Heungkuk Life shakes up Korean financial markets with delayed call option redemption
The Korean financial markets were taken for a spin recently, when Heungkuk Life Insurance, a mid-sized actor in the Korean insurance industry, announced on November 1 that it would delay the exercising of a $500 million November 9 call option for its foreign-currency bonds — although ultimately, the insurer reversed its decision on November 7.
Heungkuk Life plans to repay the debt via its own capital and repo transactions, a spokesman said, and the exact amounts haven’t yet been decided — but had the insurer not taken this step, it would have been the first time since 2009 that a Korean financial institution has failed in early redemption of foreign currency bonds.
These callable US dollar-denominated bonds were a solution years ago for many insurers with a tight risk-based capital (RBC) margin, according to Andrew Shin, head of Investments Korea at advisor firm WTW, formerly known as Willis Towers Watson.
Now, the Korean credit market is going through a crunch, and while most people expected the bonds to be called, Heungkuk Life initially decided not to — a likely reason being that the US dollar is currently relatively more expensive, and funding costs have gone up dramatically.
“The life insurer might have done a cost-benefit analysis of two options: exercising the call option versus deferring it; and arrived at a conclusion that it was less expensive to choose the latter option,” Shin told AsianInvestor.
“However, after the market confusion, the insurer has finally decided to exercise it. Unfortunately, the market is not back to normal yet, hence this has led to the situation in the Korean insurance industry now,” he elaborated.
FALLING IN LINE
Some larger Korean insurance firms, including Hanwha Life and KDB Life, are supposed to redeem $1 billion and $200 million in hybrid securities respectively next year.
The current depreciation of the Korean won against the US dollar is not the only issue in the rising interest rate environment. Korean companies are generally challenged to evaluate the cost considerations as well as the feasibility of refinancing an existing debt with a most costly issuance, according to Siew Wai Wan, senior director of insurance at Fitch Ratings.
“We believe there could be implications for the pricing of capital instruments going forward in cases where the market has factored in the expectation that instruments will be called. From a credit rating perspective, we do not expect any changes per se — rather, we consider features of the instrument as well as the regulatory treatment in deciding the rating or equity credit afforded to these instruments,” Wan told AsianInvestor.
CHANGE IN RULES
Following the Heungkuk Life case and the general situation for Korean insurers, Korea’s financial regulator is seeking to temporarily relax regulations in the country’s insurance industry to prevent insurers from selling bonds and to stabilize the country’s money markets.
The financial authorities relaxed regulations in the insurance industry as life insurers face increasing capital strain next year, with the implementation of two new sets of rules: the local statutory insurance accounting standards K-ICS; and the International Financial Accounting Standards 17, IFRS17.
Many insurers have prepared themselves for the upcoming change. However, many have also pointed out that there are other insurers facing call-maturity next year, such as the previously mentioned Hanwha Life’s $1 billion worth of hybrid securities.
“This could be a source of uncertainty should the market rates and funding cost stay much higher. If it becomes harder to raise funds from overseas, that will become a head wind for many insurers in securing sufficient capital in terms of regulatory requirements,” Shin said.
Under measures announced by the Financial Services Commission and Financial Supervisory Service on November 3 after a meeting with life insurers, insurance companies’ liquidity index evaluation rating will be upgraded by one notch in their risk assessment and application system (RAAS) evaluation until the end of this year. An insurer with a second-grade evaluation rating will be moved up to first grade, for instance.
Conceptually, the situation should lead to limited material changes to the way the new regimes are to be implemented. Once implemented, the new regimes will require insurers to adopt a marked-to-market valuation for both assets and liabilities, Wan from Fitch Ratings said.
“This is also one of the major differences that differentiates the K-ICS from the existing RBC regime. Fitch does not expect to see significant changes to the current investment profiles of most market players. There could be some adjustments of their investment mixes to incorporate the latest risk charges under K-ICS, where practicable and beneficial to the insurers,” Wan said.
A CHALLENGING ENVIRONMENT
The regulators will also temporarily allow insurers to include assets with a maturity of more than three months, like bonds that are immediately cashable, as liquidity assets. Currently, assets of under three-month maturity are regarded as liquidity. In response to this, insurance companies have to refrain from selling bonds and cooperate with the government to stabilize the money markets in their role as institutional investors, the financial authority urged.
Fitch Ratings believes that domestic fixed-income instruments should still be the mainstay of the investment mix of the Korean insurers, with some diversification into alternative investments such as beneficiary certificates.
Many Korean insurers, just like other asset owners in the country, are sitting on the sidelines, given that there are many investment opportunities with much higher yield. For example, state-owned entities such as KEPCO are rolling over their two to three-year bonds at 5.99% per year, WTW’s Shin pointed out.
“This makes other investments including those private market assets from overseas less attractive, as the illiquidity premium and the compensation for FX volatility and so on are not as attractive as before. While the funding costs for most insurance companies are now higher, the required rate of return would be adjusted upwards, and the situation gets more complicated as the new K-ICS comes into effect next year,” Shin said.
Also read: Opinion: Korean asset owners are weathering the perfect storm