Insurance Companies Introduce 'Stress Tests' for Alternative Investments with High Loss Risks

Promotion of In-House Risk Management Committee
Establishment of Step-by-Step Emergency Response Plans

[Asia Economy Reporter Oh Hyung-gil] Insurance companies are conducting stress tests on alternative investments with high loss potential. Due to the prolonged low-interest-rate environment, insurers have increased alternative investments, and this is to prevent the risk of losses from expanding in the wake of COVID-19.

According to the insurance industry on the 23rd, the Life and Non-life Insurance Associations recently established and announced the "Alternative Investment Risk Management Best Practices" to build a risk management system for alternative investments and enhance the soundness of alternative investment asset management.

Insurers must regularly monitor each alternative investment asset according to the best practices. If problems such as losses above a certain scale or a sharp drop in Net Asset Value (NAV) occur, they must prepare countermeasures including whether to continue holding the product, repayment or sale, impairment losses, provision accumulation, and actions regarding the asset management company.

Also, considering that most alternative investment assets are overseas, on-site inspections are mandatory except in cases where local visits are difficult due to large-scale infectious disease outbreaks. In cases such as blind funds where the investment target assets cannot be specified, the management personnel and management procedures will be inspected. For new types of investments without prior experience or high-risk alternative investments such as Loan-to-Value (LTV), a separate internal risk management committee approval process has been established.

In particular, when the possibility of losses related to alternative investments increases, emergency response plans at each stage will be established through stress tests reflecting key variables related to alternative investments. The impact on exposure related to alternative investment operations, including soundness and liquidity, must be analyzed periodically every year.

Financial authorities have instructed the institutionalization of strict valuation for alternative investment assets that may pose risks due to COVID-19 since the beginning of this year. Since last year, assets showing signs of insolvency among insurers' overseas alternative investments are estimated at about 1.2 trillion KRW. By asset type, real estate accounts for 690 billion KRW, Social Overhead Capital (SOC) 460 billion KRW, and aviation and shipping 110 billion KRW.

Last year, Mirae Asset Life's operating profit decreased by 17.7% compared to the previous year due to losses from a fund holding Brazilian real estate. KB Insurance also suffered about 26.7 billion KRW in losses out of a 53 billion KRW investment due to failure in a U.S. hotel investment. Lotte Insurance recorded a large loss of 159 billion KRW in asset management losses from aircraft investments last year.

A financial authority official explained, "Along with the implementation of the best practices, we plan to focus on managing the soundness and insolvency of alternative investments in insurers with high alternative investment ratios and weak internal controls on a monthly basis."