🚨 Insurance Companies' Capital Securities Fundraising Trend and Background Analysis
Today Korean Economic News | 2025.01.31
📌 Insurance Companies' Capital Securities Fundraising Trend... Continues This Year
💬 The trend of insurance companies issuing capital securities (hybrid securities, subordinated bonds) is expected to continue this year following last year. This is because capital expansion has become necessary as the solvency ratio (K-ICS) has decreased due to the interest rate cut trend and the reduction of the insurance liability discount rate. However, uncertainties in global macroeconomic variables such as interest rates and exchange rates may act as variables.
1️⃣ Simple Explanation
There is news that insurance companies are actively issuing financial products called capital securities. Let's understand the background and meaning of this phenomenon easily.
What are capital securities? To explain simply, it's a way for insurance companies to borrow money, but it's a bit different from regular loans or bonds. These securities have characteristics closer to capital than general debt, so they can be recognized as capital to a certain extent when evaluating the financial soundness of insurance companies.
Why are insurance companies suddenly issuing these capital securities in large numbers? This is due to two main factors.
First, interest rates are going down. This is similar to the interest on your deposits decreasing. Insurance companies need to generate returns by managing premiums received from customers, but when interest rates fall, it becomes difficult to generate returns.
Second, the 'insurance liability discount rate' has been lowered. This is a somewhat complex concept, but simply put, it's the rate used by insurance companies to calculate the present value of insurance payments that must be made in the future. When this discount rate is lowered, the amount of money (liabilities) that insurance companies need to prepare increases. For example, if you need to pay 1 million won after 10 years, you need to prepare more money now when the discount rate is 2% than when it is 3%.
Due to these two factors, insurance companies' 'solvency ratio (K-ICS)' has decreased. This ratio indicates how stably insurance companies can pay the insurance money promised to customers. It's similar to the concept of how much emergency funds a household has. If this ratio falls below the legal standard, insurance companies need to increase their capital, and issuing capital securities becomes an effective method at this time.
In this situation, insurance companies must also keep an eye on the uncertain global economic environment. If interest rates and exchange rates fluctuate unexpectedly, capital raising plans may need to be adjusted. This is similar to a household having to adjust their financial plans due to sudden changes in economic conditions, despite having made income and expenditure plans.
2️⃣ Economic Terms
📕 Capital Securities
Capital securities are hybrid securities that have characteristics of both debt and equity.
- Hybrid securities (perpetual bonds) and subordinated bonds are representative examples, and they are recognized as regulatory capital under certain conditions.
- They provide higher interest rates than general bonds, but are also riskier because debt repayment is subordinated.
📕 Solvency Ratio (K-ICS)
The solvency ratio (K-ICS) is an indicator that evaluates the ability of insurance companies to fulfill financial obligations such as insurance payments.
- It is expressed as a percentage by dividing available capital by required capital, and financial authorities require maintaining a certain level (100%) or higher.
- K-ICS (Korean Insurance Capital Standard) is a new solvency system introduced in 2023, applying risk measurement methods in line with international standards.
📕 Interest Rate Cut Trend
The interest rate cut trend refers to the policy direction of the central bank lowering the base rate to stimulate the economy.
- It refers to a situation where the central bank implements monetary easing policies due to economic slowdown, price stabilization, etc.
- Interest rate cuts lower funding costs but can act as a factor reducing interest income for financial institutions.
📕 Insurance Liability Discount Rate
The insurance liability discount rate refers to the interest rate applied to calculate the present value of future insurance payment obligations.
- When the discount rate is lowered, more present value liabilities must be set aside for the same future payment obligations.
- Insurance supervisory authorities set discount rate application standards considering insurance product types and market environment.
3️⃣ Principles and Economic Outlook
💡 Structural Background of Increased Issuance of Insurance Companies' Capital Securities
The phenomenon of insurance companies expanding the issuance of capital securities is a result of the complex interaction of changes in the regulatory environment of the insurance industry and macroeconomic factors.
First, changes in the regulatory environment are raising the capital requirement levels for insurance companies. The new solvency system, K-ICS (Korean Insurance Capital Standard), introduced in 2023, has strengthened the risk measurement method in line with international standards. This system calculates required capital by comprehensively evaluating all risks of insurance companies, with particularly high sensitivity to interest rate risks and market risks. Due to the introduction of K-ICS, most insurance companies have seen a decrease in their solvency ratio compared to the previous system (RBC), which has become a factor increasing the need for capital expansion.
