"Insurance Companies Must Calculate Solvency Ratio Using Internal Models"

Insurance Research Institute "Standard Model Fails to Reflect Insurers' Unique Characteristics"

An analysis has emerged suggesting that insurance companies' solvency ratios should be calculated using each company's individual internal model rather than a uniform standard model.

According to the Korea Insurance Research Institute on the 12th, insurance companies have been applying the new financial soundness indicator and standard model that complies with international standards, the new solvency ratio (K-ICS·K-ICS), since last year. In the K-ICS system, the solvency ratio is calculated by dividing available capital by required capital. The financial authorities recommend a K-ICS ratio of 150% for insurance companies, meaning the higher this ratio, the safer the insurer's financial condition. If it falls below 100%, the insurer faces sanctions from the financial authorities.

Calculating K-ICS using the standard model is convenient in terms of comparability between companies. However, it fails to properly reflect the unique characteristics of individual insurers and limits the establishment of a risk-centered management culture system. This is because the standard model applies risk classification and risk assessment models uniformly without considering the company's business structure or scale.

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If an insurer manages risk through an internal model rather than the standard model, management can understand the company's business characteristics and identify necessary capital and risk management strategies. Additionally, the board of directors can effectively manage and supervise the management, which is another advantage.

International supervisory organizations such as the International Association of Insurance Supervisors (IAIS) and the Bank for International Settlements (BIS) recommend the use of internal models to improve risk management in financial institutions. Global insurers and banks in Europe have already applied internal models. The number of European insurers applying internal models increased from 169 at the beginning of 2016 to 194 by the end of 2018.

No Geon-yeop, a research fellow at the Korea Insurance Research Institute, said, "The introduction of internal models can contribute to enhancing management efficiency, such as efficient capital management and performance evaluation considering risks for insurers," adding, "It will also serve as an opportunity to increase international trust." He continued, "However, considering the domestic situation, insurers need to secure personnel and experience necessary for preparing internal models, so a phased introduction is required," and added, "Comparability between insurers and the connection with other systems should also be considered."