fees, and the availability of hedging strategies. However, they cannot capitalize on market movements, only track market performance, and cannot outperform the market. They may be unwelcome during a bear market. Therefore, statements I and II are correct.

Investment-linked policies offer the flexibility of partial withdrawals, allowing policyholders to access funds without incurring interest costs associated with policy loans or surrendering the policy and losing protection. This feature is particularly beneficial compared to traditional life policies. However, it’s crucial to consider the potential impact of withdrawals on the policy’s value and future performance. Market risk is inherent in investment-linked policies, as the value fluctuates with the performance of the underlying investments. Liquidity risk arises from the long-term nature of these policies and potential encashment charges for early redemption due to upfront expenses. Other risks include credit and insolvency risks of insurers and fund managers, foreign exchange risk, reinvestment risk, and risks associated with premium financing or premium holidays. Understanding these risks is essential for making informed decisions about investment-linked policies in accordance with IIQE Paper 5 Investment guidelines.

Investment-linked policies, as regulated under Hong Kong’s IIQE framework, are characterized by transparent fee structures, investment in policyholder-selected funds separate from the insurer’s assets, and fluctuating policy values based on investment performance. The policyholder bears the investment risk, and these policies may not be suitable for small premium amounts due to expense deductions. Understanding these characteristics is crucial for advising clients appropriately and complying with regulatory requirements.

Charges in investment-linked policies include the cost of insurance (mortality charges), policy fees/initial charges, fund management fees, surrender charges, and switching fees. The cost of insurance covers mortality and other benefits, based on factors like age and smoking habits. Policy fees cover distribution and policy issuance expenses. Fund management fees compensate the investment manager. Surrender charges apply upon early policy termination, and switching fees are incurred when transferring between investment funds.

When evaluating investment-linked policies, it’s important to consider the impact of charges on the policy’s value and investment returns. High charges can erode returns, especially in the early years of the policy. Policyholders should carefully review the policy’s fee disclosure and understand how charges are calculated and applied. Additionally, it’s important to assess the policyholder’s investment goals, risk tolerance, and time horizon to determine if an investment-linked policy is suitable for their needs.

The Insurance Authority (IA) is responsible for regulating and supervising the insurance industry in Hong Kong, including the conduct of insurance intermediaries through a licensing regime. The IA also promotes understanding of insurance products among policyholders and potential policyholders. The Securities and Futures Commission (SFC) regulates the securities and futures markets. While investment-linked insurance policies may fall under the definition of collective investment schemes regulated by the SFC, insurance intermediaries are generally not required to be licensed under the SFO solely for promoting or selling these policies. However, if an intermediary engages in activities that are an integral part of a business of advising on or dealing in securities, they may need to be licensed by the SFC. Therefore, statements I and II are correct.

Real estate investment offers potential capital appreciation and can act as a hedge against inflation. Leverage is available through bank mortgages, and ownership can provide a sense of pride. However, real estate investments also carry disadvantages such as high volatility, substantial transaction costs, and the challenge of managing properties. Additionally, real estate is considered an illiquid asset, requires significant capital, and may offer low rental yields. Therefore, statements I and II are correct.

The Product Key Facts Statement (KFS) is a concise document designed to provide investors with essential information about an investment product. According to the SFC guidelines, the KFS should be no more than a few pages long and must highlight key features, risks, and fees associated with the product. The aim is to enable investors to make informed decisions by understanding the product’s characteristics and potential implications before investing. The KFS is not intended to be a marketing document but rather a balanced and objective summary of the product’s key aspects, facilitating transparency and investor protection in line with HK IIQE exam regulations.

Investment funds offer various fee structures, including sales fees and management fees. A front-end load is charged at the time of purchase, while a back-end load is charged upon redemption. Level load funds involve a small front-end charge and potentially a back-end charge, along with a distribution fee. Management fees are annual charges for investment advisory services. The ‘Code on Unit Trusts and Mutual Funds’ mandates clear disclosure of all costs and charges. Performance fees can only be levied annually and on a high-on-high basis. Therefore, statements I and II are correct.

The Financial Needs Analysis (FNA) initiative by the HKFI aims to enhance the quality of financial advice provided to customers. A comprehensive FNA should consider various aspects of a customer’s financial situation, including their financial goals, risk tolerance, and existing financial commitments. It should also identify any gaps between the customer’s current financial situation and their desired future state. A key aspect of the FNA is to ensure that the recommended financial products align with the customer’s needs and objectives. While considering the customer’s existing insurance coverage is important, the FNA should not solely focus on selling insurance products. The FNA should also be regularly reviewed and updated to reflect any changes in the customer’s circumstances or financial goals. Therefore, statements I, II and III are correct.