Second, the interest rate cut trend is putting dual pressure on the profitability and soundness of insurance companies. When interest rates fall, insurance companies' asset management returns decrease, negatively affecting profitability. Life insurance companies in particular still bear the burden of fixed interest rate products sold during past high-interest periods, increasing the risk of negative interest margin (loss due to the difference between the assumed interest rate and actual asset management return) when interest rates fall. Additionally, interest rate decreases lower the discount rate applied when evaluating insurance liabilities, increasing the value of liabilities and putting additional pressure on the solvency ratio.
Third, the impact of the insurance liability discount rate reduction measure is significant. Financial authorities adjust the discount rate applied to the evaluation of insurance liabilities considering market interest rate fluctuations and long-term insurance industry stability. When the discount rate is lowered, the present value of the same future insurance payment obligations increases, so insurance companies need to set aside more reserves. This becomes a factor decreasing available capital and lowering the solvency ratio through increased liability value.
Fourth, there are strategic advantages that capital securities have among insurance companies' capital raising options. Methods for insurance companies to expand capital include capital increase, profit retention, issuance of capital securities, etc. Among these, capital securities cost more than general bonds, but have the advantage of being able to expand capital without diluting shares as with new share issuance. Also, under the K-ICS system, capital securities that meet certain conditions are recognized as available capital, making them an effective means for improving the solvency ratio.
In this structural background, insurance companies are responding to the task of meeting regulatory requirements and securing financial soundness through the issuance of capital securities. In particular, a trend of large insurance companies preemptively expanding capital buffers is emerging, which can be seen as a strategic choice to strengthen risk management capabilities in an uncertain economic environment.
💡 Current Status of the Capital Securities Market and Investor Trends
The capital securities issuance trend of insurance companies is showing various characteristics and changes from the perspectives of issuers and investors.
First, an expansion in issuance scale and entities is appearing. Last year, capital securities issuance was mainly centered around large insurance companies, but recently there is a trend of issuance entities expanding to include medium and small insurance companies. Also, the issuance scale is increasing, and issuance through overseas markets as well as domestic ones is becoming active. In particular, the issuance of foreign currency-denominated capital securities such as dollars and euros is increasing, which can be seen as a strategy for diversifying the investor base and optimizing funding costs.
Second, the structure and characteristics of capital securities are diversifying. Hybrid securities (perpetual bonds) and subordinated bonds differ in terms of redemption period, interest payment conditions, capital recognition ratio, etc. Insurance companies are designing optimal capital securities structures by comprehensively considering their financial situation, market conditions, regulatory requirements, etc. Some insurance companies are maximizing the effect as regulatory capital while managing issuance costs by issuing hybrid securities including various conditions such as call options, interest rate reset clauses, interest payment deferral options, etc.
Third, changes in the investor base and price determination factors are attracting attention. Traditionally, institutional investors (asset management companies, pension funds, insurance companies, etc.) were the main investors in insurance companies' capital securities, but recently, with rising interest rates, interest from individual investors is also increasing. The price (interest rate) of capital securities is basically determined by the creditworthiness of the insurance company, the structural characteristics of the securities, the market interest rate environment, etc. However, price volatility may increase according to regulatory changes and market supply and demand situations, so investors need to make investment decisions by comprehensively evaluating these factors.
Fourth, market liquidity and price discovery functions are developing. As the issuance of capital securities increases, the depth and breadth of the trading market are also expanding. This increases the possibility for investors to sell their held securities when needed, which is a factor promoting market participation. Additionally, as the market's price discovery function for various insurance companies and securities structures develops, more efficient capital allocation based on risk-return profiles is taking place.
Thus, the insurance companies' capital securities market is achieving both quantitative growth and qualitative development. As it becomes an attractive market for both issuers and investors, it is expected to continue evolving due to various factors such as changes in the global financial environment, regulatory trends, and insurance companies' financial strategies. Particularly in an environment where interest rate and exchange rate volatility is increasing, the price determination and risk assessment mechanisms of the capital securities market are expected to become more sophisticated.
💡 Capital Securities Issuance Outlook and Influencing Factors
The outlook for insurance companies' capital securities issuance this year needs to comprehensively consider various influencing factors.
First, changes in the interest rate environment are expected to act as a key variable. The interest rate path will be determined by the central bank's monetary policy stance, inflation trends, global financial market trends, etc. If the interest rate cut trend continues, insurance companies may face a greater need for capital expansion due to decreased asset management returns and increased liability values. On the other hand, if interest rate volatility expands or the pace of cuts is slower than expected, it may be necessary to adjust the timing and scale of issuance. Also, the interest rate environment directly affects issuance costs, making it an important consideration in designing the structure and conditions of capital securities.
