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Insurance Regulatory Changes in 2023

The year 2023 is going to be a transformative year for the Korean insurance industry given that major regulatory changes are taking effect and their implications could be significant across the insurance sector. Here is a rundown of the latest insurance regulatory changes:

Implementation of IFRS 17

The insurance industry implements the transition to the International Financial Reporting Standard 17 (IFRS 17) starting January 1, 2023. The accounting transition to IFRS 17 represents the most sweeping change in decades to financial reporting for insurers. The new accounting standard is designed to achieve the goal of a consistent, principle-based accounting for insurance contracts, bringing fundamental changes to accounting, actuarial, and reporting practices in the insurance industry. It will be a globally uniform basis for the accounting of insurance contracts.

IFRS 17 requires insurers to measure their insurance liabilities at fair value and recognize their revenue on an accrual basis not on a cash basis, allowing revenue to reflect the services provided and exclude deposits. This method of revenue recognition is consistent with the recognition of revenue for most contracts with customers in other industries and for many short-term insurance contracts. As such, IFRS 17 will move insurers closer to other industries in terms of the comparability of financial statements.

In 2023, improvements will be made in insurance financial statements due to the implementation of IFRS 17, and more transparent and useful information will be provided in financial reporting of insurance companies. While the impact of changes will be notable for life insurers, the accounting transition will still be important for all insurers across the board.

However, no major disruption or confusion is unlikely in the wake of the official transition to IFRS 17 as insurers have been preparing to run business on IFRS 17 systems for many years now. Indeed, most insurance companies in Korea have already been trying to apply the new rules in parallel with their existing accounting that is based on IFRS 4. This is because prior year comparatives must also be reported under IFRS 17 in the 2023 financial statements. Insurers have made a lot of investments in making sure that their existing IT landscapes are adjusted to integrate new functions necessary to implement the new accounting requirements.

Implementation of K-ICS

The Korean Insurance Capital Standard (K-ICS), a full-fledged risk-based capital system, comes into force on January 1, 2023 in step with the implementation of IFRS 17. This new capital regime requires insurance companies to measure their assets and liabilities at market value and use a full fair-value balance sheet to calculate the amount of required capital, which is consistent with global best practices and standards. It allows risk measurement to be more precise using shock scenarios, and the required capital of an insurer is defined as the value-at-risk (VAR) of the own funds of the insurer subject to a confidence level of 99.5%.

The required capital is calculated for a new set of five risk categories: life/long-term insurance risk, general P&C insurance risk, market risk (including interest rate risk), credit risk and operational risk. A major change in risk categories is the division of insurance risk into life/long-term insurance risk and general P&C insurance risk, with four subcategories being created within insurance risk - longevity, surrender, expense and catastrophe. A new subcategory under market risk is asset concentration.

The focus of the new solvency regime is taking a substantive risk management approach towards capital requirements. Its primary goal is to ensure that insurers hold sufficient economic capital to protect the policyholders by helping to align their risk profile with economic conditions.

Insurers in Korea have been under pressure to increase their capital in the run-up to the implementation of K-ICS, with supervisory authorities guiding insurers to improve their capital strength in time for the new capital regime. Given the profitability of insurers was generally weak, it has been challenging for them either to boost capital from retained earnings, or to convince shareholders to contribute to rights issues. Under these circumstances, mid-sized or small insurers were left with few choices but to issue subordinated debt. Some insurers raised new capital from the issuance of hybrid capital securities to strengthen their capital position.

Although there were concerns initially that K-ICS would force the insolvency of some smaller insurers, financial regulators have been careful to tighten capital standards in stages so that all companies can keep up with regulatory demand and increase their solvency levels gradually.

