Paper 5 Investment-linked Long Term Insurance Quiz 05

The Insurance Ordinance (Cap. 41) is the primary legislation governing the insurance industry in Hong Kong. It was formerly known as the Insurance Companies Ordinance and was renamed with relevant amendments in 2017. This ordinance establishes the framework for regulating insurance business, protecting policyholders, and promoting the stable development of the industry. The Insurance Authority is the independent regulator established under this ordinance. While other bodies like the Hong Kong Federation of Insurers play a role, the Ordinance itself is the foundational legal document.

The question tests the understanding of how changes in non-price factors affect the equilibrium in a market, specifically focusing on the demand side. An increase in general income for a society typically leads to an increased demand for normal goods. In the context of the provided text, an increase in general income of a society leads to an increase in the quantity demanded of oranges at each price level, causing the demand curve to shift to the right. This rightward shift in demand, with an unchanged supply curve, results in both a higher equilibrium price and a higher equilibrium quantity. Option (a) correctly identifies this outcome. Option (b) is incorrect because a decrease in demand would lead to a lower equilibrium price and quantity. Option (c) is incorrect because while a shift in supply could affect equilibrium, the scenario specifically points to a change in income, which directly impacts demand. Option (d) is incorrect because an increase in demand, assuming a normal supply curve, will lead to an increase in both price and quantity, not a decrease in price and an increase in quantity.

The question tests the understanding of the convexity of the price-yield relationship for bonds, a key concept in fixed income analysis. Convexity implies that the price appreciation from a decrease in yield is greater than the price depreciation from an equal increase in yield. This is because as yields fall, the present value of future cash flows increases at an accelerating rate, and as yields rise, the present value decreases at a decelerating rate. The provided table and graph illustrate this phenomenon, showing that a 2% decrease in yield from 8% to 6% results in a larger price increase (from $1,000.00 to $1,231.19, a gain of $231.19) than a 2% increase in yield from 8% to 10% results in a price decrease (from $1,000.00 to $828.36, a loss of $171.64). Option (a) accurately describes this asymmetric response. Option (b) is incorrect because it suggests an equal magnitude of change, which contradicts the concept of convexity. Option (c) is incorrect as it describes a linear relationship, which is only an approximation for very small yield changes and ignores the inherent convexity. Option (d) is incorrect because it suggests that price changes are solely dependent on the coupon rate and not the market yield’s impact on the present value of those cash flows, and it also mischaracterizes the nature of the relationship as being solely about the coupon rate’s influence on discount versus premium.

This question tests the understanding of the payoff structure for option buyers and writers, a core concept in investment-linked insurance products. For an option buyer, the maximum loss is indeed limited to the premium paid. This is because the premium is the upfront cost to acquire the right, and if the option expires worthless, the buyer forfeits only this premium. Conversely, the potential profit for a call option buyer can be theoretically unlimited as the underlying asset’s price can rise indefinitely. For the option writer, the situation is reversed: their gain is capped at the premium received, but their potential loss can be unlimited, especially for uncovered call options, as the underlying asset’s price could rise significantly. The scenario presented in the provided text about Cheung Kong Holdings illustrates this asymmetrical payoff. Option (b) incorrectly states that both buyer and writer have unlimited potential loss. Option (c) is incorrect because while a buyer’s loss is limited, their gain is not necessarily limited to the premium. Option (d) is incorrect as it reverses the roles of limited gain and unlimited loss for both parties.

The question tests the understanding of how changes in non-price factors affect the equilibrium in a market, specifically focusing on the demand side. An increase in general income for a society typically leads to an increased demand for normal goods. In the context of the provided text, an increase in general income is cited as an example of a factor that shifts the demand curve for oranges to the right. A rightward shift in the demand curve, with an unchanged supply curve, results in both a higher equilibrium price and a higher equilibrium quantity. The other options describe scenarios that would either shift the supply curve (e.g., changes in production costs, technology) or have a different impact on equilibrium price and quantity (e.g., a decrease in demand leading to lower price and quantity, or a supply shift leading to a price increase and quantity decrease).

This question tests the understanding of the relative risk and return characteristics of different money market instruments, as outlined in the provided text. Government Bills, such as US Treasury Bills and Hong Kong Exchange Fund Bills, are considered virtually default-risk free due to the backing of the government. Consequently, they offer the lowest yields among similar instruments. Short-term Certificates of Deposit (CDs) are issued by commercial banks, which carry a higher default risk than governments, leading to higher yields than government bills. Commercial Papers (CPs) are unsecured promissory notes issued by corporations and, while typically offering higher returns than government bills and CDs, reflect a higher liquidity risk and default risk compared to government-issued securities. Therefore, the statement that government bills offer the lowest yield due to their minimal default risk is accurate.

