FSS Responds to Criticism of Inflated Profits Using Long-Term Insurance Loss Ratios: "Supplementary Measures Will Be Prepared"

Yongbum Kim of Meritz Financial Group Calls for Guidelines on Long-Term Insurance Loss Ratios
FSS Hints at Preparing New Guidelines
On Lotte Insurance Incident: "Swift Action Will Be Taken"

The Financial Supervisory Service (FSS) has responded to the criticism from Yongbum Kim, Vice Chairman of Meritz Financial Group, who pointed out that long-term insurance loss ratios are being used to inflate profits, by stating, "We are currently in discussions with the industry, and if necessary supplementary measures are prepared, we will provide a separate announcement."

Sehun Lee, Senior Deputy Governor of the FSS, held a briefing at the FSS office in Yeongdeungpo-gu, Seoul on May 15 and said, "There are some companies that appear to be compromising long-term stability for short-term performance, and we will actively manage these aspects."

Sehun Lee, Senior Deputy Governor of the Financial Supervisory Service.

Lee's remarks are interpreted as a response to Vice Chairman Kim's comments during a Q&A session at the previous day's earnings conference call, where he stressed the need for specific guidelines regarding long-term insurance loss ratios. Vice Chairman Kim stated, "As the systems related to loss ratios for indemnity insurance and lapse rates for non-surrender and low-surrender insurance have been improved, there are concerns that a balloon effect may occur through assumptions about long-term loss ratios, for which there are still no concrete guidelines." He also criticized, "After reviewing the long-term loss ratio assumptions disclosed by insurers, the overall accounting consistency is still only at 70%."

Under the International Financial Reporting Standards (IFRS17) regime, insurers' performance is determined based on actuarial assumptions related to the Contractual Service Margin (CSM). If the assumptions used here set future loss ratios higher, the CSM decreases and profits fall; if they are set lower, the CSM increases and profits rise. Vice Chairman Kim pointed out, "Current loss ratios are similar across companies, but long-term loss ratio trends are sometimes completely opposite," adding, "There are even companies that assume expected loss ratios significantly lower than their actual loss ratios."

The FSS evaluated that, since the introduction of IFRS17 in 2023, the CSM has become the main source of company profits, while the burden of operating expenses has decreased. However, it also noted that competition has intensified to secure CSM, including sales of non-surrender and low-surrender insurance with embedded long-term risks, single-premium whole life insurance, and expansion of hospitalization daily benefit limits.

To address these issues, financial authorities are working to rationalize actuarial assumptions and improve unhealthy product development and sales practices focused on short-term performance through initiatives such as the Insurance Reform Council. Key measures include rationalizing lapse rate assumptions for non-surrender and low-surrender insurance, strengthening risk management processes for insurance products, improving the corporate insurance agency (GA) system, and establishing best practices for executive compensation and corporate governance.

Recently, the issue of insurer soundness has come to the forefront following incidents such as Lotte Insurance's failure to pay off its subordinated bonds through a call option. Lee stated, "Lotte Insurance is working with shareholders to develop a concrete capital increase plan," adding, "We plan to take action as quickly as possible in close consultation with the authorities."

Financial authorities are also preparing measures to address insurer soundness issues such as reduced dividend capacity and declining risk-based capital ratios (K-ICS). The authorities recently decided to lower the capital regulation standard related to subordinated debt and licensing requirements under insurance laws from the current K-ICS 150% to 130%. The intention is to help reduce interest expenses on subordinated debt, facilitate the refinancing of supplementary capital, and secure future growth engines.

There are also plans to prepare for the possibility that capital adequacy may weaken due to factors such as the adjustment of the discount rate for liability valuation, falling market interest rates, and increased volatility in exchange rates and stock prices. An FSS official stated, "We will promptly institutionalize and implement the improvement tasks announced through the Insurance Reform Council and ensure they take root in the market to enhance insurers' overall risk management capabilities. In addition, we will closely analyze the impact of individual companies' risk factors on the insurance market and consumers and take preemptive measures to prevent risk contagion."