**Comparison between Previous RBC Regime and K-ICS**

Suspension of Medical Expense Insurance Coverage

There has been a change in the availability of medical expense coverage suspension since January 2023. The change is aimed at preventing individuals from having overlapping medical expense insurance coverage. For the insured individuals (employees) of a group medical expense insurance policy, who have their separate individual medical expense insurance, it has now become possible to have their group coverage suspended if the group policyholders (employers) agreed to attach a rider to the group policy to allow the temporary opt-out option. When the insured opt to suspend their individual medical expense coverage, they are allowed to restart the coverage whenever they want by choosing either the same policy they held previously or a new one available at the time of resumption.

About 1.33 million people in Korea had more than one medical expense insurance policy, and 95% of them were insured under both individual and group policies as of late March 2022. As medical expense insurance is an indemnity-based health insurance policy that pays a set portion of the actual medical treatment and hospitalization expenses, having more than one policy is not necessary. With the introduction of coverage suspension option, insurance consumers will be saved from unnecessary premium payments.

Relaxation of the Insurance Licensing Regulation

The insurance licensing regulation has been revised to relax the one company, one license policy to enable the insurance industry to better deal with digitalization and an evolving insurance market environment. Since the revision went into force in November 2022, more than one life or non-life insurance business license can now be held by each insurance group. Subsidiaries of existing insurers are allowed to engage in the insurance business as small-amount and short-term insurers or mono-line insurers specializing in the products that their parent companies do not handle. They are permitted to work with the same exclusive solicitors tied to their insurance group. In addition, insurers are allowed to use cyber marketing channels like mobile phones and websites even if there is an insurer within the insurance group that specializes in cyber marketing.

Changes in the Standard Terms and Conditions of a Car Insurance Policy

There have been changes in the standard terms and conditions of a car insurance policy, which became effective in January 2023. Patients with minor injuries from car accidents must pay for a portion of medical expenses in excess of Third Party Bodily Injury I Coverage depending on the degree of their own negligence. The payment can be made from their own insurance or out of their own pockets.

In addition, when patients with mild injuries receive long-term treatment for more than four weeks, they must submit a diagnostic report issued by the medical institution to the insurance company. Previously, it was possible for a car accident victim to receive medical treatment and get insurance coverage for an unlimited period of time without submitting a proof document like a diagnostic report, but now car insurance coverage for such long-term treatment is available only for a period specified in the medical report.

Another change is to expand the types of repair and include towing costs in losses covered by Third Party Property Damage Coverage so as to provide adequate protection to insurance consumers.

Increase in Reward for Reporting Insurance Fraud

The maximum reward for reporting insurance fraud has been raised from KRW 1 billion to KRW 2 billion since January 2023 in order to encourage the reporting of insurance fraud and curb fraudulent insurance claims. When an insurance claim is filed, a notification message is sent to the claimant regarding the reporting of insurance fraud. This will help raise public awareness of insurance scams.

False or inflated claims are a serious issue for the insurance industry. Insurance fraud is a crime committed against or by an insurance company or agent for profit. It is essential for the industry to work closely together with supervisory authorities to detect fraudulent claims arising from the dishonest intent of policyholders who expect to make financial gains from their insurance policies and the collusion of insurance professionals, agents, doctors, medical service providers, and car repair shops.

Preliminary Business Results of Insurers in Korea for the First Nine Months of 2022

Insurance carriers in Korea reported KRW 7,761.2 billion in net income for the first nine months of 2022, up 1.7% from a year earlier. Life insurers' results stood in stark contrast to those of non-life insurers. The former continued to suffer a large decline in net income while the latter performed strongly in terms of bottom-line growth. Life insurers saw their net income decrease by 20.3% year on year to KRW 2,943.7 billion for the nine-month period as they experienced the double whammy of widening underwriting losses and falling investment gains. A decline in premium income aggravated their underwriting results, and their investment operations also performed weakly due to a reduction in gains on disposition of financial assets.

On the other hand, the non-life insurance sector delivered strong results, with their net income surging by 22.3% to KRW 4,817.5 billion for the first nine months of 2022. This robust performance was backed by improvements in both underwriting and investment gains. Non-life insurers' underwriting losses narrowed thanks to a drop in long-term insurance loss ratios amid a relatively benign claim environment. Their investment results also improved on the back of rising foreign currency translation gains due to a strong US dollar.

