Industry experts have expressed concerns about South Korea’s smaller and mid-tier insurers’ ability to meet proposed mandatory core capital requirements, which could lead to increased consolidation in the market.
This month, the Financial Supervisory Service (FSS) announced plans for a two-fold change to capital requirements. The first change involves reducing the capital adequacy ratio of the Korean Insurance Capital Standard (K-ICS) from 150% to between 130% and 140%. The second would introduce a mandatory requirement for insurers to maintain a core capital solvency ratio above 50%.
The new regulatory framework is expected to be finalised in the first half of the year and applied starting from year-end financial statements. While the first change would ease capital requirements, the latter would add pressure to the industry, particularly for smaller insurers.
“Large-sized insurers could have the capacity to increase their core capital due to their stronger financial positions and broader access to capital markets. However, mid-sized and smaller insurers could face significant challenges in meeting these core capital requirements,” Sue Kim, Associate Director at Fitch Ratings, tells (Re)in Asia.
Capital adequacy, measured under the K-ICS standard, is a broader measure that includes supplementary capital such as bonds and reflect an insurer’s overall financial stability. In comparison, core capital refers to high-quality—also known as Tier 1—capital and retained earnings, which are essential to maintaining operational stability and absorbing potential losses.
Sue Kim
Associate Director at Fitch RatingsWhile the easing in overall capital adequacy requirements will provide some relief for insurers’ capital management, the implementation of a core capital ratio is expected to be burdensome, Ben Son, CEO of Lockton Korea, tells (Re)in Asia. “Increasing basic capital can realistically only be achieved through limited means such as capital increases or increases in current net income.”
In response to the introduction of a mandatory core capital requirement, insurers would likely conserve profits rather than pay dividends to shareholders. “In the short-term, we expect that insurers might choose to retain their earnings without distributing them as dividends to shareholders in order to bolster their core capital levels,” says Kim.
Ben Son
CEO of Lockton KoreaIndustry changes
Korea shifted to K-ICS, as well as the IFRS-17 accounting standard, in January 2023. AM Best says the K-ICS framework “enhances insurers’ overall risk management capabilities through higher and stricter solvency requirements and a more economic-based valuation of available capital.”
Korean insurers have seen declining K-ICS ratios despite a significant surge in operating profits, largely due to regulatory changes — including the phased realisation of discount rates and the gradual expiration of transitional measures aimed to help the industry transition to the K-ICS standard.
“Consequently, since 2024, there has been a surge in capital raising by insurance companies through instruments like hybrid bonds and subordinated bonds,” Son says. “This has increased the interest burden on these companies.”
The new K-ICS standards have also made capital raising efforts less effective, as the absolute amount of required capital has increased to 2-3 times the amount needed under IFRS 4, Son adds.
And as K-ICS standards tighten and interest rates decline, insurers face mounting pressure. “We see (an) increasing pressure on insurers’ solvency ratios, and, subsequently, a rapid increase in the issuance of capital supplementary instruments that can lead to greater interest expense obligations and potentially undermine (insurers’) quality of capital,” says Seokjae Lee, Senior Financial Analyst at AM Best.
As a result, more reinsurance arrangements are being used as a capital management tool to preserve their K-ICS ratio, says Youngjin Kim, Partner for Actuarial and Risk Consulting at EY. “Mass Lapse and Financial Reinsurance (Co-Re) policies are being actively traded on the Korean reinsurance market. We expect to see continued growth in reinsurance products designed to support the K-ICS ratio,” he adds.
Youngjin Kim
Partner for Actuarial and Risk Consulting at EYInsurers who have been struggling to meet the new K-ICS requirements have already become acquisition targets, EY’s Kim says. And the new capital rule could accelerate the process.
Industry-wide, the Core Capital K-ICS ratio stood at 132.6% in September last year, down from 145.1% in March 2023, according to data from the FSC.
While the new measures have not been finalised, should the FSS implement a core K-ICS ratio of 50%, seven domestic insurers risk falling below the requirements, according to an analysis by Korean business news outlet Electronic Times.
The outlet’s analysis of the Q3 financial results of 40 domestic insurance company disclosures—22 life and 18 non-life—found that seven had Korea Insurance Capital Standard (K-ICS) core capital ratios below 50%.
The majority of overall capital from these insurers was composed of supplementary capital like bonds, instead of Tier 1 capital and retained earnings, according to the analysis. Two insurers, KDB Life and Fubon Hyundai Life, had negative ratios.
“Market consolidation could take place if the cost of capital is highly in excess of the return that insurers are able to generate from the insurance books,” Sue Kim says.
Sue Kim
Associate Director at Fitch RatingsA focus on fundamentals
While the introduction of core capital requirements could fundamentally alter how insurers manage their capital, the easing of overall capital adequacy requirements may provide some short-term relief by reducing the pressure on insurers to meet solvency standards.
“The reduction of the K-ICS ratio will contribute to a decrease in the issuance of hybrid bonds and subordinated bonds by insurance companies for the time being, and may provide some relief in their capital management,” says Son.
Korean insurers have used hybrid bonds and subordinated bonds as a means to bolster their K-ICS ratio. These instruments have been attractive because they can be treated as regulatory capital, helping insurers meet solvency requirements without diluting shareholder equity.
However, excessive debt issuance creates higher interest burdens and fails to fundamentally improve an insurer’s fundamental financial soundness, notes Fitch’s Kim.
Insurers are expected to continue issuing capital securities in preparation for tightening liability discount rates and expected interest rate cuts. “However, whether insurers’ reliance on subordinated debt will decrease depends on their target capital structure, risk appetites, and costs associated with different forms of capital issuances,” she adds.
Seokjae Lee
Senior Financial Analyst at AM BestIn the medium term, insurers could have more leeway in dividend policies following changes to surrender value reserve standards that have constrained some insurers’ distributable capital, AM Best’s Lee says.
“That said, the simultaneous adoption of mandatory core capital K-ICS ratio can partly balance the impact of the regulation easing,” Lee adds. “It will push insurers with relatively weak or moderate solvency positions to focus more on fundamental improvements, such as by expanding profit retention, issuing new shares or reducing risk exposures.”
South Korea’s regulators do not distinguish between accounting standards insurers use for financial reporting and standards regulators use to assess insurers’ solvency, says Son, essentially eliminating any flexibility insurers have in presenting their financial position to investors or regulators.
Strict regulatory prescriptions have overshadowed the need for ‘market autonomy’, Son adds. “It is expected that insurers may face challenges this year due to the continued influence of regulatory accounting, and thus, market stabilisation is anticipated to take additional time.”
