Key Verification Points for Insurance Coverage in Sponsor Due Diligence

The SFC’s 2024 thematic inspection of sponsor work papers, detailed in its December 2024 circular (SFC/TH/2024/12), revealed that 40% of sampled IPO dossiers contained material gaps in the verification of insurance coverage for target assets and operational risks. This finding is not a footnote — it is a direct compliance exposure for every sponsor executing a Hong Kong listing under the Listing Rules. For a sponsor relying on the due diligence defence under section 213 of the Securities and Futures Ordinance (Cap. 571), an unverified insurance policy is a liability that can be used to demonstrate a lack of reasonable inquiry. The HKEX’s 2023 revision to Listing Decision LD143-2023 further clarified that sponsors must verify not merely the existence of a policy but its adequacy, scope, and enforceability against the risk profile disclosed in the prospectus. With the SFC now embedding insurance verification into its routine sponsor inspections, the margin for error has narrowed to zero. This article sets out the key verification points — from policy wording to claims history — that a sponsor must address to satisfy the SFC’s standard of care under the Code of Conduct for Persons Licensed by or Registered with the SFC (the Code), paragraph 17.6.

The Regulatory Framework for Insurance Verification in Sponsor Due Diligence

The sponsor’s obligation to verify insurance coverage arises from two converging regulatory streams: the SFC’s Code provisions on sponsor due diligence and the HKEX’s Listing Rules requirements for prospectus disclosure. Paragraph 17.6(b) of the Code requires a sponsor to take reasonable steps to satisfy itself that each material statement in the listing document is accurate and not misleading. Insurance coverage — whether it covers physical assets, product liability, directors’ and officers’ liability, or professional indemnity — is a material statement when it supports a risk factor, a business description, or a financial projection in the prospectus. The HKEX’s Guidance Letter HKEX-GL57-13 (updated July 2024) reinforces this by stating that sponsors must verify the factual basis for any statement about insurance coverage that an investor would reasonably rely upon in making an investment decision.

The SFC’s Standard of Care Under Paragraph 17.6

Paragraph 17.6 of the Code is the operative standard. It imposes a duty of “reasonable care” on the sponsor to ensure that the listing document does not contain any untrue statement. This is not a subjective standard — it is an objective one, measured against what a reasonably competent sponsor would have done in the circumstances. In practice, this means that a sponsor cannot simply accept a management representation that “the company has adequate insurance.” The SFC’s 2024 inspection findings identified that 35% of sampled sponsors had accepted such representations without independent verification, a practice the SFC described as “inconsistent with the standard of care expected of a sponsor.”

The verification process must include: (a) obtaining the actual insurance policies for all material coverage; (b) reviewing the policy wording for exclusions, sub-limits, and conditions precedent; (c) confirming the policy is in force at the time of listing; and (d) assessing whether the coverage limits are commensurate with the risks disclosed in the prospectus. The SFC’s December 2024 circular explicitly states that a sponsor should not rely solely on a certificate of insurance, as certificates often omit critical terms such as deductibles, aggregate limits, and territorial scope.

The HKEX’s Disclosure Requirements Under the Listing Rules

The HKEX’s Listing Rules do not contain a standalone rule on insurance verification, but the requirement flows from the general disclosure obligation under Main Board Rule 11.07 and GEM Rule 14.08, which require a listing document to contain “full, accurate and complete” disclosure of all material facts. Insurance coverage becomes a material fact when it is referenced in the risk factors section, the business description, or the financial statements. For example, if a prospectus states that the company’s manufacturing facilities are insured against fire and business interruption, the sponsor must verify that the policy covers the specific facilities named, that the sum insured is sufficient to cover the replacement cost, and that the policy does not exclude the specific perils that are most likely to affect the business.

The HKEX’s Listing Decision LD143-2023 provides a concrete example. In that decision, the Exchange rejected a listing application because the sponsor had not verified that the applicant’s product liability insurance covered claims arising from defects in products sold into the European Union, a market that accounted for 60% of the applicant’s revenue. The sponsor had accepted a certificate of insurance that stated “worldwide coverage” but had not reviewed the policy wording, which contained an exclusion for claims arising from non-compliance with EU product safety directives. The Exchange held that the sponsor had failed to exercise reasonable care under paragraph 17.6 of the Code.

