The implementation of K-ICS will reshape Korean insurers’ strategy

The implementation of the Korean Insurance Capital Standard (K-ICS) will continue to reshape Korean insurers’ operational strategy, as insurers seek to optimise capital efficiency and reinforce solvency adequacy, says Fitch Ratings.

The year 2023 is going to be a transformative year for the Korean insurance industry given that major regulatory changes are taking effect and their implications could be significant across the insurance sector.

A grace period of 10 to 20 years will be given at the same time, with the standard implemented in stages.

The grace period, which is to help South Korean insurance companies prepare for the new regulation, is linked to the fact that the completion of implementation of Solvency II in the European Union is scheduled for 2032.

From 2023 to 2024 or 2025, the current risk-based capital (RBC) and the K-ICS may be simultaneously applied so that the companies’ shocks and risks can be mitigated and dispersed. 

The adoption of K-ICS in 2023 has affected South Korean insurers’ solvency strength to varying degrees depending on their capital structure and risk profile. Many insurers are still in the process of fully adopting the framework.

Fitch believe insurers are likely to revise their business mix or investment strategy constantly during the transition phase to optimise their level of required capital, aside from enhancing available capital through fresh equity infusions or issuance of capital supplementary bonds.

They could also utilise reinsurance, including co-insurance arrangements, for capital management, depending on affordability.

Implementation of IFRS 17

The insurance industry implements the transition to International Financial Reporting Standard 17 (IFRS 17) starting January 1, 2023. The accounting transition to IFRS 17 represents the most sweeping change in decades to financial reporting for insurers.

The new accounting standard is designed to achieve the goal of a consistent, principle-based accounting for insurance contracts, bringing fundamental changes to accounting, actuarial, and reporting practices in the insurance industry.

It will be a globally uniform basis for the accounting of insurance contracts.

In 2023, improvements will be made in insurance financial statements due to the implementation of IFRS 17, and more transparent and useful information will be provided in financial reporting of insurance companies. While the impact of changes will be notable for life insurers, the accounting transition will still be important for all insurers across the board.

Implementation of K-ICS

The Korean Insurance Capital Standard (K-ICS), a full-fledged risk-based capital system, comes into force on January 1, 2023 in step with the implementation of IFRS 17.

The required capital is calculated for a new set of five risk categories: life/long-term insurance risk, general P&C insurance risk, market risk (including interest rate risk), credit risk and operational risk.

This new capital regime requires insurance companies to measure their assets and liabilities at market value and use a full fair-value balance sheet to calculate the amount of required capital, which is consistent with global best practices and standards.

It allows risk measurement to be more precise using shock scenarios, and the required capital of an insurer is defined as the value-at-risk (VAR) of the own funds of the insurer subject to a confidence level of 99.5%.

A major change in risk categories is the division of insurance risk into life/long-term insurance risk and general P&C insurance risk, with four subcategories being created within insurance risk – longevity, surrender, expense and catastrophe. A new subcategory under market risk is asset concentration.   

K-ICS was rolled out alongside the adoption of IFRS 17. A major feature that differentiates K-ICS from the previous risk-based capital regime (RBC) is that it requires insurers to adopt marked-to market valuations for both assets and liabilities.

Other key considerations under K-ICS include the addition of more granular risk categories that were not measured under the previous RBC regime, such as longevity, surrender, expense and catastrophe risks. K-ICS also tightens the confidence level used to calibrate the regulatory capital regime to 99.5%, from the previous 99%.

The regulator grants insurers a period of up to 10 years to apply transitional measures, to allow a smooth transition to the new regime.

The transitional measures are divided into four categories – insurance risk, equity risk, interest risk and available capital – and insurers can apply a measure in each category, based on their capital condition, for gradual recognition of the K-ICS framework.

A total of 19 insurance companies, out of the 53 in the market, had applied the transitional measures as of end-March 2023, according to the regulator. The 19 companies comprise 12 Korean life insurers, 6 non-life insurers and one reinsurance company.

The average K-ICS ratio without applying the transitional measure amounted to 192.7% at end-1Q23, ranging between -0.6% and 359.7%.

Three of the life insurers’ K-ICS ratios fell below 100% of the regulatory minimum without the transitional measure, due mainly to the sharp decline in available capital under the new regime and relatively small contractual service margin.

The market capital ratio under the previous RBC framework was 206.4% at end-2022. Nonetheless, the average K-ICS ratio improved to 219.5% if we consider the transitional measure for life insurers.

Fitch believe insurers that applied transitional measures are likely to adjust their operational approach continuously in terms of business composition or asset mix to defend their capital adequacy, as required capital will rise gradually each year during the transition period.

This could be particularly true for small- and medium-sized life insurers with small contractual service margins if they have difficulty strengthening available capital through equity or subordinated debt issuances.

Yana Keller   by Yana Keller