Insurance Companies' Soundness Shaken by Ultra-Low Interest Rates... Financial Supervisory Service to Revise 'RBC' System

Declining Solvency Ratio... Concerns Over Financial Soundness Deterioration
Revision of Insurance Business Supervision Enforcement Rules Underway
Introduction of 'Internal Model' for Interest Rate Risk Measurement Using Proprietary Statistics

[Asia Economy Reporter Oh Hyung-gil] Financial authorities are overhauling the RBC (Risk-Based Capital) system, a key financial soundness indicator for insurance companies, to improve the deterioration of the RBC ratio. This comes amid concerns that the prolonged ultra-low interest rate environment is causing a surge in interest rate risk for insurers, leading to a decline in RBC ratios and worsening financial soundness.

According to financial authorities and the insurance industry on the 13th, the Financial Supervisory Service (FSS) plans to revise the Insurance Business Supervision Rules to improve the RBC system, aiming to reduce insurers' burden of interest rate risk.

The main point is to establish grounds for the use of an 'internal model' that allows insurers to use risk coefficients based on their own statistics alongside the current standard model when calculating the RBC ratio.

The internal model refers to a method where insurers calculate risk probabilities using their own statistics and reflect these in the RBC. The FSS expects this will enable a more practical calculation of liability duration.

This involves calculating the gap between the durations of liabilities and assets, an indicator showing how much the value of liabilities changes when market interest rates fluctuate. If the gap widens, interest rate risk increases and the RBC ratio may decrease.

With the continuation of ultra-low interest rates, the value of liabilities has grown larger than assets, causing capital to shrink. Furthermore, under the new International Financial Reporting Standard (IFRS 17) and the new solvency regime (K-ICS) set to be introduced in 2023, liabilities will be measured at fair value, causing their scale to surge further. Insurers will inevitably face the burden of capital expansion through issuing subordinated bonds and increasing long-term government bond investments.

A financial authority official explained, "Depending on the insurer's situation, duration can lengthen or shorten, so the impact may vary," adding, "This move opens the door for insurers to use internal models as an option, providing them with a new choice."

The FSS also plans to establish standards allowing insurers to reflect interest rate derivatives used for hedging purposes to reduce interest rate risk in the RBC calculation.

In reality, insurers' financial soundness has deteriorated. At the end of last year, the overall RBC ratio of insurers was 269.5%, down 17.4 percentage points from the previous quarter. After three consecutive quarters of increase, the RBC ratio has turned downward.

Available capital decreased due to bond valuation losses and cash dividends, while operating assets increased. Credit and market risk amounts also rose, expanding the required capital. The RBC ratio is calculated by dividing available capital, which can cover losses from various risks, by required capital, the amount needed to cover losses if risks materialize.

The Insurance Business Act mandates maintaining the ratio above 100%. The number of insurers with RBC ratios in the 100% range is increasing. Among domestic life insurers are NH Nonghyup Life (192.4%), DGB Life (169.1%), DB Life (176.2%), and IBK Life (178.5%).

Among non-life insurers, Hanwha General Insurance (181.0%), Lotte Non-Life Insurance (183.7%), MG Non-Life Insurance (117.1%), Heungkuk Fire & Marine Insurance (184.7%), KB Insurance (188.5%), and The-K Non-Life Insurance (127.7%) all exceed 100% comfortably.

With this measure, large insurers that possess extensive internal statistics are expected to analyze interest rate risk caused by low interest rates more accurately and enhance their ability to manage duration accordingly.

A life insurance industry official said, "Large insurers suffering from profit deterioration due to high interest rate negative spreads will be able to breathe easier in capital management," adding, "It will help in preparing mid- to long-term response strategies."

This content was produced with the assistance of AI translation services.