Key Verification Points: Policy Wording, Coverage Limits, and Exclusions

The core of insurance verification lies in the policy document itself. A sponsor must move beyond the certificate of insurance and examine the full policy wording, including the schedule, the insuring clauses, the exclusions, the conditions, and the definitions. Each of these sections can contain traps that render the coverage illusory for the specific risk the prospectus describes.

Verification of Policy Wording and Scope of Coverage

The first verification point is the scope of coverage. The sponsor must confirm that the policy insures the correct legal entity, the correct location, and the correct activity. For a Hong Kong listing applicant that operates through multiple subsidiaries in the PRC, the sponsor must verify that each material subsidiary is named as an insured under the policy. A common problem is a policy that names only the parent company, leaving subsidiaries uninsured for their own operations. The SFC’s 2024 inspection found that 25% of sampled policies had a mismatch between the named insured and the entities disclosed in the prospectus.

The sponsor should also verify the policy’s territorial scope. Many policies limit coverage to specific geographic regions, such as “Hong Kong and Macau” or “Asia excluding Japan.” If the prospectus discloses that the company exports to Europe or North America, the sponsor must confirm that the policy covers claims arising from those jurisdictions. The HKEX’s LD143-2023 decision is directly on point: a policy that excludes the jurisdiction where the company generates material revenue is not adequate coverage.

Verification of Coverage Limits and Deductibles

The second verification point is the adequacy of coverage limits. The sponsor must assess whether the sum insured is sufficient to cover the maximum probable loss for the insured risk. This is not a task for the sponsor alone — it typically requires input from the applicant’s internal risk management team or an external insurance broker. The sponsor should obtain a written confirmation from the applicant’s insurance broker that the coverage limits are consistent with industry benchmarks for the applicant’s sector and size. The SFC’s December 2024 circular states that a sponsor should document the basis for its conclusion on adequacy, including any benchmarking data or broker opinions.

Deductibles are equally important. A policy with a high deductible may effectively leave the applicant uninsured for smaller but frequent claims. If the prospectus states that the company is “fully insured” for a particular risk, but the policy carries a deductible equal to 10% of the company’s annual net profit, that statement may be misleading. The sponsor must verify that the deductible is disclosed in the risk factors section and that it does not materially affect the company’s financial position.

Verification of Exclusions and Conditions Precedent

The third verification point is the list of exclusions. Exclusions can gut a policy of its practical value. The sponsor must review each exclusion and assess whether it applies to the risks that the prospectus describes. For example, a property insurance policy may exclude “flood” or “earthquake” — if the applicant’s principal manufacturing facility is located in a flood-prone area, the exclusion makes the coverage illusory. The sponsor should obtain a written representation from the applicant’s management that no exclusion applies to the material risks disclosed in the prospectus, and the sponsor should cross-check that representation against the policy wording.

Conditions precedent to coverage are another trap. Some policies require the insured to take specific actions — such as installing fire suppression systems or conducting regular safety inspections — before coverage attaches. If the applicant has not complied with these conditions, the policy may be voidable. The sponsor should verify compliance with all conditions precedent by reviewing inspection reports, maintenance logs, and other documentary evidence.

Verification of Claims History and Policy Continuity

Insurance verification is not a static exercise — it must account for the applicant’s claims history and the continuity of coverage. A policy that is in force today may be cancelled tomorrow, and a history of claims can affect the enforceability of future claims.

Verification of Claims History

The sponsor should request a claims history report from the applicant’s insurance broker for the past three to five years. This report should list all claims made under the policy, the amounts paid or reserved, and the status of each claim (settled, pending, or denied). The sponsor must assess whether the claims history indicates a pattern of underinsurance or coverage gaps. For example, if the applicant has made multiple claims for product liability but the policy limit has never been increased, the coverage may be inadequate for the current risk profile.

The SFC’s 2024 inspection found that 30% of sampled sponsors had not reviewed claims history at all, relying instead on management representations that “no material claims have been made.” This is a compliance gap. The sponsor should also verify that the applicant has not been the subject of a policy cancellation or non-renewal due to claims frequency or severity. A history of cancelled policies is a red flag that the applicant may be uninsurable on standard terms, which is a material fact that must be disclosed in the prospectus.

