[Why&Next] Major Overhaul of Insurers' Capital Quality... Will M&A and Contract Transfers Gain Momentum?

Insurance Capital Adequacy Ratio Standard to Be Lowered: 150%→130%
'Basic Capital K-ICS' Regulation Introduced: Six Insurers Fall Below 50%
Will Business Restructuring and M&A Accelerate in the Insurance Sector?

Financial authorities have begun a major overhaul to improve the quality of insurance companies' capital. The key measures include easing the capital adequacy ratio indicator for insurers, known as the K-ICS (Korean Insurance Capital Standard), for the first time in 24 years, and introducing a new basic capital K-ICS regulation. This decision takes into account the fact that insurance companies have relied heavily on subordinated bonds and other instruments to easily raise capital, which has led to a decline in high-quality capital, as well as the need to align with global standards and capital regulation levels.

Insurance Capital Adequacy Ratio Standard to Be Lowered: 150%→130%

The K-ICS is an indicator that shows an insurer's ability to pay insurance claims promised to customers. It is calculated by dividing available capital by required capital. For example, a K-ICS of 200% means the insurer holds twice the capital required by the authorities (100%) to pay claims. Regulators currently recommend that insurers maintain a K-ICS of 150%. If this ratio falls below 100%, the insurer becomes subject to prompt corrective action (management improvement recommendation, order, or requirement).

The authorities are currently pursuing a plan to lower the recommended K-ICS standard to 130%. This adjustment comes amid repeated criticism that the 150% K-ICS regulation is excessive, given the base rate cuts and the stagnation in the insurance industry. Currently, the amendment to the Enforcement Decree of the Insurance Business Act and supervisory regulations is in the legislative notice period. The new standard is expected to take effect as early as the third quarter, following the Financial Services Commission's regular meeting scheduled for June 11 and subsequent approval by the Cabinet.

With the easing of K-ICS regulations, requirements for early redemption of subordinated bonds, reserve ratios for surrender value reserves, and conditions for licensing overseas subsidiaries will also be relaxed. If the early redemption requirements for subordinated bonds are eased, the risk of incidents such as the recent delay in the call option (early redemption) of Lotte Insurance's 90 billion won subordinated bond will be reduced. Easing the reserve ratio for surrender value reserves is also expected to enhance insurers' capacity for dividend payouts.

'Basic Capital K-ICS' Regulation Introduced: Six Insurers Fall Below 50%

In exchange for easing the K-ICS, financial authorities have decided to introduce the 'basic capital K-ICS' regulation. The basic capital K-ICS is an indicator that assesses an insurer's ability to pay claims using only basic capital, such as paid-in capital and retained earnings. The aim is to improve the quality of capital by encouraging capital increases through rights offerings, contingent convertible bonds (CoCo bonds), and net profit growth, instead of relying on subordinated bonds (supplementary capital) raised through rollovers.

The authorities have not yet set the basic capital K-ICS standard that would trigger prompt corrective action. However, considering global standards, it is highly likely to be around 50%. The minimum basic capital K-ICS standard is also 50% in major overseas jurisdictions, such as the European Solvency II framework, which served as the model for K-ICS, and Canada's Life Insurance Capital Adequacy Test (LICAT).

As of the end of last year, six major domestic insurers fell below the 50% threshold for basic capital K-ICS: Fubon Hyundai Life (43.1%), Hana Insurance (42.8%), KDB Life (24.8%), iMLife (12.5%), Lotte Insurance (-1.5%), and MG Insurance (-7.4%). Hyundai Marine & Fire (57.5%) and Heungkuk Fire & Marine (53.1%) also remained just above 50%, so the situation is not entirely reassuring. The basic capital K-ICS regulation is expected to be reflected from this year's year-end closing. However, it is likely that there will be a grace period of several years before prompt corrective action is immediately applied. Noh Geonyeop, a research fellow at the Korea Insurance Research Institute, said, "The basic capital K-ICS can enhance the quality of insurers' capital, but companies that are unprepared or lack sufficient resources will need time to prepare," adding, "It would be helpful if the authorities provide a soft-landing plan and support the development of private sector actuarial standards."

Will Business Restructuring and M&A Accelerate in the Insurance Sector?

With the introduction of new capital regulations for insurers, there are expectations that large-scale business restructuring will occur in the insurance industry. This is because, amid structural challenges such as low birth rates and an aging population, as well as a trend of base rate cuts, profitability and financial soundness are deteriorating, making it necessary to efficiently manage capital by divesting underperforming businesses and focusing on core strengths.

As part of this, the transfer of insurance contracts held by one insurer to another?known as 'contract transfer'?is likely to become more active. Financial authorities recently announced plans to subdivide contract transfer units and rationalize review requirements. Noh, the research fellow, explained, "In the past, all insurance contracts with the same technical basis for calculating reserves were transferred in a comprehensive transfer, but now it will be possible to transfer insurance contract portfolios by sales channel," adding, "Since growth is limited with new contracts alone, contract transfers will become a key growth strategy for insurers going forward."

Mergers and acquisitions (M&A) are also expected to become more active. For insurers with weak capital positions, M&A is an effective way to boost basic capital. As more insurers become available for sale in the M&A market, financial firms seeking to build insurance portfolios at reasonable prices may increase their bets. An industry insider said, "The recently announced capital regulations and related measures by the authorities appear to be encouraging M&A activity," adding, "Cases such as the merger of Tongyang Life and ABL Life, or Hanwha General Insurance and Carrot General Insurance, are likely to become more common in the future."