ILAS: Financial Weapon of Mass Desctruction

To Mr. Stephen Tisdall and the SFC:

Thanks for your lengthy reply, and I apologize for my delayed response. I got carried away with other ILAS-related business, which was referred to in the South China Morning Post on Monday:

Insurance Product Faces Gloomy Future

Investment-Linked Insurance Schemes a Trap for Unwary Investors

Insurance Activist Lai Yan-cheong: Sales Tactics Are Wrong

In case you didn’t already see it, SCMP also recently mentioned your prior response to me:

SFC Rejects Head Accusation

I followed your suggestion and read the SFC’s 13 August 2009 circular, and unfortunately, this document reaffirmed my conviction that the SFC’s head is placed firmly where I said it was.

In particular, I am referring to the following paragraph:

ILAS are first and foremost insurance policies providing the policyholder with life cover, but which have an additional investment element. Life cover, as distinct from investment, would appear to be the dominant factor motivating a policyholder to acquire an ILAS product because there are many pure investment products on the market which tend to have lower initial charges, are more negotiable than ILAS and do not give rise to the same penalties for early termination. These types of products would appear to be more suitable for, and attractive to, those who are principally concerned with investment and are unconcerned with the acquisition of life cover. Accordingly, although the value of an ILAS policy is usually determined by reference to fluctuations in the value of the underlying funds that are selected by the policyholder, it cannot be said that the purpose of acquiring an ILAS policy, or even the dominant purpose of doing so, is to secure a profit from fluctuations in the value of the underlying funds. The SFC therefore considers that promoting, offering or selling ILAS to the public does not constitute dealing in securities within the meaning of paragraph (b) of the SFO definition of that expression.”

The parts I’ve underlined are unquestionably false. The only possible reason for acquiring most ILAS policies is to “secure a profit from fluctuations in the value of the underlying funds”, not to get “life cover”. The so-called 1% insurance protection typical of most ILAS policies is only enough to qualify as an insignificant partial refund of the annual management fees. I’ll illustrate with an example: My girlfriend has contributed $13,000 to an ILAS policy. Nearly all of that money was indirectly paid as commission to the broker. That $13,000 can only be recovered by her family if she dies. Her fictional account value is subject to a $720 annual policy fee and a 6% annual administration charge. In total, the annual fees add up to 11.5%, which is 11.5 times higher than the 1% “protection” in the event of death. If one cuts through all the complexity and obfuscation, one will see that my girlfriend has already paid nearly $13,000 in fees, yet her family will only receive a so-called “death benefit” of $130 if she dies. In other words, she paid $13,000 for $130 of life coverage. If “ILAS are first and foremost insurance policies providing the policyholder with life cover”, then ILAS is a scam and the SFC shouldn’t have authorized any of them.

But of course, everyone knows that ILAS are not “first and foremost insurance policies”. One can simply browse through the websites of companies selling ILAS to read about the real purpose of ILAS. According to Sun Hung Kai Financial’s website, “Unit-linked products are a kind of insurance plans but they are different from traditional life policies. They emphasis on providing investment returns rather than protection.” But according to the SFC, “it cannot be said that the purpose of acquiring an ILAS policy, or even the dominant purpose of doing so, is to secure a profit from fluctuations in the value of the underlying funds”. Everyone in the industry is saying one thing, and only the SFC is saying the opposite. Why? Did no one at the SFC even bother to read the names of the ILAS products it authorized? Here’s a list of some of the juiciest one:

The Executive Wealthbuilder Account

Fortune

FORTUNE Builder

Harvest Wealth Investment Plan

Wealth Regular Investment Savings Plan

International Investment Account

International Wealth Account

Manulife Wealth Creator

Premier Investment Plan

PRUlink smart wealth builder

PRUsaver Investment Plan

Rainbow Investor

Rainbow WealthMaster

SunWealth

SUPRA Savings and Investment Plan

SwissInvestor

SwissWealth

Treasure Accumulator

Uniflex Investment

“Wealth Accumulator” Plus

Wealth Amplifier Investment Plan

Wealth Builder

Wealth Express Invest Plan

Wealth Plus Invest Plan

Wealthmaster Plan

The primary purpose of these products is clearly indicated in their names: to profit from an investment in the underlying funds. Yet the SFC pretends to be oblivious to the obvious. I think it’s completely fair to say that the SFC has its head up its ass.

