Will Interest Rates Rise Further by Year-End... Insurance Companies Take a Breather

Base Interest Rate Hike After 15 Months
Bond Investment Profit and Loss Improvement Expected

[Asia Economy Reporter Oh Hyung-gil] With the base interest rate hike, insurance companies are expected to improve their performance by increasing profitability. However, it is also anticipated to have a negative impact on soundness by lowering capital.

The Financial Monetary Policy Committee of the Bank of Korea held a monetary policy meeting on the 26th and raised the base interest rate by 0.25 percentage points (p) from 0.5% to 0.75%. This is the first increase in 2 years and 9 months since November 2018.

The insurance industry expects this rate hike to be the first to affect profits.

Insurance companies invest the premiums received from policyholders. In particular, the proportion of bonds, which guarantee stable returns, is overwhelmingly high. According to the Korea Insurance Research Institute, as of the end of last year, bonds accounted for 47.9% of life insurers' managed assets and 36.1% of non-life insurers' managed assets.

If interest rates continue to rise, new bond investments will apply higher yields than before, potentially improving investment gains and losses. When the base interest rate rises, bond prices fall and bond yields increase.

[Image source=Yonhap News]

Also, if operating asset income rises due to the interest rate increase, the burden of negative interest margin, which has troubled insurance companies in the past, can be reduced. Due to the deterioration of bond yields, asset management returns have sharply declined, causing losses as companies cannot cover the interest on high-interest products sold in the past with rates around 7-8%.

For life insurers that sold high-interest fixed products, the burden rate on insurance reserves was 4.09% as of September last year, higher than the operating asset yield of 3.30%.

However, since market interest rates have risen since early this year, and much of this base rate hike has already been reflected, there is also an interpretation that the actual impact on increasing asset management income will be limited.

Moreover, the interest rate hike may lower soundness. If the upward trend in interest rates continues, the solvency margin ratio (RBC ratio) of insurance companies may decline, worsening capital adequacy. Under the current insurance liability evaluation system, rising interest rates can lead to a decrease in capital and thus a reduction in the RBC ratio.

Insurance companies holding bonds in an available-for-sale form may face negative effects from this base rate hike. Since bond prices and interest rates move inversely, rising interest rates cause the prices of available-for-sale bonds to fall, resulting in valuation losses.

Insurance companies that have expanded capital through issuing hybrid capital securities and subordinated bonds may also face burdens from higher interest expenses due to rising rates.

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