Impact on DB Insurance and Others When Applying the Principle Model for Cancellation Rates of Non-Guaranteed and Guaranteed Policies

Financial authorities recently improved assumptions on lapse rates for no-surrender and low-surrender value insurance policies, and applying these assumptions as is is expected to negatively impact the performance of many non-life insurers.

According to the Korea Insurance Development Institute on the 13th, as of the first half of this year, Lotte Non-Life Insurance had the highest proportion of no-surrender and low-surrender value insurance sales at 36.1% among non-life insurers. Following were Hana Non-Life Insurance (36%), MG Non-Life Insurance (29.8%), Samsung Fire & Marine Insurance (20.7%), Heungkuk Fire & Marine Insurance (20.4%), and DB Insurance (18.7%) in order of high sales proportion of no-surrender and low-surrender value insurance. Based on monthly first premium, the proportion of no-surrender and low-surrender value insurance sales among all domestic non-life insurers nearly doubled from 33.2% in Q1 last year to 62.2% in Q3 this year. No-surrender and low-surrender value insurance products have lower premiums than regular insurance because they offer little or no refund upon cancellation during the premium payment period. Insurers have been criticized for assuming high lapse rates for these policies to inflate the insurance contract margin (CSM).

Analyzing the lapse rates of no-surrender and low-surrender value insurance from one insurer, the assumption was about 1.9% from around the 10th year of a 30-year contract, gradually decreasing to 1.1%, and then sharply dropping to the 0% range at the 30th year. For no-surrender and low-surrender value children's comprehensive insurance with a 20-year payment period sold by non-life insurers this year, the lapse rates at the completion of premium payment (20th year) were approximately 2.5% for DB Insurance, 2.5% for KB Insurance, 1.7% for Hyundai Marine & Fire Insurance, and 1.4% for Lotte Non-Life Insurance.

This is far from the lapse rate guidelines for no-surrender and low-surrender value insurance presented by the Financial Services Commission on the 7th. The core of the guideline is that insurers should follow the 'principle model (log-linear model)' when assuming lapse rates for no-surrender and low-surrender value insurance. The principle model assumes lapse rates more conservatively than existing models, causing lapse rates to rapidly converge to 0% as the insurance contract duration increases. This measure prevents insurers from optimistically assuming lapse rates to inflate CSM.

Authorities have allowed insurers to use exception models based on their own experience statistics instead of the principle model, but the Financial Supervisory Service (FSS) effectively pressured insurers to follow the principle model yesterday, making it inevitable that insurers with a high proportion of no-surrender and low-surrender value insurance sales will be hit. The FSS held a meeting chaired by Senior Deputy Governor Lee Se-hoon with executives of major insurers yesterday and warned them to refrain from choosing exception models. If not followed, they plan to include such insurers in the priority inspection list for next year and even conduct interviews with major shareholders. While executives with fixed terms who prioritize short-term performance have strong incentives to choose exception models, the FSS intends to persuade major shareholders who desire long-term company development that choosing the principle model is more reasonable.

In this regard, the insurance industry is raising voices of criticism. A representative from an insurance company said, "Announcing an improvement plan to choose between the principle model and exception model and then reversing it in just four days is proof of the authorities' incompetence," adding, "If International Financial Reporting Standards (IFRS17) keep fluctuating like this, the credibility of insurance accounting will inevitably decline significantly."