Insurance companies in Korea saw their capital strength improve as of the end of first half of 2022, with their average risk-based capital (RBC) ratio increasing by 9.4%p quarter on quarter to 218.8%. This improvement came after the ratio had dropped for the three quarters in a row since the third quarter of 2021 amid rising interest rates. The average RBC ratio of life insurers rose by 7.4%p to 216.2%, while the ratio of non-life insurers jumped by 12.7%p to 223.2%.
The amount of insurers’ available capital increased by 5.6% to KRW 144.1 trillion as of the end of June 2022 due to the inclusion of surplus under the Liability Adequacy Test (LAT) into available capital. In June 2022, the Financial Services Commission (FSC) introduced a measure to allow insurance companies to recognize a portion of their LAT surplus as available capital when calculating RBC ratios in a bid to help insurers who are struggling with plummeting RBC ratios due to rising interest rates. As a result, LAT surplus of KRW 33.3 trillion was added to the available capital in the latest calculation of RBC ratios as of late June 2022, even though interest rate hikes caused a decrease of KRW 23.4 trillion in accumulated other comprehensive income. Since the new measure has become effective, insurers are now allowed to add up to 40% of the LAT surplus to their available capital within the limit of losses on the valuation of available for sale securities.
Meanwhile, there was a 1.2% reduction in their required capital owing to an increase in interest rate risks. Insurers saw their interest rate risks grow as the maximum duration of insurance liabilities that is used for interest rate risk calculation has been further extended to 50 years from the current 30 years. With this change likely to create a wider gap between the durations of assets and liabilities, insurers have been exposed to higher interest rate risks, and their RBC ratios may drop unless there is an increase in capital. The gradual extension of the maximum duration of insurance liabilities has been intended to help insurers prepare for the implementation of the Korean Insurance Capital Standards (K-ICS), which will replace the current RBC regime in 2023. On the other hand, their credit risks declined because of a fall in invested assets. As of late June 2022, the total invested assets of insurers shrank to KRW 1,028.8 trillion, down 1.5% from three months earlier.
Although the RBC ratios of insurers in Korea have improved recently, solvency capital management has remained one of the top priorities for the insurance industry. Many insurers have been exploring various options to boost their RBC ratios by reducing capital requirements or increasing available capital because they have been under rising pressure in terms of capital strength, with the implementation of IFRS 17 scheduled for 2023 along with K-ICS, which will require strengthened capital adequacy. Rising interest rates on new bonds continue to have a short-term adverse effect on insurers’ bond portfolios as the value of older bonds remaining on their portfolios has been lowered, cutting into unrealized capital gains.
The RBC ratio of an insurer is a key measure of how financially strong an insurer is, indicating its ability to absorb losses and pay insurance claims to policyholders. It gives insight into the insurer’s cash flow as well as whether this cash flow is adequate enough to meet the company’s liabilities. The lower the RBC ratio, the higher the likelihood that the company will default on its financial obligations.
Insurers are required by law to maintain the ratio at 100% or above in Korea, and their RBC ratios are regularly monitored by the supervisory authorities. In case of any signs of deterioration in the ratio, the financially weakening insurer will be guided to take proactive actions such as more rigorous stress testing and capital raising. The Financial Supervisory Service, which supervises insurance companies in Korea, is responsible for identifying solvency issues of insurers at an early stage and intervening effectively in order to minimize losses to policyholders.