The Illustration Document for Investment-linked Policies (Version 2) mandates that illustrations must clearly distinguish between guaranteed and non-guaranteed benefits. This is crucial for policyholders to understand the potential range of outcomes and the assumptions underlying the projected values. Non-guaranteed benefits are subject to market performance and the insurer’s investment strategy, and therefore, their illustration requires explicit labeling to avoid misinterpretation. The document also emphasizes the importance of providing a realistic projection of returns, avoiding overly optimistic scenarios, and ensuring that all charges and fees are transparently disclosed. The Regulations for Insurance Brokers (CIB) further reinforce the broker’s responsibility to provide clear and accurate information to clients, aligning with the principles of fair dealing and client protection.

The CIB’s Code of Conduct mandates that its members prioritize client interests above all other considerations, subject to satisfying their insurance requirements. This principle is fundamental to ethical broking. While integrity and avoiding misleading statements are also crucial, the core duty in advising clients, especially on complex products like ILAS, is to place the client’s needs first. The ILAS Regulations specifically reinforce this by requiring thorough ‘know your client’ procedures and risk disclosures, all aimed at ensuring the client’s best interests are served.

The Cooling-off Period is a statutory right granted to policyholders to review their insurance policy after issuance and cancel it if they are not satisfied, receiving a refund of premiums paid, subject to certain deductions. The Hong Kong Federation of Insurers (HKFI) provides specific guidelines to ensure this right is clearly communicated. According to these guidelines, the announcement of cooling-off rights must be included on the application form immediately above the signature space. The printing size of this statement should be no smaller than other declarations on the form, with a minimum font size of 8. Furthermore, this announcement must be in the same language(s) as the rest of the application form. Option (a) correctly reflects these requirements. Option (b) is incorrect because while policy delivery is important, the primary location for the initial announcement of cooling-off rights on the application form is above the signature, not on the policy jacket itself (which is for post-issue reminders). Option (c) is incorrect as the minimum font size for the application form statement is 8, not 10 (which applies to policy issue communications). Option (d) is incorrect because the statement must be on the application form itself, not in a separate brochure provided at the time of application.

The question tests the understanding of the regulatory framework governing investment-linked insurance products in Hong Kong, specifically the role of the Securities and Futures Commission (SFC) and the Insurance Authority (IA). Investment-linked insurance policies involve both investment and insurance components. The SFC regulates the investment aspect, ensuring that the investment products offered are compliant with securities laws and that intermediaries are licensed to deal in securities. The IA regulates the insurance aspect, ensuring the solvency and conduct of insurers. Therefore, for an investment-linked insurance product to be legally offered, it must comply with the regulations of both authorities. Option (b) is incorrect because while the IA is crucial for the insurance component, it does not directly regulate the investment products themselves. Option (c) is incorrect because the Hong Kong Monetary Authority (HKMA) primarily regulates banks and monetary policy, not investment-linked insurance products. Option (d) is incorrect because the Mandatory Provident Fund Schemes Authority (MPFSA) regulates the Mandatory Provident Fund schemes, which are distinct from general investment-linked insurance policies.

This question tests the understanding of the primary and secondary debt markets, specifically focusing on the characteristics of the over-the-counter (OTC) market. The primary market is where new securities are issued, while the secondary market is for trading existing securities. The OTC market is a decentralized network of brokers and dealers where trade specifications are negotiated, making it less standardized than an exchange. Exchange Fund Notes (EFNs) are government-issued debt securities in Hong Kong. While EFNs can be listed on the Stock Exchange of Hong Kong (an exchange market), their trading predominantly occurs in the OTC market, which is characterized by negotiated terms rather than standardized contracts. Therefore, the statement that EFNs are predominantly traded in an informal network of brokers and dealers where trade specifications are negotiated accurately describes their secondary market trading environment.

The question tests the understanding of the regulatory framework governing investment-linked insurance products in Hong Kong, specifically the role of the Securities and Futures Commission (SFC) and the Insurance Authority (IA). Investment-linked insurance policies are dual-regulated products. The SFC regulates the investment component, ensuring compliance with securities laws, while the IA regulates the insurance component, ensuring solvency and consumer protection in insurance matters. Therefore, both authorities have oversight. Option (b) is incorrect because while the IA is primarily responsible for insurance, the investment aspect falls under SFC purview. Option (c) is incorrect as the SFC’s role is crucial for the investment component, and excluding it would be a regulatory gap. Option (d) is incorrect because while the Financial Secretary has ultimate authority, the day-to-day regulation and enforcement are delegated to the SFC and IA.

