1Q Net Profit Estimated at 5.2 Trillion
Inflated Due to Inclusion of Investment Securities Valuation Gains
"CSM Assumptions Will Be Provided"
The Financial Supervisory Service (FSS) emphasized that the record-breaking net profits reported by insurance companies in the first quarter of this year are an optical illusion caused by the adoption of new accounting standards. They analyzed that the impact of unrealized gains from various investment assets being reflected in net profits is the main factor. The FSS pointed out the need to strengthen the actual financial health of insurance companies and to thoroughly manage risks.
On the 21st, the FSS announced that the combined net profit of life insurance and non-life insurance companies in the first quarter of this year was approximately 5.23 trillion KRW. This figure is nearly 2 trillion KRW less than the industry’s forecast of 7 trillion KRW. They cautioned that overly optimistic projections are close to an optical illusion caused by changes in accounting standards and advised careful attention.
From this year, insurance companies have adopted IFRS17 and IFRS9. IFRS17 requires insurance liabilities to be measured at fair value at the evaluation point rather than at the point of sale. The recognition criteria for revenue and expenses also changed to an accrual basis, recognizing revenue over the service period rather than at the time of premium receipt.
IFRS9 changes the treatment of equity securities, which were previously classified under other comprehensive income, to be recognized in profit or loss. Although this was introduced in the financial sector from January 2018, insurance companies decided to apply it starting this year.
The FSS explained that excluding the effects of these accounting changes, the net profit of insurance companies in the first quarter of this year was 3.02 trillion KRW, which is actually less than the 3.07 trillion KRW recorded in the first quarter of last year. For life insurers, the net profit excluding the effects of the accounting changes was 1 trillion KRW, down from 1.42 trillion KRW in the same period last year, while non-life insurers recorded 2.02 trillion KRW, up from 1.65 trillion KRW in the first quarter of last year.
They explained that life insurers had about twice the amount of equity securities, so the unrealized gains recognized under IFRS9 in the first quarter created a larger optical illusion. Jeong Haeseok, Director of the Insurance Risk and Accounting Division at the FSS, stated, "A significant portion of insurance companies’ profits in the first quarter came from unrealized gains on investments under IFRS9." He added, "Since valuation gains and losses fluctuate daily like stock prices and can vary greatly with interest rate changes, it is difficult to use them for dividends. Therefore, insurance companies must manage volatility carefully and oversee risk and dividend policies."
He also viewed the application of IFRS9 this year as fortunate. If it had been introduced last year when the bond market was highly volatile, valuation losses would have been immediately reflected in net profits, potentially causing an 'earnings shock' on the surface despite no significant changes in the insurance business environment.
The FSS also addressed recent controversies regarding the inflation of Contractual Service Margin (CSM) under IFRS17. CSM, which evaluates future profits from insurance contracts, is recognized as a liability at the contract inception and amortized as profit over the contract period. Since insurers can choose the recognition ratio, there have been criticisms that this subjective interpretation inflated earnings. In response, the FSS plans to provide guidelines on detailed assumptions within this month.
Director Jeong explained, "We are not presenting specific figures for assumptions such as the loss ratio of indemnity health insurance or the lapse rate of no-surrender insurance." He added, "While it is reasonable to use loss ratio statistics from the past 10 years or more to predict future loss ratios, we intend to restrict unreasonable decision-making such as estimating the future based solely on the lowered loss ratios during the recent COVID-19 period and to present principles."
Additionally, the FSS stated that it will periodically review the appropriateness of basic assumptions for companies showing large discrepancies between expected and actual amounts on financial statements and will monitor the management status of investment gain volatility.
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