New rules, new disclosures. The rollout of International Financial Reporting Standards 17 and 9 and Korean Insurance Capital Standard (K-ICS) in Korea means the time has come to evaluate how its insurers have been adapting. In particular, we believe an insurer's capacity to manage capital volatility will indicate its financial strength.

IFRS 17 and 9 replace IFRS 4 and International Accounting Standard (IAS) 39 with revisions in local supervisory accounting rules from 2023. The financial and solvency disclosures of Korean insurers are shifting to better represent the underlying economics of the insurance business. This is because insurance liabilities under IFRS 17 reflect market-consistent interest rates and actuarial accounting assumptions whereas under IFRS 4, assets were based on market value and liabilities on book value. However, the new standards call for insurers to adopt more sophisticated management of interest rate risk and accounting assumptions.

The shareholders' equity of Korean insurers jumped following the transition to IFRS 17 and 9, which took effect in January 2023. This was mainly because of interest rate rises and partly because of the revised accounting treatments of insurance policy acquisition costs. That said, Korean insurers will likely continue to face some volatility in their capitalization. This could happen if reserving requirements increase more than asset valuations when interest rates decline or if new regulatory guidelines lead to revisions in reserve provisions.

To understand if the release in capital following IFRS 17 and 9 adoption will sustain amid tightening regulatory oversight and interest rate movements, we will examine financial disclosures and key actuarial assumptions applied by insurers under the new accounting rules. We note that fully audited financial statements under IFRS 17 and 9 will be made available around end-March 2024.

How The New Rules Change Reported Capital Positions, Particularly For Life Insurers

Since IFRS 17 and 9 took effect, the Korean insurance industry reported a large one-off jump in capital positions. The sector's aggregate reported shareholders' equity rose by about 88% as of end-June 2023 based on IFRS 17 and 9, compared with that at end-2022 based on prior accounting standards.

Life insurers saw an increase of about 110%--nearly twice the 60% increase for property & casualty (P/C) insurers. We attribute the outsized increment to a reduction in insurance liabilities amid higher interest rates. Concurrently, a revised treatment of insurance policy acquisition costs also contributed to the increase in shareholders' equity; although we estimate the extent to be smaller than the impact from higher interest rates.

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While higher interest rates help to alleviate the reserve burden of Korean life insurers under IFRS 17, their legacy high-yield fixed-rate guarantee policies will remain a concern for capital management. We estimate policies with more than 5% fixed-rate guarantees accounted for about 25% of Korean life insurers' reserves as of end-2022, based on IFRS 4 accounting rules. We expect Korean life insurers will continue to strengthen their asset-liability management to reduce duration mismatches.

Under IFRS 17, insurance liabilities are valued based on market-consistent actuarial and economic assumptions. Under the previous IFRS 4-based rules, insurance liabilities were measured using locked-in assumptions at the start of a contract.

While Korean insurers have been reducing asset and liabilities duration mismatch in the past several years ahead of the adoption of IFRS 17, the increase in domestic interest rates in the past two years has led to higher discount rates. This has helped to put the valuation of insurance liabilities on a more economic basis at the transition to IFRS 17. This is relevant to Korean insurers that have longer duration in liabilities than assets, such as life insurers and some P/C insurers with long-term insurance business.

In addition, at the transition to IFRS 17, revised accounting rules on the recognition of insurance policy acquisition costs led to a one-off increase in retained earnings for some insurers. Under IFRS 4, insurance policy acquisition costs that exceeded a local regulatory deferral limit were expensed immediately. Under IFRS 17, insurance policy acquisition costs are recognized evenly over the contract period, in line with the provision of insurance services, and included in the measurement of insurance liabilities. As a result, insurers that had recognized more upfront insurance policy acquisition costs in the past several years saw a one-off increase in retained earnings at the transition to IFRS 17.

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Continued Focus On Capital Management Amid Interest Rate Movements

In our view, insurers will maintain a very close eye on capital management, given the capital sensitivity to interest rates under IFRS 17 and 9. If the interest rate sensitivity of assets and liabilities are not well-managed, Korean insurers could face volatility in their capital positions.

As insurance liabilities are based on market value under IFRS 17, we will no longer need to make adjustments to incorporate unrealized gain/losses on life bonds. Previously under IFRS 4, we removed unrealized gains or losses from life bonds, to reflect market value of the liabilities under IFRS 4.

Ongoing Regulatory Developments Add Another Layer Of Complexity

Regulatory oversight on actuarial assumptions and management of interest rate risk is strengthening. In July 2023, the regulator announced additional guidelines on actuarial assumptions, which prevent insurers from reflecting overly optimistic assumptions; for example, on prospective loss ratios of medical indemnity policies. While the guidelines aim to enhance consistency and comparability of assumptions used among insurance companies, their application could result in restatements of financial statements for some insurers in the third quarter of 2023.

In addition, the regulator's plan to gradually adjust the calculation of the discount rate curve over the next four years could lead to reserve burden increasing for insurers. We expect this is especially the case for insurers with long-term liabilities or high-yield fixed-rate guaranteed liabilities. The regulatory adjustments include gradual reduction of the Korean won long-term forward rate to closer to 4.0% levels over the next three to four years from 4.8% in 2023.

The adjustments also include an extension of the last liquid point to reflect market risk-free rates up to 30 years--rather than the current 20 years--starting 2025. These measures will gradually lower the longer end of the discount rate curve over the next several years.

Korean Insurers To Update Risk Management Under K-ICS

Along with new accounting rules, a new regulatory capital framework, Korean Insurance Capital Standard (K-ICS), took effect this year. Under K-ICS, regulatory capital requirements are calculated based on market value of assets and liabilities with more granular risk categories and higher confidence level compared with the previous risk-based capital regime. Accordingly, we anticipate Korean insurers will strengthen risk management practices in relation to risk appetite and limits, asset-liability mismatches, and stress-testing frameworks.

The regulatory required capital increased for the overall industry under K-ICS. However, it was largely mitigated by the increase in available capital driven by growth in reported shareholders' equity and the provision of contractual service margins under IFRS 17. The industry average K-ICS ratio stood at about 198% as of end-March 2023, compared with the old RBC ratio of about 206% as of end-2022, well above the minimum regulatory requirement of 100%.

We expect rated insurers' capitalization to remain well above regulatory minimum requirements, amid the transition to IFRS 17. While we base our view on insurers' capitalization on our risk-based capital adequacy framework, narrowing regulatory solvency buffers could entail heightened regulatory intervention risks.

Incorporating IFRS 17 In Our Rating Analysis

In our capital projection under S&P Global Ratings' risk-adjusted capital framework, we need to assess how the financial statements based on IFRS 17 and 9 affect our forecast of retained earnings, and business growth or contraction, and changes in risk profile. For example, as insurers adapt to new accounting and solvency rules, strategies related to product mix, investment allocation, and shareholder return policies could also change.

We should be able to establish a more informed opinion on Korean insurers' credit profiles under the new regimes in the coming year, noting fully audited financial statements for fiscal year 2023 will be available in March 2024.

We anticipate that annual financial statements will provide more disclosures related to, for example, updated accounting policies, actuarial assumptions, interest rate risk sensitivity, and asset liability mismatch management, and comparative financial statements. We will assess and incorporate any persistent changes revealed by the new information into our assessment of the insurers' overall creditworthiness.

Editor: Lex Hall

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