Mr. Tisdall, you have suggested that the only way the SFC could regulate the sale of ILAS is if there were a change in the laws. It’s not so clear to me that this is the case. Perhaps the SFC just needs to correct a misinterpretation of the laws. Contrary to the comments in the 2009 circular, the sale of ILAS seems to fall within the legal definition of dealing in securities, which is as follows: “making or offering to make an agreement with another person…the purpose or pretended purpose of which is to secure a profit to any of the parties from the yield of securities or by reference to fluctuations in the value of securities”. The only point which isn’t clear is the exclusion in sub-paragraph (xi) of that definition, which says that a person is not dealing in securities if that person issues an advertisement, invitation, or document authorized under section 105. I’ve looked at section 105, which points to section 103, and my understanding of these sections is that the sales materials of all investment products, not just ILAS, are authorized under section 105. So if the sale of ILAS is not “dealing in securities”, then neither is the sale of mutual funds. But the sale of mutual funds is “dealing in securities”, so why wouldn’t the sale of ILAS also be considered “dealing in securities”? Can you please clarify? Have I overlooked something?

If it’s the case that the sale of ILAS is in fact “dealing in securities”, and the companies selling it are not complying with SFC regulation, could they be held legally accountable for their non-compliance? If so, I am interested in knowing whether their non-compliance could be grounds for recovering the money of thousands of ILAS victims. I would be grateful for any thoughts you have on this matter.

Myself and others have been in contact with the offices of several members of the Legislative Council. There’s a meeting scheduled next week with one LegCo member to discuss possible legislative changes concerning ILAS. I would like to get your opinion about which parts of the law need to be changed to bring ILAS exclusively under SFC regulation. As you hinted in your email, the Insurance Authority has done a terrible job regulating ILAS. I agree, and I think it deserves to be stripped of that responsibility. It would be much better if ILAS were regulated solely by the SFC and if it were regulated just as strictly, if not more strictly, than other investment products. If I could have my way, ILAS would be banned, as well as the entire commission-based sales model, but short of that, I think bringing ILAS under SFC regulation is the least bad alternative.

I am cc-ing this email to other regulators and multiple news organizations. I am also posting it at TheRapeOfHongKong.com. It would be great if you could give a public response addressing the issues I have raised.

Thanks for your time,

Lindell Lucy

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Dear Mr. Lucy,
 
Your e-mail of 26 July 2013 addressed to the “SFC and OCI” (attached below) has been drawn to my attention.  I am not in a position to comment on all of the matters raised by you in your e-mail for reasons that will be clear to you after you have read this response.  However, there are two sentences in your e-mail which particularly caught my attention and in respect of which I am able to respond.  Indeed, I feel that I should do so in order to correct your apparent misunderstanding concerning the issue of the supervision of the conduct of insurance intermediaries who carry on ILAS business in Hong Kong.
 
The two sentences to which I refer are the following:
 
With all due respect, the SFC needs to pull its head out of its ass.  Does putting an insurance wrapper around securities magically transform them into something other than securities?
 
With respect to the first sentence, I am relieved to be able to advise you that the SFC’s head is not located in the particular part of its anatomy to which you referred.  With respect to the question posed in the second sentence, the answer is “yes”, although I should add that there is no need for any type of magical intervention because the legal position in respect of this matter is very clear.  I am sure that you will appreciate that a regulator, such as the SFC, may only act in accordance with the law governing it, and pursuant to the powers conferred on it, and that it simply cannot pretend that ILAS are securities when Hong Kong law expressly provides that they are not.
 
The SFC issued a circular [http://www.sfc.hk/edistributionWeb/gateway/EN/circular/intermediaries/licensing/openFile?refNo=H557] on 13 August 2009, which principally dealt with the issue of whether intermediaries conducting ILAS business in Hong Kong are required or permitted to be licensed by the SFC under the Securities and Futures Ordinance (SFO).  I invite you to read the circular because it clarifies, in a reasonably straightforward manner, the issues that lie at the heart of the question that you posed in the second sentence to which I referred above.   As you will observe from the SFC’s circular, interests in ILAS were expressly excluded from the definition of “securities” when the SFO was enacted.  This means that under Hong Kong law, ILAS are not securities.  Instead, they fall within the meaning of class C linked long term insurance business under the Insurance Companies Ordinance (ICO).  Accordingly, intermediaries selling ILAS cannot be regarded as “dealing in securities” under the SFO.  Rather, they are selling contracts of insurance, which obviously requires that ultimately they be regulated by the Insurance Authority under the ICO.
 
