Life Insurers Face Earnings Decline Due to Variable Insurance Reserve Burden

Lower Interest Rates Increase Reserve Accumulation Burden
Expanded Hedging in Preparation for IFRS17 and K-ICS

[Asia Economy Reporter Oh Hyung-gil] The expectation that the burden on life insurance companies to accumulate variable insurance guarantee reserves would decrease due to the stock market rise after the COVID-19 crisis last year has proven incorrect. Due to the significant drop in market interest rates, additional accumulation of variable insurance guarantee reserves was made all at once at the end of the year, causing the fourth-quarter performance to also decline sharply.

Large life insurers have planned to increase hedging to reduce volatility in variable insurance reserves ahead of the introduction of the new International Financial Reporting Standards (IFRS17) and the new solvency ratio (K-ICS).

According to the insurance industry on the 4th, Samsung Life Insurance recorded a variable guarantee profit and loss of 327 billion KRW, including hedging costs, due to the reversal of variable guarantee reserves following the stock market rise in the fourth quarter of last year. While 829 billion KRW was reversed from reserves and 58 billion KRW was generated from fee income, a loss of 560 billion KRW occurred in the hedge position.

Accordingly, Samsung Life plans to expand the hedge ratio on reserves before the implementation of IFRS17 in 2023 to reduce volatility caused by variable insurance guarantee reserves.

A Samsung Life official explained, "Currently, out of 32 trillion KRW in reserves, we hedge up to 20 trillion KRW, which is 61%," adding, "We have expanded the hedge ratio to 75% for stock-related and 90% for interest rate-related under IFRS17 standards, and plan to hedge 100% for stock-related before IFRS17 implementation."

Hanwha Life to Hedge Over 30% of Reserves

Hanwha Life recorded a net loss of 44.4 billion KRW by additionally accumulating 187 billion KRW in variable guarantee reserves in the fourth quarter of last year alone. In response, Hanwha Life expects market volatility to continue this year due to the low-interest-rate trend and stock price declines, and plans to hedge more than 30% of the total variable guarantee reserves to reduce interest rate sensitivity.

A Hanwha Life official said, "As the hedge ratio increases, the reversal of guarantee reserves will decrease," adding, "We will adjust the hedge ratio according to interest rate and stock market conditions."

Kyobo Life Insurance also additionally accumulated about 170 billion KRW in variable guarantee reserves last year, resulting in a net profit of 382.9 billion KRW, down 29.9% from the same period the previous year.

Variable insurance requires insurers to accumulate guarantee reserves equal to the difference when investment returns fall below the assumed interest rate (the rate used to determine premiums) at the time of sale due to declines in interest rates or stock prices. Even if variable insurance investment performance deteriorates, insurers separately prepare reserves to secure the ability to pay the minimum guaranteed insurance benefits to policyholders.

When the size of variable guarantee reserves increases, the opportunity loss grows, reducing net profit and directly impacting performance.

Variable insurance guarantee reserves are applied using a fair value evaluation method, so when market interest rates rise, less is accumulated, and when they fall, more must be accumulated. Especially with the introduction of IFRS17 and K-ICS, which evaluate insurance liabilities at fair value, variable insurance guarantees and minimum interest rate guarantees linked to interest rates are reflected in liabilities, requiring risk reduction.

An insurance industry official said, "If market interest rates rise this year, the burden of accumulating guarantee reserves can be somewhat alleviated," adding, "The key is to reduce volatility caused by guarantee reserves through hedging strategies."