Second, the evolution of the regulatory environment is also an important influencing factor. As the K-ICS system enters a stabilization phase, insurance companies are gaining a better understanding of capital requirements and strengthening their capacity to design optimal capital structures. Changes in the regulatory environment, such as the direction of financial authorities' soundness supervision, changes in capital recognition criteria for capital securities, and discussions on the introduction of the international Insurance Capital Standard (ICS), directly affect insurance companies' capital strategies. If regulatory predictability and consistency are maintained, insurance companies will be able to manage capital more planned and systematically.
Third, uncertainties in the global financial market may affect capital raising strategies. Global financial environment factors such as geopolitical risks, major countries' economic growth outlooks, and international capital flows are important variables, especially for capital securities issuance through overseas markets. If global financial market volatility expands or risk-averse tendencies strengthen, it could lead to increased issuance costs or decreased investment demand. Especially for foreign currency-denominated capital securities, cost changes due to exchange rate fluctuations and hedging strategies are important considerations.
Fourth, individual insurance companies' financial situations and strategic priorities also affect issuance decisions. The necessity and priority of capital expansion may vary depending on the current solvency ratio, business portfolio, growth strategy, risk preference, etc. Also, corporate governance and external stakeholder factors such as shareholder composition, credit rating management goals, and investor relations also affect capital strategy. Insurance companies will seek optimal capital structures beyond simple regulatory compliance, from the perspective of long-term value creation and risk management.
Considering these factors comprehensively, the issuance of capital securities by insurance companies is expected to remain active this year following last year, but its pattern is expected to differentiate according to the economic environment and individual insurance companies' situations. Considering uncertainty factors such as expanded volatility in interest rates and exchange rates, evolution of the regulatory environment, and changes in the competitive structure of the insurance industry, insurance companies are expected to adopt more strategic and flexible capital management approaches.
4️⃣ In Conclusion
The trend of insurance companies issuing capital securities is a phenomenon triggered by structural factors such as changes in the regulatory environment and interest rate decreases, and is expected to continue this year. This can be seen as a process beyond simple financial decision-making, as the Korean insurance industry transitions to an international standard soundness system and adapts to an uncertain financial environment.
From an insurance company's perspective, issuing capital securities can be a strategic opportunity beyond regulatory response. Besides the direct goal of improving the solvency ratio, it can be a means to achieve various financial strategic goals such as optimizing the capital structure, diversifying funding sources, and managing interest rate risks. Especially in the midst of changes in the interest rate environment and reorganization of the insurance industry competitive structure, securing sufficient capital buffers serves as a foundation for capturing future growth opportunities and responding to crisis situations. However, a systematic capital management strategy that comprehensively considers issuance costs, maturity structure, foreign exchange risk, etc. is needed.
From an investor's perspective, insurance companies' capital securities can be an attractive investment alternative, but it's important to accurately understand their characteristics and risks. While capital securities offer higher yields than general bonds, they also carry additional risks such as subordination, the possibility of deferred interest payments, and maturity extension risk. In particular, investment decisions should be made by comprehensively evaluating the financial soundness of individual insurance companies, the sustainability of their business models, and their ability to respond to changes in the regulatory environment. Consideration of price volatility due to interest rate and exchange rate fluctuations is also necessary, and awareness of liquidity constraints is needed.
From a supervisory authority's perspective, the growth of the capital securities market contributes to strengthening the soundness of the insurance industry, but new risk factors also need to be monitored. Particular attention is needed to ensure that insurance companies' increased leverage, maturity mismatches, and reliance on foreign currency funding do not expand into systemic risks. Institutional support to enhance the transparency and price discovery function of the capital securities market can also be considered. In the long term, a balanced supervisory philosophy that comprehensively considers the harmonization of K-ICS with international standards, enhancement of the long-term competitiveness of the insurance industry, and consumer protection is important.
In conclusion, the trend of insurance companies issuing capital securities shows one aspect of the challenges and changes facing the Korean insurance industry. Amid factors such as changes in the interest rate environment, regulatory strengthening, and global uncertainties, insurance companies are seeking strategic responses to secure financial soundness and competitiveness. Capital securities are becoming an important tool in this process, and their utilization and market size are expected to continue expanding. However, in an environment where uncertainties in macroeconomic variables such as interest rates and exchange rates are increasing, insurance companies need to adopt more systematic and preemptive capital management approaches.