The total premium volume of the insurance market increased by 0.5% to KRW 156.3 trillion in the January - September period of 2022. The growth was fueled by the non-life insurance sector. Non-life insurance premiums amounted to KRW 78.6 trillion, up 7.2% from a year earlier. Traditionally, non-life premiums would be smaller than life premiums, but that has not been the case since 2022 due to the continued growth of the non-life sector. General P&C insurance premiums increased by 9.5%, while long-term and motor premiums grew by 4.8%, and 3.0%, respectively. Meanwhile, the non-life industry witnessed an unusually high growth rate of 33.5% for retirement annuity premiums, which was led by three insurers - DB Insurance, KB Insurance, and Meritz Fire & Marine Insurance.

In contrast, life insurance premiums shrank by 5.5% to KRW 77.7 trillion mostly because of a sharp decrease in variable life premiums. Savings insurance sales also declined, with premium income falling by 6%. Retirement annuity and protection-type insurance premiums grew by 3.3% and 2.6%, respectively.

The profitability ratios of the insurance industry improved in the first nine months of 2022 compared to the same period of the prior year. Its return on assets (ROA) ratio rose by 0.01%p to 0.78%, and its return on equity (ROE) ratio jumped by 2.12%p to 9.45%. Non-life insurers reported higher ratios than life insurers as below:

As of the end of September 2022, insurers reported a decrease in assets compared to nine months earlier. Their total assets declined by 3.9% to KRW 1,305.8 trillion, which is broken down into KRW 937.2 trillion for life insurance and KRW 368.6 trillion for non-life insurance. Life insurers continued to dominate insurance industry assets, accounting for 72% of the total, but their assets diminished by 5.6%, while non-life assets increased marginally.

**Total Assets and Shareholders' Equity**

Over the same nine-month period, the insurance industry saw its total shareholders' equity dip by 37.4% to KRW 84.3 trillion as of late September 2022 because rising interest rates caused insurers to suffer a reduction in unrealized gains on the value of securities they hold as investments. The coupon rate on the ten-year treasury bond shot up to 4.10% at the end of September 2022 from 2.25% at the end of December 2021.

In the long-term, the gradual upward movement of interest rates may help insurers improve their profitability because their investment portfolio yields increase in step with interest rate rises. However, insurers may experience setbacks from rate hikes in the short term. When rates go up, the value of their bond portfolios goes down as existing bonds become less attractive than new bonds that offer relatively higher rates. Although this decrease in value does not affect net income because it is recognized as unrealized gains or losses, it reduces insurers' book value or net worth. Over time, insurers can benefit from higher interest rates as they will have the opportunity to invest at higher rates and improve their overall profitability.

Trend of the Whole Life Insurance Market in Korea

Whole life insurance is one of the major segments of the life insurance market in Korea. Although its growth pace has slowed recently after years of strong sales, whole life insurance still takes up a large share of the individual life insurance market in the country. The share of whole life insurance in the total individual life insurance sector had increased from 23% in 2010 to 30% in 2019 and then stayed at 29% in 2000 and 2021 according to a report by the Korea Insurance Research Institute.

**Share of Whole Life Insurance in the Individual Life Insurance Market (2010-2021)**

In terms of whole life premium income, the pace of growth stabilized after recording a year-on-year increase rate of 12.8% in 2015 and 9.7% in 2016. The growth rate turned to negative in 2021 mostly because of declining economic prospects and strengthened supervision of new product development due to concerns over mis-selling.

Whole life insurance provides permanent death coverage for the life of the insured and typically offers a fixed amount of premium and a fixed death benefit together with a cash value savings component. As long as premium payments are made as agreed upon, the insured will be covered for life unlike with term life insurance that provides coverage for a set period of time. With the savings component, a whole life policy can function as an investment because the accumulated cash value can be used as an emergency fund or for other purposes.