The 6/49 lottery is a specific type of lottery game where players select six numbers from a pool of 49. Understanding the basic mechanics of this lottery is crucial for assessing its risk and return characteristics. The odds of winning are determined by the number of possible combinations of six numbers that can be drawn from the 49 available. The payout structure is typically tiered, with larger prizes awarded for matching more numbers. The expected return is influenced by the prize pool and the number of tickets sold. Therefore, all of the above statements are correct.

The Securities and Futures Ordinance (SFO) in Hong Kong establishes a comprehensive regulatory framework for the securities and futures markets. Section 107 outlines provisions related to false trading, market rigging, and other manipulative practices that can distort market prices and mislead investors. Engaging in such activities is strictly prohibited under the SFO to maintain market integrity and protect investors. The Securities and Futures Commission (SFC) is the primary regulatory body responsible for enforcing the SFO and overseeing the conduct of market participants. Therefore, all of the above statements are correct.

When an insurer becomes insolvent, the Policy Holders’ Protection Scheme (PHS) steps in to protect policyholders. The PHS covers 100% of the guaranteed benefits under a policy, up to a limit of HKD 1 million for non-guaranteed benefits. This protection is crucial for maintaining public confidence in the insurance industry and ensuring that policyholders are not left entirely without recourse in the event of an insurer’s failure. The PHS is designed to provide a safety net, allowing policyholders to recover a significant portion of their policy’s value. Therefore, statements I and II are correct.

Investment funds provide several advantages to investors, including diversification, professional management, growth potential, convenience, access to global markets, flexibility, liquidity, affordability, cost efficiency, administration, and protection. Diversification is achieved by investing in a variety of assets, reducing risk. Professional management offers expertise in investment decisions. Investment funds also offer the potential for higher long-term returns compared to traditional savings accounts. The convenience of investment funds allows investors to easily purchase and redeem investments. They also provide access to global markets that may not be directly accessible to individual investors. Investment funds offer flexibility in choosing investments that align with individual objectives and risk tolerance. Liquidity allows investors to easily realize their investments. Affordability makes investing accessible to a wider range of investors. Cost efficiency is achieved through economies of scale. Investment funds also handle administrative tasks and provide protection of assets through trustees and custodians. Therefore, all of the above statements are correct.

The Securities and Futures Ordinance (SFO) in Hong Kong establishes a regulatory framework for the securities and futures market. One of its key objectives is to maintain market integrity and protect investors. Section 107 outlines offenses related to false trading, which involves creating a false or misleading appearance of active trading in securities on a stock market. This can be achieved through various means, such as entering orders for a security knowing that matching orders of substantially the same size, at substantially the same price, have been or will be entered by or for the same or different persons. The SFO also addresses other forms of market misconduct, including price rigging, disclosure of false or misleading information inducing transactions, and insider dealing. These provisions aim to ensure that all market participants have equal access to information and that trading activities are conducted fairly and transparently. Therefore, statements I, II and III are correct.

The Hong Kong Monetary Authority (HKMA) guideline emphasizes the importance of a risk-based approach (RBA) in Anti-Money Laundering and Counter-Terrorist Financing (AML/CFT) systems. This approach allows Financial Institutions (FIs) to allocate resources efficiently by focusing on areas with the highest ML/TF risks, applying enhanced measures where risks are higher and simplified measures where risks are lower. The guideline also requires FIs to conduct Customer Due Diligence (CDD) measures as defined in the AMLO, with the flexibility to implement additional or simplified measures based on specific circumstances. Effective ongoing monitoring is crucial for understanding customers’ activities and detecting unusual or suspicious transactions, which is an integral part of an effective AML/CFT system. Therefore, all of the above statements are correct.

Investment-linked policies offer the flexibility of partial withdrawals, allowing policyholders to access funds without incurring interest costs associated with policy loans or surrendering the policy and losing protection. This feature is particularly beneficial compared to traditional life policies. However, it’s crucial to consider the potential impact of market risk, liquidity risk, and other risks such as credit and insolvency risks of insurers and fund managers, foreign exchange risk, and reinvestment risk. Understanding these risks is essential for making informed decisions regarding investment-linked policies, as highlighted in the IIQE Paper 5 syllabus.

