By AIR team | June 13, 2022
In response to insurance companies’ declining risk-based capital (RBC) ratios following interest rate hikes causing an expanded level of losses on the valuation of bonds, the authorities have prepared a measure for providing a buffer to release a portion of surplus that insurance companies may recognise as available capital for calculating RBC ratios, says the Financial Services Commission (FSC) in a statement.
The FSC says that the authorities will recognise the inclusion of the LAT (liability adequacy test) surplus into the available capital for the calculation of RBC ratios. Insurers will be able to include 40% of the LAT surplus to their available capital within the limit of losses on the valuation of bonds available for sale.
The FSC issued the statement after a meeting on 9 June to review risks and discuss response measures in the insurance sector amid increasing volatility in the financial environment.
The meeting discussed in depth the risk factors in global financial markets such as interest rate hikes and exchange rate volatility following monetary tightening by major economies amid inflation pressure and the war in Ukraine. Meeting participants dealt with long- and short-term response measures.
Under the FSC’s decision, 40% of the LAT surplus reserve, which represent an increase in insurance liabilities, is deducted from the available capital in times when interest rates fall. Considering this, when interest rates rise, the incorporation of 40% of the LAT surplus amount will be recognised as an increase in the available capital.
As the recent drop in RBC ratios is mainly due to losses on the valuation of bonds available for sale which insurers maintain for the purpose of matching with their long-term insurance liabilities, counterbalancing for accounting purposes will be restricted to such losses, says the FSC.
When applying this buffer, it is expected that insurance businesses will be able to stably maintain their financial soundness as the RBC ratios of some of the insurers that have recently seen a drop in their RBC ratios will be above 100%.
Strengthening management over exchange rate changes
In addition, the authorities discussed the need for closer monitoring of insurers’ foreign exchange liquidity and alternative investments that are deemed to be at risk and more closely managing and supervising insurers to enable insurance businesses to adequately prepare for risks.
Capital increases
Participants at the meeting shared the same view that insurers need to fundamentally enhance the soundness of their capital structures through capital increases in order to ensure maintaining a sufficient level of payment capabilities in response to deepening volatility in financial markets. For insurers that have been raising capital through the issuance of hybrid securities and subordinated bonds to maintain the RBC ratio requirement, their capital structures have turned 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 that will allow more precise measurement of the risks of insurers, the authorities will continue to perform weighted impact assessments on insurers and promote capital growth for those that have low capital adequacy levels through capital increase with consideration, etc.
Further plan
It is expected that the RBC buffer will begin to apply from the calculation of RBC ratios for the end of June period. Moreover, the authorities plan to maintain close monitoring of market situations and strengthen management and supervision to ensure that insurers are sound despite the unfavourable financial environment.
Moody’s comment
Gil Jo, analyst at Moody’s Investors Service, said, “The decision by the Financial Services Commission (FSC) to allow Korean insurers to recognise up to 40% of their liability adequacy test surplus as available capital until the introduction of the new capital regime in January 2023 will benefit insurers.
“It will provide them with a buffer to withstand the decline in their local risk-based capital (RBC) ratios amid rising interest rates. The FSC has also set a limit that insurers can only adjust up their available capital to the extent of mark-to-market losses upon the valuation of bonds under the available-for-sale account.
“We expect the regulatory relaxation to enable most insurers to maintain their local RBC ratios above the regulatory minimum of 100%.”