The recent decline in interest rates is expected to adversely affect the insurance industry’s growth and profitability. Accordingly, insurance companies are advised to aggressively restructure their debts.
Cho Young-hyun, a researcher at the Korea Insurance Research Institute (KIRI) released a report on the effects of lower interest rates on the insurance industry on Sept. 1
The market interest rate recently reached a record low. The Bank of Korea (BOK) lowered the benchmark rate from 1.75 percent to 1.5 percent in July. The interest rates on 1-year, 10-year and 30-year government bonds stand at 1.108 percent, 1.229 percent and 1.242 percent, respectively, as of Aug. 22. The figures are all lower than the benchmark rate.
When the interest rate goes down, insurance companies’ capital decreases and the interest rate risk, also known as the “duration gap,” expands. Then, insurance firms expand the purchase of super-long-term bonds in order to deal with the expanded duration gap caused. However, the move is more likely to lower long-term interest rates further.
Cho said, “It seems that sales of saving insurance products will fall further due to the decline in official interest rates. For coverage insurance, premiums are likely to increase on the reduction in estimated interest rate and this can lead to lower sales in the long term.”
He added, “It is inevitable for the insurance industry to see a worsening profitability owing to the expansion of the second reversal of interest rates and the additional amount of policy reserves and guarantee funds for variable insurance products as well as the expansion of capital securities issuance when the interest rate drops.”
Insurance firms are more likely to issue more capital securities, such as subordinated bond and new types of capital securities, to cope with the deterioration of the financial stability from lower interest rates and this is why the conditions of issuance can get worse in the future. Cho said, “The insurance industry has been making an effort to respond to the fall in interest rate since the 2000s by converting saving insurance to mainly interest rate-linked products and expanding their asset duration. However, it has a high burden on worsening financial stability, growth potential and profitability, with the market interest rate decreasing at a faster pace than expected.”
The possibility of permanent super low interest rates has emerged as the greatest challenge in the insurance industry in line with a lower potential growth rate from the ageing population. Cho said, “Insurance companies needs to change their risk management policy and business models to brace for super low interest rates. Financial authorities should also come up with plans to encourage insurance firms to proactively manage their risks and to promote the growth in the industry.