Insurers face 2 trillion won reserve hit as new actuarial rules take effect

New actuarial standards requiring insurers to factor inflation into operating expenses — including new contract costs and policy maintenance costs — will take effect starting with second-quarter financial results this year. Some small and digital insurers with structurally high expense ratios are expected to absorb a significant blow. Higher liabilities directly reduce the contractual service margin (CSM) — the core measure of future profits under the IFRS 17 accounting framework — so companies hit hardest will face simultaneous pressure on both earnings and capital adequacy.

The additional best-estimate liabilities (BEL) insurers must set aside this year under the "actuarial supervision advancement plan" are estimated at roughly 2 trillion won ($1.31 billion) across the industry, according to insurers and financial authorities Thursday. Insurers had earlier submitted impact assessments to financial authorities showing how the new actuarial assumption standards would affect their balance sheets, BEL, risk adjustment (RA) and CSM, and authorities are now consolidating and analyzing those submissions.

BEL represents the present value of an insurer's projected future insurance payouts and operating expenses, minus the premiums it expects to collect — in essence, money set aside in advance to cover future obligations.

The critical issue lies in the variance hidden behind the industry average. The 2 trillion won figure amounts to just 0.4 percent of the industry's total BEL of 585.6 trillion won, but the impact varies sharply from company to company. Some insurers with structurally weak expense profiles could see their own BEL rise by as much as 4 to 5 percent. Actuarial firm analyses suggest that for the subset of companies with the most vulnerable expense structures, the burden could be as much as 10 times the industry average.

Earlier this year, the Financial Services Commission and the Financial Supervisory Service announced the actuarial supervision advancement plan, saying they aimed to improve the objectivity of insurance liability valuations. The initiative targets the so-called "rubber-band accounting" practice, in which insurers set overly optimistic assumptions for future loss ratios and expenses to understate their liabilities. Among the various items covered, the change to expense assumptions carries the largest impact. Unlike most other items, which apply only to new contracts going forward, the revised expense assumptions are applied retroactively to all existing policies.

Incorporating inflation into expense assumptions means the projected cost of maintaining and servicing policies grows each year, increasing the reserves that must be held. The resulting rise in liabilities eats into the CSM — the measure of profits an insurer expects to earn from its in-force policies. The CSM is both the primary source of reported earnings under IFRS 17, as a fixed proportion is recognized as profit each year, and a central indicator of the framework's health.

The liability increase does not stop there: it flows through to a reduction in capital, pulling down the Korea Insurance Capital Standard (K-ICS) solvency ratio, the key measure of an insurer's financial soundness. Companies most affected face simultaneous pressure on both future profits and capital adequacy. "Looking at the overall ratio, it may seem small, but for companies bearing the brunt of the burden, this is anything but trivial," one insurer official said. "Depending on a company's financial strength, it hits some harder on the profit-and-loss side and others harder on the K-ICS."

Against this backdrop, insurers of all sizes have engaged accounting firms for consulting. Major firms including Samil PwC and Samjong KPMG have been brought in. Large non-life insurers are focused on calibrating the appropriate level of expense assumptions under the new standards, while life insurers and smaller companies facing heavier burdens are concentrating on securing exemptions under an exception clause. Financial authorities included a provision allowing companies to forgo the inflation adjustment if they can document a reasonable basis for doing so — meaning firms that can adequately explain their own expense structures may be able to build their own case and reduce the impact.

The burden grows heavier the smaller the company. For small and mid-size insurers and digital insurers with thin CSM buffers, the increase in liabilities could translate directly into losses rather than merely reduced profits. Digital insurers in particular argue that applying inflation adjustments is fundamentally at odds with their business model. Because policy maintenance and servicing are handled almost entirely through online self-service, they say labor-driven inflation has little bearing on their costs — and that once systems are built, processing costs tend to fall rather than rise.

Financial authorities say they will make decisions after fully hearing out the industry. "We have allowed companies to set and apply their own standards if they have a reasonable basis for doing so," a financial authority official said. However, the bar for exemptions is high. "It would be difficult to change the overall framework or delay implementation," the official added, drawing a line: "What a company considers a reasonable standard and what the authorities consider reasonable may not be the same."

Ultimately, a tug-of-war between insurers and financial authorities over how broadly to recognize "reasonable grounds" for exemptions is expected to continue. Detailed guidelines incorporating the new standards are set to be finalized and distributed by the end of this month, with immediate application to second-quarter results.

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https://biz.heraldcorp.com/article/10769469?sec=002