Verification of Policy Continuity and Renewal

The sponsor must confirm that the policy will remain in force for a reasonable period after listing. The HKEX’s Guidance Letter GL57-13 states that a sponsor should verify that the applicant has a “reasonable expectation” that its insurance coverage will be renewed on substantially similar terms. This requires the sponsor to review the policy’s renewal date, the notice period for cancellation, and any conditions that could lead to non-renewal.

If the policy is due to expire within 12 months of the listing date, the sponsor should obtain a written confirmation from the insurer that it intends to renew the policy on similar terms. If the insurer is unwilling to provide such a confirmation, the sponsor should consider whether the risk of non-renewal is a material fact that must be disclosed in the prospectus. The SFC’s December 2024 circular specifically warns sponsors not to assume that a policy will be renewed automatically, as insurers are under no obligation to renew.

Verification of Insurer Solvency and Regulatory Status

The final verification point is the financial strength and regulatory status of the insurer. A policy is only as good as the insurer’s ability to pay claims. If the insurer is insolvent or unlicensed, the coverage may be worthless.

Verification of Insurer Solvency

The sponsor should obtain the insurer’s latest financial statements, including its solvency ratio, from a recognised credit rating agency or the insurer’s regulator. For insurers authorised in Hong Kong, the sponsor can check the Insurance Authority’s register of authorised insurers and review the insurer’s solvency margin, which must be maintained at a minimum of 200% of the required margin under the Insurance Ordinance (Cap. 41), section 41. For offshore insurers, the sponsor should obtain a solvency certificate from the insurer’s home regulator.

The sponsor should also check the insurer’s credit rating from Moody’s, S&P, or Fitch. A rating below investment grade (BBB- or equivalent) should trigger additional scrutiny. The SFC’s 2024 inspection found that 15% of sampled sponsors had not verified the insurer’s solvency at all, a practice the SFC described as “a serious deficiency in due diligence.”

Verification of Insurer Regulatory Status

The sponsor must confirm that the insurer is licensed to write the class of insurance in the jurisdiction where the risk is located. For a Hong Kong listing applicant with operations in the PRC, the sponsor must verify that the insurer is authorised by the National Financial Regulatory Administration (NFRA) to write insurance in the PRC. If the insurer is not licensed in the PRC, the policy may be unenforceable under PRC law, and the coverage is illusory.

The sponsor should also check whether the insurer is subject to any regulatory sanctions, enforcement actions, or insolvency proceedings. The SFC’s December 2024 circular states that a sponsor should conduct a public records search for any adverse regulatory findings against the insurer. This can be done through the Insurance Authority’s enforcement database or through a commercial database such as LexisNexis.

Verification of Reinsurance Arrangements

For large risks, the insurer may have ceded part of the coverage to a reinsurer. The sponsor should request a summary of the reinsurance arrangements and verify that the reinsurer is licensed and solvent. If the insurer’s solvency depends on its reinsurance recoveries, the sponsor should assess the risk that the reinsurer may not pay claims. The SFC’s 2024 inspection found that 10% of sampled sponsors had not reviewed reinsurance arrangements, even though the policy wording stated that coverage was subject to reinsurance.

Actionable Takeaways for Sponsor Compliance

1. Never accept a certificate of insurance as sufficient evidence of coverage — obtain and review the full policy wording, including exclusions, conditions precedent, and territorial scope, for every material risk disclosed in the prospectus. 2. Verify that each material subsidiary is named as an insured under the policy, and confirm that the policy’s territorial scope covers the jurisdictions where the applicant generates material revenue, as required by the HKEX’s LD143-2023. 3. Obtain a claims history report for the past three years and assess whether the pattern of claims indicates underinsurance or coverage gaps that must be disclosed. 4. Confirm the insurer’s solvency ratio and credit rating, and verify its regulatory status in the jurisdiction where the risk is located, using the Insurance Authority’s register for Hong Kong insurers. 5. Document every step of the verification process in the sponsor’s work papers, including the basis for any conclusions on adequacy, and be prepared to present this documentation to the SFC on inspection.