Korean Life Insurance Stable Industry Outlook

Transcription

1 NOVEMBER 17, 2010 INSURANCE INDUSTRY OUTLOOK Korean Life Insurance Stable Industry Outlook Table of Contents: SUMMARY RATING RATIONALE 1 GOOD UNDERLYING ECONOMIC STRENGTH AND GROWTH SUPPORTS THE INDUSTRY 2 PREMIUM GROWTH PROSPECTS ARE GOOD THANKS TO AGING POPULATION AND POLICY INITIATIVES; SUPPORT LIQUIDITY 2 INTENSE COMPETITION MAKES INSURERS TAKE HIGHER RISKS IN PRODUCTS OR INVESTMENTS 4 PROFITABILITY SHOULD CONTINUE TO RISE 7 IPOS ARE CREDIT-POSITIVE FOR IMPROVING CAPITAL ADEQUACY AND TRANSPARENCY 7 UPCOMING ADOPTION OF IFRS AND RISK-BASED CAPITAL REGIMES: MILD IMPACT 8 MOODY S RELATED RESEARCH 10 Analyst Contacts: HONG KONG Sally Yim Vice President Senior Analyst Sally.Yim@moodys.com Athena Lee Associate Analyst Athena.Lee@moodys.com Stephen Long Managing Director - Financial Institutions Stephen.Long@moodys.com SYDNEY Wing Chew Vice President-Senior Analyst Wing.Chew@moodys.com Summary Rating Rationale The outlook for the Korean life insurance industry is stable, and reflects Moody s opinion of the fundamental credit conditions for the insurance industry over the next months. Moody s is maintaining a stable outlook for the Korean life insurance industry due to the sector s stable premium growth and improving profitability and capital adequacy, thanks to the recovery of the Korean economy and investment market. Insurers initial public offerings in the past year have improved their capital positions. These positive trends are counterbalanced by intense competition, which has given rise to new products and an increase in marketing costs; continued pressure on capital from rising bond spreads; and an increase in life insurers exposures to loans, especially project finance loans. Particularly, variable annuity product sales are increasing in Korea. While some insurers have priced their products at a higher premium in order to compensate for the tail risk, Moody s believes that hedging is still insufficient to cover the significant tail risk associated with these products with minimum guarantees. Korea s life insurers fared comparatively well during the financial crisis, as they suffered only slightly from weaker investment income and lower investment portfolio valuations. Even better news is that their ample liquidity allowed them to hold on to their securities holdings until they recovered their values. Moody s expects that the profitability of the Korean life insurers will improve over the next months, on a recovery in the investment markets and stabilization of the economy. Also, rising interest rates will certainly help investment income. In addition, the stock market has rebounded quite substantially since the beginning of 2010, and companies may thus find opportunities to realize investment gains from their equity investment portfolios. Finally, the life insurance market remains poised for growth, supported by:» stable economic recovery and growth, creating higher demand for life insurance;» an aging population, which supports demand for retirement and medical insurance products;» an expanding corporate pension market driven by policy initiatives.

