Financial Services Commission Improves Accounting Standards for Cancellation Rates of Non-Cancellable and Low-Surrender Value Insurance Policies

Improvement in Surrender Risk Amount Calculation for Non-Cancellable Insurance
40% Reduction in Surrender Rate Shock Applied to Some Products
Enhanced Monitoring and Disclosure of Operating Expense Execution

Financial authorities will improve the new International Financial Reporting Standards (IFRS17), which sparked controversy over insurance companies' 'performance inflation,' and strengthen insurance soundness supervision. In particular, the authorities plan to refine the application criteria for lapse rates in the Solvency Capital Requirement system (K-ICS) to ensure that the product risks of no-surrender and low-surrender insurance policies are properly reflected.

On the 4th, the Financial Services Commission and the Financial Supervisory Service held the 4th Insurance Reform Meeting chaired by Kim So-young, Vice Chairman of the Financial Services Commission, with participation from the Financial Consumer Society, academia, related organizations, research institutions, insurance companies, and the Insurance Association to finalize institutional improvement measures for the stabilization of IFRS17.

IFRS17, introduced to insurance companies last year, is based on the principles of 'fair value measurement' and 'accrual basis.' At each settlement date, optimal actuarial assumptions such as loss ratios and lapse rates are reflected, and fair value is measured using discount rates that consider economic conditions such as market interest rates. The accrual basis recognizes revenue and expenses from insurance contracts evenly over the entire contract period. Under the IFRS17 framework, the Contractual Service Margin (CSM) has emerged as a core profit and soundness management tool for insurers, intensifying competition among insurance companies to attract new contracts. In this process, excessive competition and performance inflation through optimistic lapse rate assumptions also appeared.

Kim So-young, Vice Chairman of the Financial Services Commission.

The authorities focused on no-surrender and low-surrender insurance products as a major improvement point for IFRS17. No-surrender insurance policies offer lower premiums but provide little or no refund to the policyholder upon early termination. Generally, a high lapse rate positively affects an insurer's net assets, while a low lapse rate has a negative effect. The authorities believe that insurers have assumed excessively high lapse rates. Going forward, when calculating K-ICS, the lapse risk of no-surrender and low-surrender products will be separated from that of general (standard) products, and different lapse rate criteria will be applied. For no-surrender products that increase net assets upon contract lapse, only 60% of the optimal lapse rate in the first year will be applied to prevent overestimation of lapse rates.

On the other hand, there are no-surrender products that reduce net assets upon contract lapse. In these cases, since insurers may underestimate lapse rates, 35 percentage points will be added for high-refund types and 25 percentage points for non-high-refund types to the optimal lapse rate in the first year.

Transparency and accountability of insurance financial information have also been strengthened. With the introduction of IFRS17, the importance of actuarial assumptions and detailed financial information such as CSM in insurers' valuation has increased. However, there have been criticisms that insurers' disclosures only provide compressed general assumptions and generalities, lacking meaningful information. Although an external verification system by accounting and actuarial firms is in place to ensure the reliability of fair value-based settlements, it has been argued that the system operates formally and the effectiveness of external verification is limited.

The authorities have also prepared measures to rationalize the execution of business expenses. Since the introduction of IFRS17, the accounting burden of initial contract business expenses for insurers has decreased. In fact, last year, insurers' earned premiums decreased by KRW 15.8 trillion compared to the previous year, but business expenses increased by KRW 4.9 trillion. The authorities view this as excessive business expense execution. Since the increase in new contract acquisition costs is driving the overall rise in business expenses, if this situation continues, it could lead to deterioration in soundness as well as consumer harm due to incomplete sales and decreased persistency caused by overheated new contract sales.

Accordingly, the authorities have prepared plans to continuously monitor and supervise insurers' business expense execution. They will establish work reports on actual cash inflows and outflows, including premiums, claims, and business expenses, operate a continuous inspection system, and induce rational business expense execution through ongoing monitoring. They also plan to clarify the legal basis in the Insurance Business Act and related laws to impose sanctions for regulatory violations and eradicate irresponsible commission policies.

Going forward, the authorities plan to activate the market's self-correcting function through transparent disclosures and accountable external verification. First, the status of insurance liabilities, previously provided at the insurer level, will be subdivided at the portfolio level to disclose detailed insurance liability status, changes, and optimal assumptions (through association management disclosures and business report footnotes). Information users will be able to obtain useful information such as product types with good profitability by company, reasons for CSM changes, and estimates of future cash flows, enabling comparisons between companies.

By comparing and analyzing overseas soundness disclosure cases, the authorities will identify necessary improvements in domestic management disclosures and promote disclosure of differences and sensitivity information between general and soundness accounting. For external settlement verification, new audit grounds and data submission request rights will be established to secure the enforceability of the existing self-regulation. They will verify whether appropriate external verification has been conducted according to guidelines and conduct thorough inspections through data requests if necessary. Penalty provisions for inadequate verification will also be introduced to enhance the accountability of actuarial firms.

The agenda discussed at this Insurance Reform Meeting will be promptly applied to the market through swift amendments to related detailed rules. The refinement of K-ICS lapse risk amounts and the expansion of financial information disclosure will be applied from the settlement at the end of this year. Kim So-young, Vice Chairman of the Financial Services Commission, said, "We will ensure that IFRS17, which is based on actuarial assumptions, is not a flexible accounting standard but accurately reflects the real value of insurers," adding, "We will root out irrational and arbitrary accounting practices of individual companies."