The question tests the understanding of how international capital flows can impact a domestic economy, specifically in the context of investment-linked insurance products. The scenario describes a situation where a country with high savings and low investment opportunities attracts capital from countries with the opposite characteristics. This inflow of capital can lead to increased investment in financial markets, potentially boosting the performance of investment-linked products. The correct answer highlights this mechanism. Option B is incorrect because while diversification is a benefit, the primary impact described is the flow of capital itself. Option C is incorrect as it focuses on the negative aspect of contagion, which is not the primary mechanism at play in the scenario of attracting capital for investment. Option D is incorrect because it misinterprets the role of intermediaries; while they are compensated, the core concept is the flow of capital to fill investment gaps.

The question tests the understanding of the regulatory framework governing investment-linked insurance products in Hong Kong, specifically the role of the Insurance Authority (IA) and the relevant legislation. The Insurance Companies Ordinance (Cap. 41) is the primary legislation that governs the conduct of insurance business in Hong Kong, including the sale and distribution of investment-linked products. The IA, established under this ordinance, is responsible for its enforcement and for ensuring the stability and integrity of the insurance market. While other bodies like the Securities and Futures Commission (SFC) regulate investment products, the IA has the overarching authority for insurance products, including those with an investment component. The Mandatory Provident Fund Schemes Authority (MPFA) regulates MPF schemes, and the Hong Kong Monetary Authority (HKMA) regulates banks. Therefore, the IA and the Insurance Companies Ordinance are the most directly relevant regulatory entities and legislation for investment-linked insurance products.

The Insurance Ordinance (Cap. 41) is the primary legislation governing the insurance industry in Hong Kong. It was formerly known as the Insurance Companies Ordinance and was renamed with relevant amendments coming into effect on June 26, 2017. This ordinance establishes the regulatory framework for insurance business, aiming to protect policyholders and promote the stable development of the industry. The Insurance Authority is the independent regulator established under this ordinance. While the Hong Kong Federation of Insurers plays a role in agent registration and handling complaints, it is not the overarching legislation itself. An Initial Public Offering (IPO) is a capital markets event and not directly part of the insurance regulatory framework.

This question tests the understanding of how monthly premiums are applied in an investment-linked insurance policy, specifically focusing on the deduction of charges and the subsequent investment of the remaining premium. The provided text outlines that monthly premiums are converted into investment units, and then sufficient units are cancelled to cover monthly charges. The calculation for units purchased per month is the monthly premium divided by the offer price. In the given example, the monthly premium is HKD500 and the offer price is HKD12.60. Therefore, the number of units purchased is HKD500 / HKD12.60 = 39.68 units. The other options represent incorrect calculations, such as using the bid price, dividing by the annual premium, or misinterpreting the role of charges in the initial unit purchase.

The question probes the understanding of common unprofessional practices in the life insurance business, as outlined in the IIQE Paper 5 syllabus. Twisting involves inducing a policyholder to lapse or surrender an existing policy to purchase a new one, often to the detriment of the policyholder and for the agent’s benefit. Misrepresentation involves providing false or misleading information about a policy’s terms, benefits, or risks. Rebating involves offering an inducement (like a portion of the commission) to a policyholder to purchase a policy. Receiving commission is a standard and legitimate part of an insurance agent’s compensation and is not considered an unprofessional practice in itself. Therefore, twisting, misrepresentation, and rebating are the unprofessional practices that must be avoided.

The Illustration Document for Investment-linked Policies (Version 1) from the SFC provides guidance on the information that should be presented to potential investors. It emphasizes clarity and comprehensiveness, particularly regarding the investment component. Option (a) correctly identifies that the document mandates the inclusion of details about the underlying investment funds, including their investment objectives, strategies, and associated risks. This is crucial for investors to make informed decisions. Option (b) is incorrect because while fees are important, the Illustration Document’s primary focus is on the investment aspect and its implications, not solely on a comprehensive fee breakdown which might be covered elsewhere. Option (c) is incorrect as the document is about illustrating the potential outcomes of the investment component, not about providing a historical performance record of the insurer’s overall financial health, which is a separate disclosure. Option (d) is incorrect because while the document aims to illustrate potential outcomes, it does not guarantee specific returns or provide a fixed projection; it focuses on illustrating the *impact* of investment performance on policy values, acknowledging variability.