2 Good Underlying Economic Strength and Growth Supports the Industry The Korean economy performed fairly well during the recent global financial crisis. Its recession lasted for only three quarters, from 4Q2008 to 2Q2009. We expect growth in 2010 and 2011 to be strong rebounding to 6% in 2010 and moderate to 4.2% in Korea s strong recovery is being supported by the government s quick moves on policy adjustments and other stimulus programs following the financial crisis. The external environment has also improved, thereby supporting exports, one of the main components of GDP in Korea. Inflation should be mild and within the central bank s medium-term target range of 3.0% +/- 1% for And the KOSPI has also almost recovered to its pre-crisis level at 2Q2008; as of end-october 2010, it had risen 19.1% from a year ago. Overall, Korea s economic strength and recovery have supported the insurance industry s financial profile throughout the crisis. They have helped the sector avoid heavy losses in its investment portfolios, especially in corporate bonds, mortgages, and corporate loans. Some insurers did suffer mark-to-market losses from the fall of the investment market, but their ample liquidity allowed them to hold on to these securities until they recovered their values. In addition, due to insurers reduced and now small exposure to equity investments (thanks to lessons learned in the 1997 financial crisis), the fall of the stock market did not have a significant impact on the insurers capital levels. We believe that Korea s favorable economic outlook will make for a good operating environment for the insurance industry. We expect to see premium growth (discussed in more detail in the next section) and the amount of investment income and realized gains return close to pre-crisis levels. In addition, financial flexibility is also improving, considering the insurers better liquidity and access to the capital markets. Nevertheless, the life insurers will see some pressure on the valuation of their large fixed-income portfolios as a result of interest rates rising. The central bank raised the base rate 1 by 25 basis points to 2.25% on July 9, 2010, for the first time, and by another 25 basis points to 2.5% on November 16, 2010, following a series of rate cuts totaling 3.25% since October We expect that the magnitude of upcoming interest rate increases will be mild and gradual given the lingering uncertainty about the global economy. Unless interest rates rise by more than 200 bps in the next months, insurers should be able to withstand the pressure on capital levels by generating more capital organically. Premium Growth Prospects are Good Thanks to Aging Population and Policy Initiatives; Support Liquidity The Korean life insurance market has one of the highest penetration rates in the world. It achieved a growth rate of 4.2% in FY2009, 2 rebounding from a contraction of 0.9% in FY2008 caused by the financial crisis, as households refrained from non-essential spending like insurance purchases. However, we believe that growth momentum will return, supported by the economic recovery. 1 Interbank overnight lending rate. 2 All fiscal years (FY) referenced in this report end in March 31 of the following calendar year, e.g., FY2009 means the year ending March 31, NOVEMBER 17, 2010 INDUSTRY OUTLOOK: KOREAN LIFE INSURANCE STABLE INDUSTRY OUTLOOK

3 CHART 1 Total Industry Premium Income and Growth Rates 60,000 Total Premium Income Premium Income Growth Rate 5.0% 4.0% 55, % (KRW billions) 50,000 45, % 1.0% 0.0% -1.0% 40,000 FY 2005 FY 2006 FY 2007 FY 2008 FY % Source: Financial Supervisory Service, Moody's Aging Population Induces Purchases The life insurance industry is still poised for growth given the country s aging population. According to Statistics Korea, 3 the proportion of the population aged 65 or older was 11.8% as of end However, by 2030, that percentage will increase to 28.1%, and possibly 46.0% by end This fast growth is attributable to the aging of Korea s baby boomer generation. Such a change in demographics will likely lead to greater demand for more insurance products such as pension, medical, retirement savings and long-term care products. As such, we have seen many insurers spending a lot of effort in developing new products in these areas. CHARTS 2A-2C Composition of Korea s Population By Age Group: 2008 By Age Group: 2030 (Projected) Ages % Ages 0 to % Ages % Ages 0 to % By Age Group: 2050 (Projected) Ages 0 to % Ages % Ages 15 to % Source: Statistics Korea, Moody's Ages 15 to % Ages 15 to % Life Insurers Continue to Play an Important Role in Corporate Pension Plans Corporate pension remains another growth area. Since the introduction of corporate pensions in 2005, life insurers have taken a significant share of the market, as have the banks and securities firms. The banking sector has the largest share, 49% of the market, followed by the insurance sector. According to Towers Watson, Samsung Life, the country s largest life insurer, is currently the market leader in the 3 Previously known as the Korea National Statistical Office. 3 NOVEMBER 17, 2010 INDUSTRY OUTLOOK: KOREAN LIFE INSURANCE STABLE INDUSTRY OUTLOOK