The development of new types of whole life insurance products in Korea accelerated in 2015 and 2019 in step with evolving market needs amid rising life expectancy and low interest rates. The number of newly launched whole life products peaked to 118 in 2015 compared to 34 in 2010. After a period of decline, it soared again to 101 in 2019.

**Number of New Whole Life Products (2010-2021)**

The boom in launching new whole life products in 2015 reflected the development of whole life insurance policies that come with the feature of prepayment of death benefit pension. This new type of whole life insurance allows the insured to receive annuity payouts from the accumulated cash value without surrendering the policy. Life insurers sought to respond to growing consumer demand for financial products that provide income security during retirement years. Consumers were attracted to insurance coverage against death in combination with the advance benefit payment component, which can be used as a source of retirement income.

Between 2019 and 2020, there was a rise in whole life insurance sales driven largely by low-surrender-value insurance products, which would charge lower premiums than other whole life policies and provide no or lower cash surrender value if policyholders cancel their insurance before the premium payment term expires. However, such products caused market confusion and resulted in mis-selling practices where insurance sales pitches focused only on the high cash surrender value after the end of the premium payment term.

Sales of simplified issue whole life policies increased during 2020 and 2021 as they gained popularity among people with chronic conditions. Simplified issue whole life insurance is a type of permanent life insurance that provides a small amount of death coverage to those who do not qualify for other traditional policies. Although premiums are higher or the coverage is lower, seniors or people with pre-existing conditions can benefit from such products as a means of increasing their financial security.

Another important driver behind strong initiatives to sell whole life insurance was regulatory changes such as commission structure reform and transition to IFRS 17, leading life insurers to shift their focus to protection products in order to reduce their interest risk exposure.

Under IFRS 17, profits from a long-term contract should be booked over the length of the contract, not in the year in which the contract is initially made. In this respect, a major profitability indicator is the Contract Service Margin (CSM), which represents the unearned profit that an insurer recognizes as it provides services over the coverage period. After initial recognition, the subsequent measurement of the CSM depends on the type of an insurance product, and long-term protection products like whole life insurance are generally favorable for insurers to increase their CSM.

**Trend of Protection Insurance Premiums in the Life Insurance Market (2014-2022E)**

Review of Natural Catastrophes in Korea

In 2022, Korea suffered the worst flooding in more than 100 years after days of heavy rainfall in August. The unprecedented rainstorm caused record flooding in many parts of Seoul and the surrounding area, with the Gangnam area being one of the worst hit. Heavy rainfall flooded streets, subway stations, buildings, and homes, causing power outage for hours.

While property losses were relatively small due to low levels of insurance penetration among households and small businesses, motor losses peaked with estimated losses reaching KRW 162 billion. More than 11,000 motor insurance claims were filed in the wake of the flooding.

The August flooding driven by torrential rain likely had to do with climate change, according to the Korea Meteorological Administration. Climate change is believed to increase the frequency of large scale atmospheric pressure patterns with little or no movement-referred to as atmospheric blocking. Weather extremes such as heavy rain, cold spells, heat waves, and drought are often associated with atmospheric blocking.

In early September 2022, Korea was struck by Typhoon Hinnamnor, the strongest cyclonic storm for the year. Cities on the southern coast experienced severe damage from the super typhoon, which made landfall near Busan on September 5 and slammed through the southern area, causing ten deaths. The typhoon took a huge toll on the country's industrial region, with an estimated property damage of KRW 1.7 trillion. It was among the top five strong typhoons that hit Korea in terms of property damage. While Typhoon Hinnamnor ranked 17^th in terms of casualties, it was the third strongest typhoon in terms of air pressure (hPa).

