Capital pressures linger as insurers adopt new accounting rule in South Korea

IFRS 17 adoption is seen to improve insight into margins and reserves, increase motivation for long-term profitability, and better global comparability for insurers.

Industry experts contend that the adoption of the International Financial Reporting Standard 17 (IFRS 17) by the insurance sector in South Korea raises valid concerns about potential strain on insurers’ capital reserves.

This adoption signals substantial transformations in the South Korean insurance landscape, with experts suggesting that relief might be found in interest-rate hikes, offering a potential solution to ease the negative spread burden for select insurers.

What transitioning entails

The impact of this transition, as a result of IFRS 17 adoption, will vary among insurers, depending on their business focus and investment risk profile, marking a period of comprehensive changes in financial reporting, capital requirements, and risk management within the industry.

“Companies implementing IFRS 17 must measure investment assets and insurance liabilities using market value, which means that companies with good asset-liability-match management and small duration gap can demonstrate their ability to maintain a low level of solvency sensitivity,” Trung Tran, analyst for Asia Pacific insurance at CreditSights, told Insurance Asia.

In compliance with regulatory requirements, all South Korean insurers have fully adopted IFRS 17, also known as KRFS 1117, since January 2023.

Companies are required to recognise profits under the standard, as they provide insurance services, rather than when they receive premiums, the IFRS 17 fact sheet stated. This change in accounting treatment ensures that profits are recognised over the duration of the insurance contract and aligns accounting with the timing of cash flows and services rendered.

“Under IFRS 17, insurance liabilities are valued based on market-consistent assumptions. Under previous IFRS 4-based accounting rules in Korea, insurance liabilities were measured using ‘locked-in’ assumptions at the inception of a contract,” Emily Yi, director at S&P Global Ratings, told Insurance Asia in a separate interview.

The standard also necessitates that companies provide information about the profits they expect to recognise from insurance contracts in the future. This forward-looking disclosure offers transparency about a company’s expected financial performance related to insurance contracts.

Korean insurers’ earnings are forecast to take small steps back to recovery due to the intense focus on “value-added products, better investment returns, a less negative spread burden, and normalised mortality margin,” Fitch Ratings stated.

“However, insurers are likely to prevail in a challenging operating environment from high-interest rates and the new accounting regime,” Fitch Ratings pointed out.

The impact and benefits of the new accounting regime can indeed vary between non-life insurers and life insurers, with certain advantages favouring non-life insurers, reinsurer Korea Re said.

The standard also requires insurance liabilities to be measured at market value, which can work in favour of non-life insurers.

This approach may result in lower liabilities for non-life insurers compared to the traditional cost-based measurement used by life insurers. Non-life insurers often deal with short-term insurance contracts that generate fewer and smaller liabilities, contributing to a more favourable financial impact.

IFRS 17 mandates the recognition of gains and losses over the entire duration of a contract rather than solely based on cash flows. This extended recognition period can benefit non-life insurers, particularly when they have a higher proportion of short-term protection policies.

Caveats to transitioning

Tran, of CreditSights, pointed out that the transition coincided with the implementation of the new solvency regime known as K-ICS (Korean Insurance Capital Standard).

South Korean insurers, such as Samsung Life, have tried to educate the public about regulatory changes. However, more communication is needed to clarify the full impact of IFRS 17 and K-ICS.

By March 2023, it has been clear that life insurers are more affected than non-life insurers. Some insurers, both local and foreign, have K-ICS ratios below the recommended 150%, indicating potential capital issues.

“For instance, Hana Life had a ratio of 117%, KDB Life only 48%, ABL Life had 111%, Fubon Life had 128%, and Tongyang Life had 162%. KDB Life and ABL Life are being put up for sale,” Tran said.

IFRS 17 has made asset and liability measurement market-based, emphasising asset-liability management (ALM) and duration gap management. A strong ALM strategy is crucial for mitigating earnings volatility, regardless of IFRS 17 adherence.

Meanwhile, Contractual Service Margin (CSM) and gradual amortisation aid earnings stability.

In anticipation of higher insurance liabilities, S&P Global Ratings’ Yi said insurers took several proactive steps such as reducing asset and liability duration mismatches, issuing hybrid capital instruments, and emphasising protection-type policies with higher margins.

A significant helping hand came from the rising interest rate environment in the country over the past two years. Higher domestic interest rates led to increased discount rates, resulting in lower insurance liabilities and reduced reserve requirements, thereby alleviating some of the initial capital pressure.

Long-term benefits

Tran said the adoption of IFRS 17 is set to offer advantages like decreased earnings fluctuations, increased motivation for long-term profitability, and improved global comparability for insurers (excluding the US and possibly Japan).

“These outcomes are in line with the preferences of most investors. However, regulators need to address issues such as tax matters and determine appropriate charges for new earnings; new tax laws will be passed,” the CreditSights expert said.

He added that “whilst policyholders for life insurers may benefit from the insurers’ more prudent approach to business growth, changes in the calculation of policyholder dividends may occur.”

On another note, S&P Global’s Yi said it will take some patience and elbow grease for insurance regulators and businesses until market players have a clear grasp of the new accounting standard. 

“Although major Korean insurance companies provided some explanation on their first quarter and first half financial disclosures, external stakeholders still face some difficulty in understanding the gap with prior disclosures,” she said.

Recently, the Korean regulator issued additional actuarial assumption guidelines that took effect in the third quarter of the year. Now, financial statements have a more detailed structure explaining these assumptions and guideline impacts. 

Over the long term, IFRS 17 is expected to enhance external stakeholder comprehension of insurance companies. The disclosure of contractual service margins and risk adjustments under IFRS 17 should improve insight into insurers’ margins and reserves for market participants. 

From CreditSights’ perspective, IFRS 17 offers greater consistency and better reflects the underlying economics of insurance compared to IFRS 4.