4 corporate pension business, with assets under administration in excess of KRW 3 trillion 4 (mostly for defined benefit plans), driven by the group s affiliate business. Moody s expects that the life insurers will continue to play an important role in developing Korea s corporate pension market. Policy initiatives are also supporting the development of the corporate pension market. By end-2010, all the existing retirement insurance schemes and trust severance plans will be abolished and replaced with corporate pension plans. In addition, the government plans to raise the threshold for tax-exempt income for corporate pension subscribers from $2,500 to $3,300 of their annual taxable income. Towers Watson estimates that the market will be worth KRW trillion by end-2010 and that it will grow even more due to the aging population. Consistent Growth Provides Stable Liquidity for Insurers One positive implication of good premium growth is that it supports the insurers liquidity. Like many their Asian peers, most Korean life insurers do not have liquidity issues. We expect their liquidity to remain good, given the insurers sizeable holdings of both domestic and foreign fixed-income securities and equity investments. The only downside is their growing appetite for mortgages and project finance loans as investments, which are less liquid than others. (See Increased Loan Investments is a Credit Risk Given Falling Real Estate Prices )Intense Competition Makes Insurers Take Higher Risks in Products or Investments Despite all these positive factors, Moody s observes that competition has been and will continue to be very keen in the Korean life insurance industry. The top life insurers, especially those who have been recently listed on the Korean Exchange, are trying hard to maintain their market share, to meet shareholder expectations. In addition, given the weaker brand equity of the foreign insurers, who suffered reputation damage after the financial crisis because of problems at parent companies overseas, the large domestic players are eager to gain market share. Because of stock market volatility, customers have shied away from investment-linked products, which have been the main focus of the foreign insurers. The shift in sales to traditional products benefits the domestic players. Nonetheless, Moody s remains mindful of the increasing heat of competition and how it may push some insurers into aggressive and risky moves, either in product design or investment strategies. New entrants may enter the industry under a financial holding company structure, as the banks are keen to set up their own insurance arms or further expand their bancassurance. Life Insurers are Looking for the Next Headline Product Korea s life insurers are looking for the next headline products as a means of differentiating themselves from their competitors. Moody s notes the increasing volume of variable annuities (VA) with minimum guarantees sold in the market. Companies without adequate hedging would suffer. Currently, VAs make up only a small percentage of life insurers total (including renewal) premium income. However, recent data show that VAs are increasingly popular amongst customers, and constitute close to 15%-20% of the new gross premium income of the past two years, according to our review of company data. 4 Korean Corporate Pension Assets Concentrated Among Top Four, Towers Watson, June 7, NOVEMBER 17, 2010 INDUSTRY OUTLOOK: KOREAN LIFE INSURANCE STABLE INDUSTRY OUTLOOK

5 Most of the VA products sold in the past two years are Guaranteed Minimum Death Benefit (GMDB) and Guaranteed Minimum Accumulated Benefit (GMAB) products. However, in early 2010, the Guaranteed Minimum Withdrawal Benefits (GMWB) product were also introduced in the market. Although the underlying exposures of these VAs are related mostly to bond funds, some still have equity investment exposures, in addition to guarantees provided by the insurance companies. Moody s is concerned about the significant risk inherent in these products, given that insurers must provide a guaranteed return while the yield they generate on their own investments is far from guaranteed, especially in Korea s low interest rate environment. Moody s found that insurers in Korea so far are not very sophisticated in hedging their risks associated with these products. Some insurers price these products at a higher premium in order to cover the tail risk, as some may find the appropriate hedging too costly. Adding to the challenge is that, realistically, there are few good ways to fully hedge these risks, meaning that insurers and their creditors will remain on the hook to make policyholders whole, as we have seen from the experience of certain US and Canadian insurers, which suffered large losses from these products during the recent financial crisis. Increased Loan Investments is a Credit Risk Given Falling Real Estate Prices Even though loans as a percentage of total invested assets have declined consistently over the past few years, Moody s notes that the Korean life insurers appetite for corporate loans and project finance loans has grown, as they invest ever larger amounts in these assets because their yield is higher than it is for other traditional asset classes like fixed income and equity securities (Charts 3 & 4). No concrete data are readily available, but Moody s looked at the loans secured by real estate and unsecured loans data from the Korea Life Insurance Association as well as the individual insurers publicly available data. Moody s observed that the absolute amount for these loans has been rising (assuming that corporate and project finance loans are included in these two categories). According to Korea s Financial Supervisory Service, construction-related project financing loans from Korea's major life insurance companies (other than Samsung Life Insurance) increased almost 30%, to KRW 3.6 trillion at end-may 2010, from KRW 2.8 trillion a year ago. Samsung Life, the country s largest life insurer, has cut its exposure substantially, likely due to its concerns about the growing risk associated with this type of loan. Many of these project finance loans are to the construction industry. As real estate prices decline in Korea, the asset quality of these loans is being tested. The Korean housing market, which had been resilient throughout the global financial crisis, has recently started showing signs of weakness, with drops of about 10% in prices in the Seoul/Kyunggi areas since end-2009 and 20% or more in some satellite cities. 5 Deterioration in households debt capacity has caused the number of unsold apartments to rise, pressuring the construction companies who rely on the proceeds from the sale of apartments to pay down their project finance loans. 5 See Moody s Special Comment, Cracks Appear in Korean Housing Market; Testing for Banks, September NOVEMBER 17, 2010 INDUSTRY OUTLOOK: KOREAN LIFE INSURANCE STABLE INDUSTRY OUTLOOK