As I presume you know, ILAS have “underlying investments”, the performance of which determines the value of an ILAS policy from time to time.  However, these “underlying investments” (which are usually funds and therefore are securities) exist in a notional sense only, with ILAS policyholders acquiring no interest in them whatsoever.  As you will observe from the SFC’s circular of 13 August 2009, insurance intermediaries who advise their clients concerning their choice of the “underlying” securities of ILAS are not advising on securities under Hong Kong law.  Stated simply, “advising on securites” under the SFO involves advising a person in relation to his/her acquisition or disposal of those particular securities.  Because ILAS policyholders never acquire any interest in the “underlying” securities of ILAS policies, they cannot be advised in relation to the acquisition or disposal by them of those “underlying” securities.  Under Hong Kong law, it is therefore clear that this type of business, and those conducting it, are not regulated by the SFC under the SFO because the intermediaries in question are not conducting the business of “advising on securities”, as defined under the SFO.  As I have already mentioned, they will also not be regarded as “dealing in securities” within the meaning of the SFO.
 
In your e-mail, you demanded to know whether the SFC and the OCI purposely designed a “regulatory loophole” with the intention that it be highly profitable to the insurance industry.  It is not clear what you meant when you referred to a “regulatory loophole”.  I assume, however, that you were referring to the situation which exists under Hong Kong law of the SFC not regulating insurance intermediaries conducting ILAS business.  In response to your demands, I advise, first, that there is in fact no regulatory loophole and, secondly, that neither the SFC nor the OCI created the separate regulatory regimes which they are respectively required by statute to administer.
 
With reference to the second of these matters, the SFC is a statutory corporation and is not a Bureau or Department of the Hong Kong Government.  The SFC largely operates independently of the Hong Kong Government.  The provisions of the SFO reflect the policy decisions of the Hong Kong Government, as enacted into law by the Legislative Council.  It is the responsibility of the SFC to apply the provisions of the SFO in accordance with the powers conferred on it under the SFO.  For the reasons stated in the SFC’s circular of 13 August 2009, the SFC does not have the power to license insurance intermediaries conducting ILAS business.  It necessarily follows from this that the SFC is not empowered to supervise or discipline these intermediaries in relation to the conduct by them of this type of business.
 
The statutory provisions governing these matters were deliberately designed to have the effects that are referred to in the SFC’s circular and elaborated in this e-mail.  The architecture of the regimes under which the SFC and the Insurance Authority perform their respective functions was deliberately conceived by the Hong Kong Government and made law under the ICO and the SFO.  The SFC and the Insurance Authority do not make the law.  However, they are obliged to comply with their separate statutory obligations and are restricted from performing regulatory functions unless they are legally empowered to do so.  The architecture to which I have referred was designed specifically to require insurance intermediaries conducting ILAS business to be regulated by the Insurance Authority under the ICO, and to exclude the SFC from having any powers to license, supervise or discipline these intermediaries in relation to the conduct by them of these activitities.  Your expression “regulatory loophole” suggests an unintended flaw in the regulatory architecture, which allows things to happen that should not be permitted.  There is no loophole of this type because a regulatory regime governing insurance intermediaries conducting ILAS business has specifically been put in place under the ICO.  Any questions you might have concerning the manner in which the resulting powers have been exercised under the ICO is a separate matter which the Insurance Authority would have to address and in respect of which it would not be appropriate for the SFC to comment.
 
I hope that this e-mail will be of assistance to you and trust that it will now be clear to you that the SFC does not have the power to regulate the conduct of insurance intermediaries carrying on ILAS business.  By design, the ICO and the SFO were formulated to define regulatory responsibility in this area, with such responsibility having been deliberately conferred on the Insurance Authority.     
 
Regards,
 
Stephen Tisdall
Senior Director | Intermediaries Licensing and Conduct
Securities and Futures Commission

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