This question tests the understanding of the fundamental characteristics and benefits of various investment vehicles, specifically within the context of investment-linked insurance policies. The question asks to identify which option is NOT a benefit of investing in investment funds. Affordability is a key benefit as funds allow smaller investors to access a diversified portfolio. Convenience is another major advantage, as fund managers handle the selection and management of underlying assets. Diversification is a primary purpose of investment funds, spreading risk across multiple securities. A bank guarantee, however, is not an inherent feature or benefit of investment funds. While some funds might invest in instruments that are bank-guaranteed, the fund itself does not typically come with a direct bank guarantee on the investment’s principal or returns. This distinguishes it from certain bank products like time deposits or certificates of deposit.

The question tests the understanding of fundamental investment analysis approaches, specifically the distinction between top-down and bottom-up analysis. A top-down approach begins with broad macroeconomic factors and then narrows down to industries and specific companies. Conversely, a bottom-up approach focuses on individual company performance first, then considers its industry, and finally the broader economic context. The scenario describes an analyst starting with global economic trends and then identifying favorable industries, which is the hallmark of a top-down analysis. The other options describe elements of fundamental analysis but do not accurately represent the initial steps of the described approach.

This question tests the understanding of the inherent risks and characteristics of real estate as an investment, specifically in the context of Hong Kong’s market history. The period between 1991 and 1997 saw a significant property market boom, leading to multi-fold increases in prices. However, the subsequent burst of the bubble in 1997 resulted in a sharp decline of over 50% in property values within a short timeframe. This historical event vividly illustrates the high volatility and risk associated with real estate investments, particularly in markets prone to speculative bubbles. While real estate can offer capital appreciation, inflation hedging, and leverage, its susceptibility to dramatic price swings and market downturns is a significant disadvantage. The other options, while potentially true in certain contexts or for specific types of real estate, do not capture the most prominent and historically demonstrated disadvantage of real estate investment in Hong Kong as highlighted in the provided text.

The Shanghai-Hong Kong Stock Connect, launched on November 17, 2014, established a direct channel for mutual stock market access between Mainland China and Hong Kong. Initially, Southbound trading (investors in Hong Kong trading Mainland stocks) was restricted to Mainland institutional investors and eligible individual investors. Northbound trading (investors in Hong Kong trading Hong Kong stocks) was open to all Hong Kong and overseas investors. The relaxation on March 27, 2015, allowed fund managers to launch new publicly offered securities investment funds that invest in the Hong Kong stock market through the Stock Connect without needing QDII status. This indicates that the initial restrictions were primarily on the southbound flow of capital from Mainland China into Hong Kong, while northbound access for overseas investors was broader from the outset. The Mutual Recognition of Funds (MRF) initiative, signed in May 2015 and effective July 1, 2015, is a separate but related development that allows eligible Mainland and Hong Kong funds to be offered in each other’s markets through streamlined procedures, but it does not directly alter the initial trading restrictions of the Stock Connect itself.

The scenario describes a policyholder needing immediate funds and considering accessing their investment-linked policy. Option (a) correctly identifies partial surrender as the most appropriate method, as it allows access to funds by cashing in units without surrendering the entire policy or incurring loan interest. This aligns with the policy provision allowing withdrawals for a minimum amount, provided the remaining balance covers charges. Option (b) is incorrect because while a policy loan provides cash, it incurs interest, which is a disadvantage compared to partial withdrawal. Option (c) is incorrect because surrendering the policy means losing all future protection and benefits, which is a drastic measure for a temporary cash need. Option (d) is incorrect because while investment funds within the policy might offer professional management and diversification, this is a feature of the policy’s investment component, not a method for accessing cash. The question tests the understanding of the practical benefits and mechanisms of investment-linked policies, specifically regarding liquidity and accessing funds, as outlined in section 4.10 (e) of the syllabus.

This question tests the understanding of the regulatory framework governing investment-linked insurance products in Hong Kong, specifically the role of the Insurance Authority (IA) and the relevant legislation. The Insurance Companies Ordinance (Cap. 41) is the primary legislation that governs the conduct of insurance business in Hong Kong, including the sale of investment-linked products. The IA, established under the Insurance Companies Ordinance, is responsible for regulating and supervising the insurance industry. While the Securities and Futures Commission (SFC) regulates the securities and futures markets, the IA has primary responsibility for regulating insurance products, including those with an investment component. The Mandatory Provident Fund Schemes Authority (MPFSA) regulates the MPF system, which is distinct from general investment-linked insurance. Therefore, the Insurance Companies Ordinance provides the foundational legal framework for the sale and regulation of these products.

