This year has seen the implementation of long-awaited regulatory changes in the finance sector – perhaps even more so in South Korea than elsewhere.
Both the International Financial Reporting Standards 17 (IFRS 17) and the Korean Insurance Capital Standard (K-ICS) and came into effect on January 1, and the changes they have ushered in have influenced insurers’ investment preferences.
The changes had originally been planned to be implemented from the beginning of last year, so many insurers had already prepared themselves and their portfolios for the changes.
Equity, in particular, has fallen out of favour among South Korean insurers, which have been selective in deploying capital to the asset class due to higher capital requirement charges, according to Andrew Shin, head of investments Korea at WTW.
Insurers have adopted ways to secure more transparency when it comes to assessing risk charges on underlying investment assets, Shin said.
Many have involved risk teams internally when assessing or quantifying risk capital charges.
“In many incidents, they have taken advantage of ratings provided by rating agencies after structuring alternative investments into a form of structured notes that are ‘rated’ for better transparency for the purpose of risk charging,” Shin told AsianInvestor.
South Korean insurers have put both K-ICS and IFRS implementation at the top of their priority list, according to Xiong Jian, senior solutions director of multi-asset investment at Abrdn.
“They either conduct strategic asset allocation-level [SAA-level] optimisation or both SAA- and security-level optimisation to mitigate the impact from K-ICS, although it seems not to be an easy task," Xiong told AsianInvestor.
"The majority of them carry out IFRS 17 implementation in an orderly manner and elect asset classification in accordance with IFRS 9 concurrently.”
Although K-ICS is a new capital adequacy regulation, IFRS 17 and 9 are frameworks for new accounting standards for insurance contracts. Together, they squeeze the capital buffers of South Korean insurers, according to Fitch Ratings.
South Korean insurers have not yet published financial statistics based on K-ICS or IFRS 17, the impact is expected to vary from company to company, depending upon individual businesses and risk profiles.
“We believe that South Korean insurers remain ... continually challenged [in] manag[ing] their capital position with the new capital regime, K-ICS, in 2023,” Siew Wai Wan, senior director of Asia-Pacific insurance at Fitch Ratings, told AsianInvestor.
One materially distinct feature of IFRS 17 and K-ICS implementation is a marked to market valuation requirement for liabilities. This deviates from that of previous regimes, in which liabilities were valued at cost.
Insurance investment professionals therefore need to understand the interaction between IFRS 9 and 17 and make adjustments on the asset side to obtain the greatest benefits for their companies, Abrdn’s Xiong said.
Insurers must also change their mindset and move from a reactive, compliance-led approach to a much more proactive one as a strategic point of differentiation to gain a competitive advantage.
“In their SAA and portfolio construction process, insurers may need to build up or outsource a new capability to optimise their investment by adding capital risk requirements as a new dimension,” Xiong said.
With the new regulations in place, South Korean insurers can now start to look at how they want to invest going forward.
Many investors in the country, including insurers, were struggling with limited liquidity throughout 2022 and the credit crunch late that year. Some seized it as a buying opportunity, while others busied themselves going through valuations of overseas private market assets and the effect of limited liquidity globally, and the overall consensus remains cautious, WTW’s Shin said.
“While many welcome the Fed[eral Reserve] being near the end of [interest rate] raising cycle, they still point out that the incentives to go for overseas private market assets are very different from those ‘lower interest rate for longer’ period,” he said.
With long-term investment capital being even more scarce, insurers can leverage their positions as capital providers with increased bargaining power. In terms of asset classes, Shin said that insurers are selectively reviewing private debt on floating rates and secondary deals involving real assets and private equity.
Fitch’s Wan does not foresee material changes in the investment mix, although the amended risk charges under the K-ICS standard could mean some adjustments and may benefit insurers.
Nevertheless, domestic, fixed-income instruments will likely still be the mainstay of insurers' investment mix, with diversification into alternative investments such as beneficiary certificates.
“While the sector reduced its overall exposure to overseas investments over the last few years, we believe that insurers’ allocation to overseas fixed-income type assets still depends on the yield difference between overseas and domestic bonds and the hedging cost of foreign exchange volatility going forward,” Wan said.
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