Business conditions for South Korean insurers have deteriorated due to the low-rate environment driven by central banks’ quantitative easing to fight coronavirus, with the situation showing no sign of immediate recovery. Both life and non-life insurers’ earnings are expected to decline in 2020 amid a double whammy of falling insurance premiums and investment income. 

Overseas alternative investments, to which insurers have increased exposure in response to the low-rate environment, are also becoming a burden to them as the possibility of those risky assets being distressed goes up significantly. 

Insurers may not be able to maintain their fundamentals in good condition in this bleak business environment, market analysts have warned. 

Impact of the lowest interest-rate in history 

South Korea’s central bank slashed its policy rate by a quarter percentage point to a record low of 0.50% on May 28 as the country’s economy is expected to grow at the slowest pace in over two decades amid the pandemic. The move came a little over two months after the Bank of Korea (BOK) cut the base rate to 0.75% from 1.2% in its first emergency rate cut since October 2008. Not only BOK, but also other global central banks including the Federal Reserve are responding with quantitative easing and interest rate cuts as the global economic downturn deepens in the aftermath of the pandemic. 

A series of rate cuts by BOK have further raised concerns over insurers’ profitability. Korean insurers have been offsetting the ever-increasing losses in insurance premium with investment income. However, given that investment income is linked to market interest rates, the recent low-rate trend is increasingly expected to have a negative impact on the income. 

According to the bond analysis company KIS Pricing, the combined operating losses of life and non-life insurers in Korea stood at 4.551 trillion won ($3.8 billion) and 6.425 trillion won respectively last year. As of the end of last year, only two insurers, Prudential Life Insurance Company of Korea and TONGYANG Life Insurance, registered operating profits from their insurance businesses. Investment incomes of life and non-life insurers were 8.599 trillion won and 23.901 trillion won respectively.

Analysts are expecting the low-rate environment to have a greater impact on life insurers than on non-life insurers. In fact, the latter can partially offset their poor performance by managing their loss ratio – the ratio of losses to premiums earned. The loss ratio of auto insurance has continued to decline recently as people drive less during the coronavirus pandemic. Meanwhile, auto insurance premiums have continued to rise from 2018 to early this year, having a positive effect on their profits. 

For life insurers, on the other hand, their performance is more sensitively affected by low rates, since it lowers their investment income while increasing their burden related to mandatory reserves they are required to add to their legal reserves. In the first quarter of this year, Korea’s life insurers transferred 5.6357 trillion won in legal reserves, up 1.529 trillion won from a year earlier. Samsung Life Insurance, Kyobo Life Insurance and Hanwha Life Insurance, the nation’s major life insurers, had 2.3385 trillion won, 1.395 trillion won and 947.1 billion won in legal reserves respectively.

Life insurers’ investment income had already started declining even before the coronavirus pandemic. The return on investment of life insurance industry fell from 4% at the end of 2015 to 3.5% at the end of last year. The low-rate environment is lowering the return on investment, while increasing the burden of setting aside legal reserves.

Alternative investments

Overseas alternative investment, which was regarded as an effective countermeasure against a low-rate environment, is also raising the burden on insurers’ fundamentals. Korean insurers have been increasing the portion of overseas alternative investments in their portfolio to rev up their investment income. However, as the global economic downturn continues, concerns are mounting over the soundness of their overseas investment.

Non-life insurers have aggressively increased the portion of alternative investments overseas. As of the end of the third quarter of last year, the total amount of their alternative investment in aircraft, hotel, and ships accounted for nearly 20% of their capital. In particular, the portion of alternative investments in Lotte Insurance and Heungkuk Fire & Marine Insurance reached 100% and 50% of their capital respectively.

“Alternative investments have gained popularity among global insurers due to low-rate environment but Korean insurers seem to have invested a little bit excessively,” a credit industry source said. “As the global economy is entering a downward phase, it is important for them to be able to manage related risks well.”  (Reporting by Hyerim Pi)