The question tests the understanding of the independence requirements for a trustee/custodian and a management company in the context of investment-linked long-term insurance, as governed by relevant regulations. The provided text states that a trustee/custodian must be independently audited and possess a minimum issued and paid-up capital, along with non-distributable capital reserves, of HKD10 million or its equivalent. This capital requirement is a fundamental aspect of ensuring the financial stability and operational integrity of the trustee/custodian, thereby safeguarding fund assets and investor interests. The other options present incorrect capital figures or focus on aspects not directly related to the minimum capital requirements for a trustee/custodian’s independence and operational capacity as stipulated.

This question tests the understanding of the regulatory framework governing investment-linked insurance products in Hong Kong, specifically the role of the Insurance Authority (IA) and the relevant legislation. The Insurance Companies Ordinance (Cap. 41) is the primary legislation that governs the conduct of insurance business in Hong Kong, including the authorization and regulation of insurance companies and intermediaries. The IA, established under the Insurance Companies Ordinance, is responsible for enforcing these regulations. Option (b) is incorrect because while the Securities and Futures Commission (SFC) regulates the securities and futures markets, its direct oversight of investment-linked insurance products is limited to the investment component and often involves collaboration with the IA. The Hong Kong Monetary Authority (HKMA) regulates banks and monetary policy, not insurance products directly. Option (c) is incorrect as the Mandatory Provident Fund Schemes Authority (MPFSA) regulates the MPF system, which is distinct from general investment-linked insurance. Option (d) is incorrect because while the Financial Services and the Treasury Bureau plays a policy-making role, the day-to-day regulation and enforcement are carried out by the IA.

The provided text highlights the convex nature of the price-yield relationship for bonds. Specifically, it states that ‘when market yield drops, the bond price will increase at an increasing rate and when market yield increases, the bond price will decrease at a decreasing rate.’ This phenomenon is directly related to the concept of convexity in bond pricing. Convexity measures the curvature of the price-yield relationship. A positive convexity means that as yields fall, prices rise more than they fall when yields rise by the same amount. This is because the bond’s price is more sensitive to decreases in yield than to increases in yield of the same magnitude. The table also implicitly supports this, showing a larger price increase for a 2% yield decrease (e.g., 8% to 6%) compared to a price decrease for a 2% yield increase (e.g., 8% to 10%). The other options misrepresent this relationship. Option 2 incorrectly suggests a linear relationship. Option 3 reverses the effect, stating prices decrease more when yields fall. Option 4 incorrectly claims the relationship is solely dependent on the coupon rate and ignores the impact of yield changes on price sensitivity.

The question tests the understanding of different types of investment funds, specifically focusing on their primary objectives. A ‘Growth Fund’ is defined as an investment fund that prioritizes capital appreciation over dividend income, investing in ‘growth stocks’. This aligns with the objective of maximizing capital gains. A ‘Fund of Funds’ invests in other funds, a ‘Global Fund’ invests internationally, and an ‘Income Fund’ focuses on generating regular income. Therefore, the fund aiming for maximum capital appreciation is the Growth Fund.

The Code of Conduct for Insurance Brokers Conducting Investment-Linked Business, as issued by PIBA, mandates that brokers must act in the best interests of their clients. This includes providing advice that is suitable for the client’s financial situation, investment objectives, and risk tolerance. When a broker recommends an investment-linked product, they must ensure that the product aligns with these client-specific factors. Misrepresenting the nature of the product, failing to disclose all relevant fees and charges, or pushing products that are not suitable for the client are all violations of this fundamental principle. Therefore, the primary ethical and regulatory obligation is to prioritize the client’s welfare and ensure product suitability.

The scenario describes a situation where a financial intermediary is recommending an Investment-Linked Assurance Scheme (ILAS) product. According to the Enhanced Requirements for ILAS sales, a Financial Needs Analysis (FNA) must be conducted before recommending any life insurance product and before the customer signs the application. The FNA is crucial for assessing the customer’s total protection needs, financial resources, and affordability, ensuring the recommended product aligns with their circumstances and willingness to pay premiums. The Risk Profile Questionnaire (RPQ) is also mandatory for ILAS products to assess investment risk appetite, but the FNA specifically addresses the broader financial needs and affordability. While the Important Facts Statement (IFS) and Applicant’s Declarations (AD) are required for all ILAS applications, they are post-recommendation documents that summarize product details and obtain customer consent, not the initial needs assessment. Therefore, the intermediary must first complete the FNA to understand the client’s financial situation and needs before proceeding with product recommendations and subsequent documentation.