🚨 Lotte Non-Life Insurance Capital Soundness Deterioration and Subordinated Bond Issuance Analysis

Today Korean Economic News | 2025.02.04

📌 Lotte Non-Life Insurance to Issue 100 Billion Won in Subordinated Bonds... Capital Soundness Deterioration 'Emergency'

💬 Lotte Non-Life Insurance, which is in an emergency due to deteriorating capital soundness, will issue 100 billion won in subordinated bonds next month. This is a measure to increase the solvency ratio (K-ICS ratio) through capital expansion, aimed at improving the capital soundness that has continuously declined recently.

1️⃣ Simple Explanation

There's news that Lotte Non-Life Insurance is issuing 100 billion won in subordinated bonds due to capital soundness issues. Let me explain this situation in a way that's easy to understand.

What is an insurance company's capital soundness? To use an everyday analogy, it's like emergency funds that a household can use to respond to unexpected expenses. Insurance companies need to pay insurance claims to customers when accidents or illnesses occur, and capital soundness refers to the financial ability to stably fulfill these obligations.

The indicator that measures this capital soundness is the 'solvency ratio (K-ICS)'. The higher this ratio, the more financially stable an insurance company is considered to be. Financial authorities require insurance companies to maintain a solvency ratio of at least 100%, and generally, maintaining 150% or higher is considered desirable.

The continuous decline in Lotte Non-Life Insurance's solvency ratio means that its emergency funds are gradually decreasing. To improve this situation, Lotte Non-Life has decided to issue a special form of bond called a 'subordinated bond'.

What are subordinated bonds? Unlike general loans, these are bonds with the condition that if the company goes bankrupt, the money is repaid after general creditors. Due to this risk, subordinated bonds generally provide higher interest rates. Since financial authorities recognize these subordinated bonds as capital to a certain extent, insurance companies can improve their capital soundness by issuing subordinated bonds.

Lotte Non-Life's issuance of 100 billion won in subordinated bonds means they are raising special forms of funds to strengthen their financial condition. This is similar to a household taking out a special condition loan to increase their emergency funds.

This measure can be seen as a signal that Lotte Non-Life is recognizing the capital soundness problem and responding actively. However, without fundamental improvements in profitability and risk management, it could be just a temporary solution, so it's necessary to monitor Lotte Non-Life's future management strategy and performance improvement.

2️⃣ Economic Terms

📕 Capital Soundness

Capital soundness refers to a financial company's financial ability to fulfill its obligations even in crisis situations.

• It comprehensively evaluates whether the company holds sufficient capital, whether the quality of assets is good, and whether risk management is appropriate.
• Financial authorities regularly supervise financial companies' capital soundness and can demand improvement measures if it deteriorates.

📕 Subordinated Bonds

Subordinated bonds are bonds with a lower repayment priority than general bonds in case of bankruptcy, a type of capital security.

• Higher interest rates are applied than general bonds, and the maturity is usually set for long-term periods of 5 years or more.
• Financial authorities recognize subordinated bonds that meet certain requirements as capital and reflect them in the calculation of capital soundness ratios.

📕 Solvency Ratio (K-ICS)

The solvency ratio (K-ICS) is an indicator of an insurance company's financial soundness, calculated by dividing available capital by required capital.

• The K-ICS (Korean Insurance Capital Standard), introduced in 2023, is a new solvency system that complies with international standards.
• Financial authorities require insurance companies to maintain a solvency ratio of at least 100% and can implement phased management improvement measures.

📕 Capital Expansion

Capital expansion refers to a financial company's act of raising funds to improve the quantity and quality of its capital.

• It is done through various methods such as rights offerings, subordinated bond issuances, profit retention, and asset sales.
• Capital expansion is implemented for purposes such as strengthening financial soundness, meeting regulatory requirements, maintaining credit ratings, and establishing a foundation for growth.

3️⃣ Principles and Economic Outlook

💡 Background and Causes of Lotte Non-Life Insurance's Capital Soundness Deterioration

• The deterioration of Lotte Non-Life Insurance's capital soundness can be seen as a result of various internal and external factors working together.

  • First, declining profitability in the insurance business is pointed out as a major cause. There has been a continuous increase in the loss ratio in the auto insurance and general insurance sectors, and Lotte Non-Life is also experiencing difficulties in auto insurance amid the industry-wide trend of worsening loss ratios. Factors such as limited insurance premium increases compared to rising insurance cost factors like repair costs and labor costs, and difficulties in underwriting (risk assessment and acceptance) management due to excessive market competition have had an impact. Additionally, the occurrence of large accidents in some specialty insurance and the resulting increase in insurance payments have also acted as factors worsening profitability.

