In response to the decline in risk-based capital (RBC) ratios of insurance companies following interest rate hikes resulting in an increased level of losses on bond valuations, the authorities prepared a measure aimed at providing a buffer to release some of the excess that insurance companies can recognize as available capital for calculating RBC ratios, the Financial Services Commission (FSC) said in a statement.
The FSC specifies that the authorities will take into account the inclusion of the excess LAT (liability adequacy test) in the capital available for the calculation of the RBC ratios. Insurers will be able to include 40% of the excess LAT in their available capital within the limit of losses on the valuation of bonds available for sale.
The FSC released the statement after a meeting on June 9 to review risks and discuss response measures in the insurance industry in the face of increasing volatility in the financial environment.
The meeting thoroughly discussed risk factors in global financial markets such as interest rate hikes and exchange rate volatility following monetary tightening by major economies amid inflationary pressure and war in Ukraine. Meeting participants discussed long-term and short-term response measures.
Under the FSC ruling, 40% of the excess LAT reserve, which represents an increase in insurance liabilities, is deducted from available capital in times of falling interest rates. Given this, when interest rates rise, the incorporation of 40% of the excess LAT amount will be counted as an increase in available capital.
Given that the recent decline in RBC ratios is primarily due to losses on the valuation of available-for-sale bonds that insurers are maintaining in an effort to match them to their long-term insurance liabilities, the offset for accounting purposes will be limited to such losses, says the FSC. .
When applying this cushion, it is expected that insurance companies will be able to maintain their financial strength in a stable manner, as the RBC ratios of some of the insurers who have recently seen their RBC ratios drop will be greater than 100%.
Strengthening the management of exchange rate variations
In addition, the authorities discussed the need for closer monitoring of the currency liquidity of insurers and alternative investments deemed to be at risk and for closer management and supervision of insurers in order to enable companies to insurance to prepare adequately for risks.
The meeting participants shared the same view that insurers need to fundamentally improve the soundness of their capital structures through capital increases in order to ensure that a sufficient level of payment capacity is maintained in response to increasing financial market volatility. For insurers that have raised capital through the issuance of hybrid securities and subordinated bonds to maintain the RBC ratio requirement, their capital structures have become vulnerable to changes in market variables such as the interest rate.
As the new capital adequacy regime (K-ICS or Korea Insurance Capital Standard) will come into force in 2023 and will allow for more accurate measurement of insurers’ risks, authorities will continue to perform risk-weighted impact assessments on insurers and to promote capital growth for those with low levels of solvency through capital increases with consideration, etc.
It is expected that the RBC buffer will begin to apply from the calculation of RBC ratios for the end of June period. In addition, the authorities plan to maintain close monitoring of market situations and strengthen management and supervision to ensure the solidity of insurers despite the unfavorable financial environment.
Gil Jo, an analyst at Moody’s Investors Service, said: “The decision by the Financial Services Commission (FSC) to allow Korean insurers to recognize up to 40% of their liability adequacy test excess in as long as capital available until the introduction of the new capital regime in January 2023 will benefit insurers.
“This will provide them with a buffer to withstand the decline in their local risk-based capital (RBC) ratios in a rising interest rate environment. The FSC has also set a limit that insurers cannot adjust their capital available only to the extent of the mark- the market losses when valuing the bonds in the available-for-sale account.
“We expect the regulatory easing will allow most insurers to keep their local RBC ratios above the regulatory minimum of 100%.”