"Lower Base Interest Rate Leads to Decreased Insurers' Solvency Ratio"
Longer Liability Duration Life Insurers More Affected
Insurers Begin Portfolio Adjustments
As the trend of interest rate cuts originating from the United States gains momentum, the domestic insurance industry is becoming tense. The perceived impact of the interest rate cut differs between the life and non-life insurance sectors, as this is the first rate cut since the introduction of the new International Financial Reporting Standard (IFRS17). It is expected that there will be significant changes in financial soundness and profitability depending on each insurer's portfolio.
According to the financial sector on the 20th, ABL Life is conducting a demand forecast for the issuance of 200 billion KRW worth of unsecured subordinated bonds today. The bonds have a 10-year maturity with a call option (early redemption right) after 5 years. Depending on the demand forecast results, the issuance limit has been set to allow an increase up to 300 billion KRW. The public offering target interest rate was proposed as a fixed rate between 5.4% and 6%.
Hanwha Life plans to issue 600 billion KRW worth of perpetual subordinated bonds with a 30-year maturity and a 5-year call option on the 24th. In the demand forecast conducted on the 11th, the amount raised exceeded the initially planned 300 billion KRW, doubling the issuance amount. Heungkuk Fire & Marine Insurance also plans to issue 200 billion KRW worth of subordinated bonds on the 26th. Last month, Meritz Fire & Marine Insurance (650 billion KRW), Hanwha General Insurance (350 billion KRW), and KDB Life Insurance (200 billion KRW) consecutively issued subordinated bonds.
These insurers' move to raise funds is interpreted as a preemptive defense against the deterioration of financial soundness due to the interest rate cut. Looking at the status of the pre-transition new solvency ratio (K-ICS, Kicks) of life insurers in the first quarter of this year, ABL Life and KDB Life recorded 114.3% and 44.5%, respectively, both below the financial authorities' recommended level of 150%. Hanwha Life's ratio was 173.1%, higher than the recommended level but lower than the life insurance industry average of 200%. For non-life insurers, Meritz Fire & Marine Insurance recorded 226.9%, higher than the non-life average of 216.1%, while Hanwha General Insurance was at 172.8%, lower than the average. The solvency ratio is an indicator of an insurer's ability to pay insurance claims.
The Korea Insurance Research Institute analyzed that if the benchmark interest rate falls by 1 percentage point, the Kicks of life insurers would decrease by 25 percentage points, and that of non-life insurers by 30 percentage points. The U.S. Federal Reserve lowered the benchmark interest rate by 0.5 percentage points on the 18th (local time) for the first time in four and a half years and signaled an additional 0.5 percentage point cut within the year. The Bank of Korea is also likely to follow suit and lower its benchmark interest rate. This means that insurers' Kicks could fall further within the year. No Geon-yeop, a research fellow at the Korea Insurance Research Institute, explained, "When interest rates fall, insurers experience greater fluctuations in liabilities, requiring more sophisticated management such as matching cash flows by maturity. To manage capital amid falling interest rates, it is necessary to utilize various capital management measures, including purchasing long-term bonds, 30-year government bond futures, and co-reinsurance."
Before the introduction of IFRS17, under the RBC (old solvency regime), a decline in interest rates had the effect of improving financial soundness. The solvency ratio was evaluated based on the size of assets relative to liabilities, and under RBC, liabilities were fixed while only assets were marked to market, so a cut in benchmark interest rates increased asset values, improving financial soundness. However, under Kicks, liabilities are also marked to market, so the impact varies depending on the insurer's asset and liability portfolio.
The industry expects life insurers to be more affected by the interest rate cut. Life insurers handle insurance products with longer maturities than non-life insurers, resulting in longer 'liability duration,' which refers to the investment recovery period. Generally, when interest rates fall, the valuation of both assets and liabilities rises, but because life insurers have longer liability durations, liabilities increase faster than assets. An increase in liabilities leads to a decrease in net assets, which reduces capital. Capital reduction also affects the decline in Kicks. A life insurer official said, "Since the beginning of the year, we have increased sales of health insurance rather than savings insurance in preparation for the interest rate cut. We are also attempting to diversify our investment portfolio."
If the benchmark interest rate decreases, the announced interest rate and the expected interest rate will also fall, which is expected to affect insurance policyholders. The announced interest rate is the interest rate applied to reserves for interest rate-linked insurance products and is similar to a bank deposit interest rate. When the announced interest rate falls, the refund amount customers receive at insurance maturity or cancellation decreases. The expected interest rate is the basis for premium calculation when insurers launch new products. When the expected interest rate falls, premiums increase.
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