Base Rate Hike Likely Next Month... Insurance Companies' RBC Faces 'Red Light'

Lee Ju-yeol, Governor of the Bank of Korea, attended the National Assembly's Public Administration and Finance Committee's audit of the Bank of Korea held at the National Assembly on the 15th, responding to questions from lawmakers. Photo by Yoon Dong-joo doso7@

[Asia Economy Reporter Oh Hyung-gil] "As long as there is no major risk to the economy, a rate hike in November can be fully considered. It is difficult to say with 100% certainty that the base rate will be raised, but according to our forecast of the economic trend, we expect that there will be no major difficulties even if the rate is raised in November."

Lee Ju-yeol, Governor of the Bank of Korea, strongly hinted at a base rate hike in November, putting the insurance industry at a crossroads once again. The insurance industry can expect an increase in profitability due to the rate hike. The burden of reserving for variable guarantee reserves caused by low interest rates can also be reduced.

However, with the introduction of the new International Financial Reporting Standard (IFRS17) in 2023, insurance companies that have increased available-for-sale securities are concerned that the Risk-Based Capital (RBC) ratio will decline depending on the timing of bond accounting and classification. It is expected that the issuance of capital securities will increase further to raise the RBC ratio.

Earlier, on the 13th, the Korea Insurance Research Institute suggested in a report titled "Financial Imbalance Mitigation Policies and the Insurance Industry" that "Since the financial authorities' and central bank's imbalance mitigation policies can affect capital flows, asset prices, and risks, insurance companies should prepare response strategies in terms of demand for savings and investment-type insurance, asset management, and capital management."

Due to financial imbalance mitigation policies, financial authorities are promoting total household loan management, and the Bank of Korea is also expected to place emphasis on mitigating financial imbalances by gradually raising the base rate.

It explained that the phenomenon of economic agents pursuing higher yields is expected to ease, resulting in a slowdown in liquidity growth, alleviation of fund short-termization, and expansion of downside risks to risky assets. It also forecasted that due to a decline in preference for risky assets, corporate bond yields will rise, leading to an expansion of credit spreads (the interest rate difference between government bonds and corporate bonds), an increase in loan delinquency rates, and a rise in long-term government bond yields.

In the case of some insurance companies, it is necessary to prepare in advance for the issuance of capital securities such as subordinated bonds and hybrid capital securities because it is not easy to meet the RBC ratio only by increasing retained earnings during a period of rising interest rates, depending on the bond accounts held.

When interest rates rise, bond prices fall, and bonds classified as available-for-sale securities see a decrease in valuation gains. The reduced bond valuation gains are directly reflected in capital, leading to a decline in the RBC ratio.

In particular, the issuance conditions for subordinated bonds or hybrid capital securities are deteriorating due to the rise in long-term government bond yields and the widening of credit spreads.

The capital recognition ratio for hybrid capital securities is 100%. On the other hand, the capital recognition ratio for subordinated bonds is reduced by 20% annually if the remaining maturity is within five years.

Jo Young-hyun, a research fellow at the Korea Insurance Research Institute, urged, "To improve expected returns, it is necessary to reduce the credit risk of managed assets that have expanded in recent years and increase the proportion of long-term government and public bonds. For household loans, the risk of unsecured loans should be carefully examined, and for corporate loans, the repayment ability of vulnerable companies and risks related to overseas alternative investments should also be closely monitored."