  • Second, declining asset management returns and increased asset value volatility have had an impact. It was difficult to secure stable asset management returns amid global interest rate volatility and investment environment uncertainty. In particular, the incurrence of valuation losses on held bonds during the rising interest rate phase, and decreased returns on alternative investment assets negatively affected asset values and profitability. Additionally, the decline in the value of related assets due to the real estate market slump is also believed to have contributed partially to the deterioration of capital soundness.

  • Third, the impact of regulatory environment changes and the introduction of a new solvency system was significant. The K-ICS (Korean Insurance Capital Standard) introduced in 2023 applies stricter standards than the previous system (RBC), resulting in an overall decline in insurance companies' solvency ratios. The K-ICS has particularly high sensitivity to interest rate risk and market risk, expanding the volatility of solvency ratios in an environment of high interest rate volatility. Lotte Non-Life is evaluated as having had relatively insufficient responses to these system changes.

  • Fourth, company characteristics and strategic factors also need to be considered. Lotte Non-Life may have experienced difficulties in terms of risk management and profitability while pursuing aggressive sales strategies to expand market share. Additionally, being relatively smaller than large insurance companies, there were limitations in securing efficiency by utilizing economies of scale. While pursuing market expansion in a situation of insufficient capital strength, this led to a deterioration in the risk-to-capital ratio.

• This deterioration in capital soundness can be seen as a result of overlapping various structural factors, not just a temporary phenomenon. In particular, there are aspects where Lotte Non-Life's business model and risk management system have not adequately responded amid the overall decline in profitability in the insurance industry, increasing uncertainty in the financial environment, and the trend of regulatory strengthening. This has become the background making the capital expansion measure of issuing 100 billion won in subordinated bonds inevitable.

💡 Impact and Effects of Subordinated Bond Issuance

• Lotte Non-Life's issuance of 100 billion won in subordinated bonds is expected to have impacts on capital soundness improvement in various aspects.

  • First, an improvement effect in the solvency ratio (K-ICS) can be expected. Subordinated bonds can be recognized as available capital to a certain extent according to financial authority standards. Subordinated bonds with maturities of 5 years or more are recognized as eligible capital under the K-ICS system and included in the calculation of the solvency ratio. The issuance of 100 billion won in subordinated bonds has the direct effect of increasing Lotte Non-Life's available capital and raising the solvency ratio. The exact improvement margin will vary depending on the current capital structure and risk situation, but a significant level of solvency ratio increase can be expected.

  • Second, it helps mitigate regulatory risk and secure management stability. If the solvency ratio falls below a certain level, there may be management intervention or sanctions from financial authorities. Capital expansion through subordinated bond issuance contributes to mitigating such regulatory risks and maintaining management autonomy. Additionally, improved capital soundness can also have a positive impact on restoring the trust of stakeholders such as customers, investors, and creditors.

  • Third, along with the short-term capital expansion effect, the cost burden must also be considered. Since subordinated bonds have higher interest rates applied than general bonds, the interest cost burden increases. Considering the current interest rate environment and Lotte Non-Life's credit rating, a substantial level of financial cost is expected to occur. These additional costs can burden future profitability, requiring an appropriate capital management strategy considering the cost versus effect.

  • Fourth, there are various considerations in terms of capital structure and financial strategy. Subordinated bond issuance is one of several methods of capital expansion, with the advantage of seeing immediate effects compared to other methods such as rights offerings or profit retention. However, in the long term, internal capital accumulation through stable profit generation is more important. Therefore, subordinated bond issuance should be used as a temporary means of improving capital soundness, but should be accompanied by long-term strategies for strengthening profitability and improving risk management.

• Overall, while Lotte Non-Life's subordinated bond issuance is effective for short-term capital soundness improvement, without fundamental improvement in the profit structure, it may end up being just a temporary solution. Based on the time and margin secured through subordinated bond issuance, fundamental management improvement efforts such as enhancing insurance business profitability, optimizing asset management strategies, and strengthening risk management systems should follow.

💡 Insurance Industry Capital Soundness Issues and Market Impact

• Lotte Non-Life's case reflects the capital soundness issues and market environment changes of the overall insurance industry beyond the problems of an individual company.

  • First, capital soundness management in the insurance industry has become more important after the introduction of K-ICS. The K-ICS introduced in 2023 is a new solvency system that complies with international insurance capital standards (ICS), characterized by the sophistication of risk assessment and economic value-based evaluation. Under this system, market variables such as interest rates and stock prices have a greater impact on the solvency ratio. Large insurance companies have responded through preemptive capital expansion and improvement of risk management systems, but small and medium-sized insurance companies are experiencing relatively more difficulties. Lotte Non-Life's case can be seen as an example showing the capital soundness challenges faced by small and medium-sized insurance companies under the K-ICS system.