The Global Financial Crisis of 2007-2008 was significantly influenced by the real estate market conditions in the US. Unsustainable property prices and rising mortgage default rates eroded market confidence, particularly in firms heavily involved in lending to property purchasers. The collapse of major financial institutions, such as Bear Stearns and Lehman Brothers, further exacerbated the crisis, highlighting the critical importance of risk management in financial institutions. A comprehensive approach to risk management, including financial, legal, reputational, and systemic risks, is essential for maintaining stability and protecting consumers. The Hong Kong Monetary Authority (HKMA) and the Securities and Futures Commission (SFC) have taken initiatives to regulate investment products and enhance consumer protection. The Life Insurance Council of the Hong Kong Federation of Insurers has also issued guidelines for selling investment-linked long-term insurance policies.

When evaluating different types of insurance policies, it’s important to understand how investment risk and potential returns are handled. Guaranteed policies offer a fixed return and protect against investment risk, but typically provide lower returns. With-profits policies offer returns linked to the insurance company’s overall investment performance, using smoothing mechanisms like bonuses and market value reductions, but future bonuses are not guaranteed. Investment-linked policies pass the investment risk directly to the policyholder, with policy values fluctuating based on the performance of the underlying investment funds. Therefore, the key difference lies in who bears the investment risk and how returns are determined.

The Shanghai-Hong Kong Stock Connect initiative, established with the joint approval of the SFC and CSRC, facilitates mutual stock market access between Mainland China and Hong Kong. Initially, Southbound trading, which allows Mainland investors to invest in Hong Kong stocks, had restrictions. These restrictions were later relaxed to allow fund managers to launch new publicly offered securities investment funds that invest in the Hong Kong stock market through the Shanghai-Hong Kong Stock Connect, without needing to be Qualified Domestic Institutional Investors (QDII). This expansion broadens the participation in Southbound trading, aligning it more closely with the accessibility of Northbound trading.

Bond investments, while generally considered stable, come with certain disadvantages. One key risk is the potential for price fluctuations due to changes in prevailing interest rates; when interest rates rise, the value of existing bonds may decrease. Another consideration is the risk of inflation eroding the real return on the investment, especially with fixed-interest bonds. Liquidity can also be a concern, as some bonds may not have an active secondary market, making it difficult to sell them quickly. Furthermore, bondholders do not participate in company profits or have voting rights, and there is always a possibility of default by the issuer. Finally, sophisticated trading techniques may be involved, which could be challenging for some investors.

Considering these factors, the absence of participation in company profits is a notable disadvantage of bond investments. Unlike equity holders, bondholders do not share in the financial success of the issuing company beyond the fixed interest payments.

A call option grants the holder the right, but not the obligation, to purchase an underlying asset at a predetermined price within a specific timeframe. Understanding this distinction between right and obligation is crucial. The holder benefits from price increases but isn’t forced to buy if the price decreases. This concept is fundamental in options trading and risk management, and its implications should be carefully considered in various investment scenarios. The other options do not correctly define the nature of a call option.

The Securities and Futures Ordinance (SFO) in Hong Kong mandates that any person or entity carrying on a business in regulated activities must be licensed or registered. This includes dealing in securities, advising on securities, and asset management. The Insurance Companies Ordinance regulates insurance intermediaries. Selling investment-linked assurance schemes (ILAS) requires licensing under both the SFO and registration/authorization under the Insurance Companies Ordinance. Therefore, only dealing in securities requires licensing under the SFO. Advising on real estate investments does not fall under the SFO’s regulatory scope. Therefore, statement I is correct.

The Guidance Note on Client Agreement for Linked Long Term Insurance Business (CIB-GN(9)) emphasizes the importance of clearly outlining the rights and obligations of both the insurer and the policyholder. This includes detailing the investment choices available, associated risks, and how the policy’s value is determined. Transparency in these aspects is crucial for ensuring that clients understand the nature of their investment and can make informed decisions. The client agreement should also address the procedures for handling complaints and resolving disputes, providing a mechanism for addressing any issues that may arise during the policy’s term. It is essential that the agreement is written in plain language, avoiding technical jargon that could confuse the client. This promotes understanding and reduces the likelihood of misunderstandings or disputes. Therefore, the client agreement serves as a vital document for protecting both the insurer and the policyholder, fostering trust and confidence in the linked long-term insurance business.