**Major Typhoons in Korea by Property Damage**

The largest insurance claim is expected to come from steel maker Posco, which has lost an estimated KRW 2 trillion in revenue due to the flooding of its hot rolling facilities in Pohang. Following the August flooding, the insurance industry suffered another large motor losses from the typhoon, with over 9,600 vehicles being damaged and estimated insurance claims amounting to more than KRW 77.2 billion.

The combined gross losses of August and September events are estimated to surpass KRW 200 billion, but insurers' net losses are not likely to be high thanks to reinsurance recoverables.

Typhoons and accompanying rain are the biggest natural perils in Korea. Over a recent ten-year period, approximately 50% of insured catastrophe losses have been caused by typhoon, 35% by torrential rain, 12.5% by weight of snow, and 2.5% by sea surge, according to AXCO.

Korea is hit by multiple typhoons each year, usually in the typhoon season from July to September. On average, the country experiences three typhoons a year. As typhoons normally approach the country from the south, the most vulnerable area is the southern part of the Korean Peninsula, particularly Jeju and Busan. Typhoons generally cause damage to properties by force of wind, but most typhoon losses arise from heavy rain.

In 2021, heavy rain and typhoons accounted for 61.6% and 31.9% respectively of overall property losses from natural disasters. Between 2012 and 2021, typhoons took up the biggest share (47.7%) of annual average property losses from natural catastrophes, followed by heavy rain (45.2%).

**Overall Property Losses by Natural Peril (2021)**

**Trends of Overal Property Losses from Natural Disasters (2012-2021)**

Latest Developments in the Agricultural Insurance Market

The agricultural insurance market in Korea has been growing with support measures from the government since 1997 when livestock insurance was first introduced in the country. Currently, around 550,000 farming households have agricultural insurance as of 2022 compared to approximately 64,000 in 2010. Market development has been led by the government-subsidized agricultural and fishery disaster insurance scheme designed to support the management of catastrophic risks and to provide financial stability to the farming and fishery industries.

Crop insurance was developed in 2001 as part of the government-sponsored agricultural insurance scheme. Most types of agricultural produce are covered by crop insurance against a broad range of perils, including natural disasters, fire, blight and damage caused by harmful insects, birds or wild animals. Typhoon, hail and spring frost are among the biggest perils, and the main insured crops are rice and fruit. The subsidy from the national and municipal governments covers up to 90% of the premium, with the insurance buyer's out-of-pocket contribution remaining relatively small. In addition, 100% of insurance operating expenses are also subsidized.

The only insurer which is authorized to write subsidized crop business is NongHyup Property & Casualty Insurance, which sets premium rates in collaboration with the government. Other insurers can participate in the crop insurance market as co-reinsurers along with the government. The co-reinsurance panel cedes to Korean Re, which retrocedes to foreign reinsurers. Livestock risks are written directly by several insurers including NongHyup Property & Casualty Insurance, KB Insurance, DB Insurance, Hanwha General Insurance, and Hyundai Marine & Fire Insurance.

Among farmers, there has been a rising need for risk management through insurance programs amid the increasing frequency and severity of extreme weather events driven by climate change. As of 2022, the crop insurance take-up rate soared to 49.9% compared to 13.6% in 2010. The portion of farmers buying livestock insurance stood much higher at 94.6% in 2022, up from 53.1% in 2010.

**Take-up Rates of Agricultural Insurance**

In January 2023, the Ministry of Agriculture, Food and Rural Affairs announced measures to improve the agricultural insurance scheme in ways that help the farming industry build resilience to natural disasters and enhance the fundamentals of the insurance programs that can provide fair, reasonable and sustainable insurance protection.

To this end, the government targets to increase the number of insured farming households by 15% to 630,000 by 2027 and raise the number of covered crops from 70 in 2023 to 80 in 2027. Insurance pricing will also be improved to better reflect risk levels of farmers. While a more granular rating system based on smaller geographical units is currently applicable to apples and pears only, the rating method will be applied further to rice, astringent and non-astringent persimmons in 2024. This more granular rating system will help prevent a high loss ratio in a particular community from affecting premium rates in others within the same county.