  • Second, the importance of asset-liability management (ALM) according to changes in the interest rate environment is being highlighted. With the expansion of interest rate volatility in recent years, asset-liability management for insurance companies has become more complex. Rising interest rates brought valuation losses on existing held bonds, and the offsetting effect due to the decrease in liability value appeared differently for each insurance company. Insurance companies with poor asset-liability matching showed more vulnerability to interest rate fluctuations. As the possibility of interest rate cuts is raised in the future, interest rate risk management is expected to continue to have a significant impact on the capital soundness of insurance companies.

  • Third, capital raising means and costs are emerging as important elements of insurance company competitiveness. As the need for capital expansion increases, efficient capital raising ability has become important as a core capability of insurance companies. The ability to appropriately utilize various capital raising means such as rights offerings, subordinated bonds, and hybrid securities, and to raise funds under optimal conditions is becoming a competitive advantage factor. In particular, there are differences in capital raising costs and accessibility between large insurance companies and small and medium-sized insurance companies, which could be a factor affecting market structure reorganization.

  • Fourth, improving the profitability structure and innovating business models in the insurance industry have emerged as urgent tasks. Macroeconomic environmental changes such as low interest rates, low growth, and aging, along with digital technology development, are challenging traditional insurance business models. Stable profit generation ability is essential for strengthening capital soundness, but many insurance companies are struggling to secure profitability. This raises the need for comprehensive management innovation such as product structure innovation, strengthening underwriting capabilities, accelerating digital transformation, and cost efficiency.

• In the midst of these industry-wide issues, Lotte Non-Life's subordinated bond issuance can be seen as a case reflecting the structural changes and challenges of the insurance industry beyond simple individual corporate fundraising. Particular attention should be paid to the trends of capital expansion and business model reorganization of small and medium-sized insurance companies, and the possibility of mergers and acquisitions (M&A), which are part of industry reorganization. Financial authorities are also expected to seek policy support and regulatory balance for strengthening the soundness and competitiveness of the insurance industry.

4️⃣ In Conclusion

Lotte Non-Life Insurance's issuance of 100 billion won in subordinated bonds appears to be an inevitable choice to respond to deteriorating capital soundness. This needs to be understood as a case showing the structural challenges faced by small and medium-sized insurance companies in the changing insurance industry environment and regulatory framework, not just a one-time event. While this subordinated bond issuance will help improve capital soundness in the short term, it must be supported by fundamental strengthening of profitability and improvement of risk management systems in the long term.

From Lotte Non-Life's perspective, there is a need to re-examine the overall management strategy on the occasion of capital expansion through subordinated bond issuance. In particular, improving profitability through management of the loss ratio in insurance operations, strengthening underwriting standards, and optimizing the product portfolio is urgent. Additionally, advancing asset-liability management (ALM) in response to interest rate volatility, diversifying the investment portfolio, and strengthening the risk management system are also important tasks. Cost efficiency and customer experience improvement using digital technology will also be key elements for enhancing competitiveness.

From an investor and creditor perspective, there is a need to closely evaluate Lotte Non-Life's capital soundness improvement plan and medium to long-term management strategy. Since subordinated bonds are higher risk than general bonds, a comprehensive judgment should be made on whether an appropriate risk premium is reflected and whether the company's capital expansion plan is sustainable. In particular, investment decisions considering the possibility of support at the Lotte Group level, changes in the competitive environment within the insurance industry, and regulatory trends are important.

From an insurance consumer perspective, there is a need to recognize that an insurance company's financial soundness is directly linked to its ability to pay insurance claims. Especially for long-term insurance contracts, the long-term soundness of the insurance company should be an important selection criterion. However, in the case of Lotte Non-Life, as it is an affiliate of a large corporation, there is a possibility of support at the group level, and supervision by financial authorities is also taking place, so excessive concerns may be unnecessary.

From a financial authority perspective, appropriate supervision and support are needed to prevent individual insurance companies' soundness issues from expanding into systemic risks. Along with policy support for the stable settlement of the K-ICS system, it is worth considering creating an institutional environment for strengthening the competitiveness of small and medium-sized insurance companies. In particular, it is necessary to seek ways to enhance industry competitiveness through digital innovation, healthy mergers and acquisitions, and overseas expansion.

In conclusion, Lotte Non-Life's subordinated bond issuance is a case showing the capital soundness challenges faced by the insurance industry and the adaptation process in a new regulatory environment. Efforts from a long-term perspective by the company and stakeholders are important for this capital expansion to lead to fundamental improvement and enhanced competitiveness, not just a short-term prescription. Additionally, it is also an important task to derive implications for enhancing the soundness and competitiveness of our overall financial industry through such individual corporate cases. Under the K-ICS system, insurance companies should focus on three key tasks: capital efficiency, strengthening risk management capabilities, and developing profitable business models.