Insurance Industry's New Capital Securities 'Call Option' Unexercised... Uneasy Financial Market [Song Seungseop's Financial Light]

Long or No Maturity, High-Interest 'New Capital Securities'
In Korea, Early Redemption by Exercising Call Option is Customary
Heungkuk and DB Life Break Custom, "No Call Option Exercise" Causes Stir
Concerns Over Further Deterioration of Already Unstable Capital Market
Political Circles Also Urge "Need for Countermeasures"

Editor's NoteFinance is difficult. It is filled with puzzling terms and complex backstories intertwined. Sometimes, you need to learn dozens of concepts just to understand a single word. Yet, finance is important. To understand the philosophy of fund management and consistently follow the flow of money, a foundation of financial knowledge is essential. Therefore, Asia Economy selects one financial issue each week and explains it in very simple terms. Even if you know nothing about finance, you can immediately understand these 'light' stories that will light up your understanding of finance.

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[Asia Economy Reporter Song Seung-seop] The domestic capital market is filled with 'unease.' This is because insurance companies have decided not to exercise the 'call option' on their 'hybrid capital securities.' Despite stabilization measures by the government and financial authorities, events are occurring that cause investors to close their wallets. What are hybrid capital securities and call options? How does the decision of insurance companies affect the domestic investment market?

Financial companies raise funds in various ways. They collect deposits and savings from customers, issue bonds, sell stocks, or borrow money from other banks. With this money, banks and card companies lend to other customers, and insurance companies pay out insurance claims. Among these methods, the financial companies particularly favor using 'hybrid capital securities.'

Debt That Does Not Need to Be Repaid, 'Hybrid Capital Securities'

Hybrid capital securities are, as the name suggests, a new type of security. They have characteristics of both bonds and stocks, so they are also called 'hybrid bonds.' They are bonds issued by companies but can be bought and sold in the market like stocks. Although price fluctuations are minimal and trading volume is low, in principle, it is possible to buy them cheaply and sell them at a higher price. In fact, high-net-worth individuals both domestically and internationally have invested in financial companies' hybrid capital securities and earned substantial profits.

Another characteristic of hybrid capital securities is that they have very long or no maturity. Such bonds are called 'perpetual bonds.' Normally, bonds must be repaid with interest after a certain period. For example, 'I will pay you 1.2 million won in one year, so please invest 1 million won now.' However, hybrid capital securities have no condition on when they must be repaid. They can pay interest forever without returning the principal. Therefore, they are recorded as 'capital' rather than 'liabilities' on accounting books.

The nature of hybrid capital securities as 'debt that does not need to be repaid' yet 'recognized as capital despite borrowing money' was a significant merit for financial companies. Domestic financial companies are subject to very strict regulations. They cannot hold too many risky assets, nor can they take on excessive debt. They must comply with set limits. But issuing bonds in this form allows them to conveniently raise funds while being less affected by regulations, which is naturally advantageous.

Exercising Call Options for Early Redemption Is Domestic Practice

Of course, there are drawbacks. Hybrid capital securities generally have higher interest rates than regular bonds. From an investor's perspective, hybrid capital securities are products where the principal may never be returned. Also, hybrid capital securities include clauses that allow the company to reduce the principal or skip interest payments if the company is struggling. The repayment order is after secured bonds, general bonds, and subordinated bonds, classified as 'sub-subordinated bonds.' Given these risks, it is natural that investors are offered higher interest rates.

So, do investors who put money into hybrid capital securities only receive interest forever without ever getting their principal back? Not necessarily. Hybrid capital securities have a 'call option.' A 'call option' means the 'right to buy.' It is the right to repurchase under predetermined conditions after a certain period. Financial companies sell hybrid capital securities with no maturity but usually grant the right to repurchase at a set price after five years.

In Korea, exercising the call option has been considered customary. Among investors, there was a belief that 'if I wait five years after buying hybrid capital securities, financial companies will repurchase them (exercise the call option).' This belief had grounds. First, if the call option is not exercised, the company's reputation is likely to suffer. Moreover, if the call option is not used, higher interest rates will apply thereafter. The belief was, 'Financial companies, for whom trust is crucial, would not damage their reputation by paying more interest; they will definitely exercise the call option.'

