[Insurance Industry Survival Cliff - Part 2] Joint Reinsurance in Zero Interest Rate... Effectiveness Controversy Already Arises

Market Risk Transferred to Reinsurers
Concerns Over Rising Costs Due to Interest Rate Cuts

Additional Capital Expansion Also a Challenge
Need to Build Up More Liability Reserves

[Asia Economy Reporters Oh Hyung-gil and Ki Ha-young] Institutional changes have also come to the insurance industry, which is filled with a sense of crisis due to sluggish business conditions and zero interest rates. The introduction of the new International Financial Reporting Standard (IFRS17) and the new Solvency Capital Requirement system (K-ICS) in 2023 has brought the prerequisite task of capital expansion to the forefront. Accordingly, concerns are growing that if capital is not increased in time and liabilities increase, there could be problems with the solvency ratio (RBC), a key soundness indicator.

Financial authorities are also preparing a safeguard measure called co-reinsurance to reduce volatility risks caused by interest rate changes. However, voices from the industry are already expressing doubts about its effectiveness.

◆ Breathing Room through Co-Reinsurance Introduction... Remaining Issue of Transaction Costs = Financial authorities will introduce a co-reinsurance system by the end of this month that transfers market risks such as interest rate fluctuations from insurance companies to reinsurers. The Financial Supervisory Service announced a preliminary notice last month to revise the 'Insurance Business Supervision Rules' and plans to implement it after gathering industry opinions.

Co-reinsurance is a system where insurance companies transfer savings premiums or additional premiums they hold to reinsurers. Since the risk from interest rate fluctuations can be shared with reinsurers, it provides relief to insurers burdened with capital expansion under the low-interest rate environment.

Additionally, financial authorities have revised insurance supervision regulations to reflect the effect of transferring interest rate risk in the solvency system. The introduction of 'proportional co-reinsurance' is likely. Proportional co-reinsurance means that all risks inherent in insurance products are transferred to reinsurers according to the ceding ratio.

A life insurance industry official said, "Unlike traditional reinsurance, all risks can be hedged through co-reinsurance, so we expect it to alleviate the burden of negative margins from previously sold high-interest products." Currently, five reinsurers, including Korean Re?the only domestic reinsurer?as well as Munich Re, RGA, Swiss Re, and SCOR, are reportedly preparing for domestic co-reinsurance.

However, there is cautious opinion that it remains to be seen whether co-reinsurance will fully perform its role as expected. There are concerns that transaction costs will increase as interest rates fall. Considering the scale of negative margins held by insurers, it is questionable whether reinsurers have sufficient capacity to take on these risks.

An official from the life insurance industry said, "Since co-reinsurance must also be beneficial for reinsurers, reaching an agreement on how to evaluate insurance liabilities will not be easy," adding, "We need to watch whether conditions will allow domestic insurers to the extent they desire."

◆ Additional Capital Expansion Task amid Zero Interest Rates = As interest rates decline, capital expansion has emerged as another challenge. Although insurers have actively expanded capital in recent years, the benchmark interest rate has dropped to an all-time low, requiring them to accumulate more reserves.

The scale of domestic insurers' liability reserves approached 853 trillion won as of the end of last year. This is a 26.5% increase over five years compared to 674 trillion won in 2015. Life insurers have set aside 626 trillion won, and non-life insurers 226 trillion won, but these amounts are still considered insufficient.

The burden of capital expansion is expected to become more tangible in the Liability Adequacy Test (LAT) conducted at the end of this month. LAT is a system designed to induce insurers to expand capital and accumulate liability reserves in preparation for the implementation of IFRS17. The problem is that as interest rates fall, additional reserve accumulation under LAT could lead to large-scale losses, which would negatively affect insurers' profitability, financial soundness, and overall financial indicators.

There is also analysis that since the interest rate cut effect has been pre-reflected in the bond market, immediate capital expansion may not be necessary.

A life insurance industry official explained, "While short-term bond yields have fallen due to the low benchmark interest rate, long-term bonds have remained stable due to the Bank of Korea's announcement of government bond purchase plans," adding, "We believe insurers are not yet at the point where they must expand capital in the LAT evaluation."

However, if the 10-year government bond yield falls, the burden of additional liability reserve accumulation could arise at any time, which is a variable to watch. A Financial Supervisory Service official said, "If further interest rate declines occur, we plan to take flexible measures by adjusting variables affecting discount rates according to scenario-based situations."

Experts point out that insurers need to review crisis response scenarios and reestablish asset management strategies in line with interest rate cuts. Noh Gun-yeop, a research fellow at the Korea Insurance Research Institute, advised, "Portfolios should be restructured focusing on products less sensitive to interest rates to reduce interest rate sensitivity," and added, "In the investment sector, since it is difficult to generate returns from bonds, insurers should consider alternative and overseas investments to increase asset yields."

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