[Financial Microscope] Surge in Insurance Companies' Capital Securities Issuance... What Is Driving the Trillion-Won Increase?

Over 5.2 Trillion Won in Capital Securities Issued by Insurers
Already Surpassing 60% of Last Year’s Record Total
As Capital Adequacy Ratios Decline, Insurers Must Also Focus on Capital Quality Management

Recently, insurance companies have been successively issuing large amounts of capital securities. This is because, due to the effects of falling base interest rates and regulatory changes such as the adjustment of insurance liability discount rates, there is an urgent need to manage the capital adequacy ratio (K-ICS, KICS). Insurers are on edge as financial authorities are expected to soon implement even stricter capital regulations.

An image depicting an insurance company struggling with capital management. ChatGPT

Will This Year See a Record-Breaking Issuance of Capital Securities?

Capital securities refer to debt securities recognized as equity capital in accounting, such as hybrid capital securities and subordinated bonds. Financial companies issue them to supplement insufficient equity capital. Hybrid capital securities pay interest like regular bonds but, like stocks, have no maturity or repayment obligation. Subordinated bonds rank lower in repayment order than other bonds in the event of the issuer's bankruptcy. However, compared to perpetual hybrid capital securities, subordinated bonds have a higher repayment priority. Generally, subordinated bonds offer lower interest rates than hybrid capital securities, making them more attractive to insurers.

According to Korea Securities Depository statistics as of June 9, insurance companies have issued 5.225 trillion won in capital securities so far this year. Even before the first half of the year ended, this amount already exceeded 60% of last year’s record total issuance of 8.655 trillion won.

Last month, Tongyang Life issued $500 million (about 700 billion won) worth of subordinated foreign currency bonds. Hanwha Life also held an extraordinary board meeting and approved the issuance of $1 billion (about 1.365 trillion won) in overseas hybrid capital securities. Combined, these two issuances bring this year’s capital securities issuance to 84% of last year’s total. It is highly likely that the total issuance by insurers this year will reach an all-time high.

Last year, the average coupon rate on capital securities issued by insurers was 5.6%. This means that insurers are paying 485 billion won in annual interest just on newly issued capital securities. Although the average coupon rate for capital securities issued this year has fallen to 4.7%, the total issuance has increased significantly, so insurers’ interest burden is expected to rise.

Falling Interest Rates and Regulatory Changes Lower Insurers' Capital Adequacy Ratios

Insurers have increased their issuance of capital securities because KICS has been steadily declining due to the impact of base interest rate cuts. KICS is a key financial soundness indicator that measures an insurer’s ability to pay insurance claims. It is calculated by dividing available capital by required capital. When insurers issue more capital securities, the available capital?the numerator?increases, which raises the KICS ratio.

When interest rates fall, the valuation of insurers’ assets and liabilities rises. However, the discount rate applied to liabilities decreases, which increases the present value of future insurance payouts, effectively increasing liabilities. As a result, liabilities grow faster than assets, causing KICS to decline. Generally, life insurers are more affected by falling interest rates than non-life insurers because they have more long-term insurance products, resulting in longer liability durations.

Looking at the first-quarter KICS status of major insurers that issued capital securities over the past year, most saw their KICS ratios decline compared to the previous quarter. NH NongHyup Property & Casualty Insurance’s KICS for the first quarter was 165.7%, down 35.9 percentage points from the previous quarter. During the same period, Lotte Non-Life Insurance’s KICS fell 34.66 percentage points to 119.9%, and Tongyang Life’s KICS dropped 28.3 percentage points to 127.2%. These insurers appear to have issued large amounts of capital securities to meet the financial authorities’ recommended KICS level of 150% (which is expected to be eased to 130%).

For the time being, managing KICS will become even more challenging for insurers. This is because there is a high likelihood of further base rate cuts, and financial authorities are pushing to gradually adjust the insurance liability discount rate to reflect market realities. Starting this year, the ultimate observation period has been extended from 20 years to 23 years. Over the next two years, this period will be gradually extended to 26 years and then to 30 years. As the period during which the government bond yield is used for the insurance liability discount rate increases, the discount rate will decrease, putting further downward pressure on KICS.

Financial Authorities Signal Introduction of 'Core Capital KICS'... Now Insurers Must Manage Capital Quality

Going forward, insurers will need to pay attention not only to the 'quantity of capital' through capital securities issuance, but also to the 'quality of capital.' This is because financial authorities are preparing to introduce a 'core capital KICS' regulation that assesses the quality of capital.

Core capital KICS is an indicator that measures an insurer’s ability to pay insurance claims using only core capital, such as paid-in capital and retained earnings. To increase core capital, insurers must pursue paid-in capital increases, issue contingent convertible bonds (CoCo bonds), or boost net income, rather than relying on supplementary capital such as capital securities. The core capital KICS regulation is expected to be reflected starting with year-end financial statements this year.

Lee Byungun, a researcher at DB Financial Investment, said, "Considering the recent interest rate cuts and the extension of the ultimate observation period, the core capital KICS of insurers could fall by more than 15 percentage points on average," adding, "This will reduce distributable profits and the capacity to issue supplementary capital securities, negatively impacting efforts to improve capital adequacy."