[Reporter’s Notebook] IFRS17 Has Only Increased the Obsession with Short-Term Performance

The unstoppable 'profit parade' of insurance companies until the first half of the year slowed down somewhat in the third quarter. In the non-life insurance sector, the net profit scale of KB Insurance, Hyundai Marine & Fire Insurance, and DB Insurance shrank, breaking the 'Big 4' structure. The life insurance sector performed even worse. Two of the 'Big 3,' Hanwha Life Insurance and Kyobo Life Insurance, recorded losses of 40.8 billion KRW and 32.9 billion KRW, respectively.

This is seen as a lingering shadow of high interest rates. Insurance companies primarily invest customer premiums in long-term bonds, and the market interest rates have not stabilized, causing a burden. In particular, available-for-sale securities, which are intended to be paid immediately upon insurance claims, became a stumbling block. Under the new accounting standard IFRS17, a significant portion of available-for-sale securities are classified as financial assets measured at fair value through profit or loss (FVPL). Even if bonds are not sold, if the market price falls, net profit decreases. In the third quarter, Hanwha Life and Kyobo Life recorded net profits in their insurance operations but suffered losses of 252.4 billion KRW and 76.8 billion KRW, respectively, in their investment sectors. Nevertheless, their expressions are not entirely gloomy. The decrease in net profit can be excused as it is due to bond 'valuation losses' caused by high interest rates.

On the other hand, insurance companies have grown the Contractual Service Margin (CSM), a profitability indicator introduced under IFRS17. Kyobo Life's third-quarter CSM was 6.4694 trillion KRW, an increase of about 1.2 trillion KRW compared to 5.284 trillion KRW in the first half of the year. Hanwha Life also saw a decrease compared to the previous quarter, but its cumulative new contract CSM reached 1.8559 trillion KRW, nearly 1.5 times higher than the same period last year.

CSM represents the insurer's expected future profit from contracts. It is initially recorded as a liability but amortized from the liability to profit as premiums are received. However, this is an 'expected' profit. With a bit of optimism, it is easier to inflate than net profit. Insurance can be canceled midway or claims can increase at any time. If predicted optimistically, CSM may be high immediately, but if the gap between expected and actual results is large, it can instantly become a loss contract, causing net profit to plummet.

The problem is that the period when losses can surge like this is likely to be after the tenure of current CEOs and management. This is why there are reactions that IFRS17 and CSM may have made companies more obsessed with short-term performance. Some insurers are still diligently selling short-term payment whole life insurance products, which regulators have tried to curb, to immediately boost their CSM. Short-term payment whole life insurance returns a lump sum exceeding the principal after maturity periods of 5 or 7 years, increasing the likelihood of mass cancellations by policyholders at once, which could trigger liquidity issues for insurers.

If an insurer becomes insolvent, the negative impact on the private sector would be significant. Insurance is both a financial product and a social safety net. This is why insurers are subject to stricter soundness regulations than other industries. Rather than simply launching one-off products or temporarily discounting premiums, true win-win finance might be managing to prevent insolvency and strengthen fundamentals in the long term.

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