Heungkuk and DB Life Break the Custom by Not Exercising Call Options

However, on the 1st, one insurance company, Heungkuk Life Insurance, decided not to exercise the call option on its hybrid capital securities. These securities were foreign currency hybrid capital securities worth 500 million dollars (about 700 billion won), issued in November 2017, with maturity scheduled for the 9th. Soon after, DB Life Insurance postponed the call option on 30 billion won worth of hybrid capital securities, scheduled for the 13th, to May next year. DB Life said it 'changed the contract through consultation with investors.' This is the first time in 13 years since Woori Bank in 2009 that a domestic financial institution has issued hybrid capital securities and not redeemed them early.

Why did these insurance companies not exercise the call options? The financial sector cites interest rate hikes as the reason. Current market interest rates have more than doubled compared to when the two insurance companies borrowed money in 2017. To exercise the call option (repay the money), they would need to raise funds elsewhere, but the capital market is frozen, making it difficult. Therefore, they seem to have judged that it is better not to exercise the call option and instead apply higher interest rates.

One might think, 'Can't they just issue new hybrid capital securities to repay the old ones?' While possible, it is not easy. Insurance companies must comply with a regulation called the 'Risk-Based Capital (RBC) ratio.' RBC indicates how sound their financial condition is and how well they can pay insurance claims. However, with interest rates currently so high, issuing new hybrid capital securities would impose a significant interest burden. This would lower the RBC ratio, making it a burdensome choice for insurance companies.

Financial authorities and the industry say there is no need to be overly concerned about the breaking of the 'call option exercise' custom. They say the insurance industry's risk is small and asset soundness is strong. On the 3rd, the Financial Services Commission issued a press release stating, 'The postponement of the early redemption date was made through prior mutual consultation between DB Life and investors, so it is not a failure to exercise the early redemption right,' and 'The investors in the relevant hybrid capital securities are few, and these securities are not traded in the market.' They also added, 'There is no impact on the bond trading market.'

Market Already Unstable... Political Circles Also Call for "Countermeasures"

However, concerns remain that the market could become unstable. Trust has been broken. If investors start thinking, 'Even if I invest in hybrid capital securities, Korean financial companies might not exercise call options,' raising funds will become even more difficult. Since market interest rates are expected to continue rising, there are worries that other financial companies might also not exercise call options. If this unease is not resolved, issuing hybrid capital securities will become difficult, and financial companies will be forced to offer even higher interest rates, deepening a vicious cycle.

Financial Services Commission Chairman Kim Ju-hyun is attending the National Assembly's audit on the Financial Services Commission held on the 24th, responding to questions from lawmakers. Photo by Yoon Dong-ju doso7@

Financial Services Commission Chairman Kim Joo-hyun emphasized that 'the important thing is the investors' position, not the authorities.' On the 4th, after attending the 'World Economy Institute-Woori Financial Group International Conference' held at the Shilla Hotel in Jung-gu, Seoul, Kim told reporters, 'If problems are perceived externally, it cannot be helped,' and pointed out, 'The insurance industry seems not to have considered this much.' He added, 'This is also a market that must be managed, so we need to think about how to respond.'

Voices calling for countermeasures have also emerged in political circles. Lee Jae-myung, leader of the Democratic Party of Korea, said, 'In addition to the financial crisis triggered by Kim Jin-tae, the recent call option abandonment by Heungkuk Life has further frozen the capital market, making the liquidity crisis a reality,' and urged, 'We must prepare preemptive measures assuming a chain of defaults and anticipate where and how collapses might occur.' He continued, 'While Heungkuk Life's abandonment of the call option is a rational choice from the company's perspective, it breaks the trust that the money will be repaid after five years, which could spread sparks throughout the bond market,' and criticized, 'This is a crisis like thin ice that collapses at the slightest touch, so patchwork measures cannot overcome it.'

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