6 CHART 3 Loans as % of Total Invested Assets: FY 2007 July % 25.0% 25.3% 25.3% 23.4% 22.5% 20.0% 15.0% 10.0% 5.0% 0.0% FY 2007 FY 2008 FY 2009 Jul-2010 Source: Korea Life Insurance Association, Moody's CHART 4 Loans Secured by Real Estate and Unsecured Loans: FY 2007 July 2010 (KRW billions) 18,000 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 Loans Secured by Real Estate Unsecured Loans FY 2007 FY 2008 FY 2009 Jul-2010 Source: Korea Life Insurance Association, Moody's CHART 5 Life Insurance Industry Loan Mix: FY 2007 July % 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Policy Loans Loans Secured by Real Estate Unsecured Loans Others 5.8% 5.4% 5.3% 5.5% 21.0% 21.9% 21.6% 21.7% 27.4% 26.7% 25.9% 25.1% 45.8% 46.1% 47.2% 47.7% FY 2007 FY 2008 FY 2009 Jul-2010 Source: Korea Life Insurance Association, Moody's 6 NOVEMBER 17, 2010 INDUSTRY OUTLOOK: KOREAN LIFE INSURANCE STABLE INDUSTRY OUTLOOK

7 Profitability Should Continue to Rise Thanks to Rising Interest Rates and the Investment Market s Rising Performance Moody s expects that the profitability of Korean life insurers will improve over the next months on an investment market recovery and stabilization of the economy. Rising interest rates will also help companies investment income. In addition, the stock market has rebounded quite substantially since the beginning of 2010; companies may thus also find opportunities to realize investment gains from their equity investment portfolios. The magnitude of the gains may not be as large in 2011 as they have been thus far in 2010, but the steady recovery of the global and Asian economies will support the stock market in Korea (and Asia) in general. The burden of negative spread is also easing gradually, as insurers continue to be prudent and sell more protection-type and floating-rate products. This has helped lower the overall cost of liability. Moody s expects that given the slow and gradual increase of interest rates, the amount of negative spread outstanding will not lessen drastically anytime soon. The negative spread burden will only be completely resolved over time, as policies with high guarantees mature. Moody s estimates that the negative spread burden will not decline to a significantly lower proportion of total reserves until the mid- to later part of this decade. Moody s expects that FY2010 and FY2011 will see an improvement in spread gains, albeit a small one (Chart 6). Expense gains and mortality gains should remain the main drivers of profitability for Korea s life insurers, as in other Asian markets. CHART 6 Source of Profit Margin: FY FY ,000 3,000 Mortality margin Interest rate margin Expense margin Other sources (KRW billions) 2,000 1, ,000-2,000 1,881 1,594 2, , ,508-3,000 FY 2006 FY 2007 FY 2008 Source: Korea Insurance Development Institute, Moody's IPOs are Credit-Positive for Improving Capital Adequacy and Transparency A major development in the Korean life insurance industry in FY2009 and FY2010 is the unveiling of life insurance company IPOs. 7 NOVEMBER 17, 2010 INDUSTRY OUTLOOK: KOREAN LIFE INSURANCE STABLE INDUSTRY OUTLOOK

8 CHART 7 Shareholders' Equity as % of Total Assets: FY 2007 July % 9.0% 8.4% 8.5% 8.0% 7.2% 7.0% 6.4% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% FY 2007 FY 2008 FY 2009 Jul-2010 Source: Korea Life Insurance Association, Moody's Three life insurers have debuted on the Korea Exchange since October 2009 Tong Yang Life, Samsung Life, and Korea Life and press reports have said that Mirae Asset Life and Kyobo Life are next in line. Moody s expects more middle-tier insurers to list, to expand their investor base or capital base, or both. Moody s sees the IPOs of the Korean life insurers as a credit positive. Qualitatively, IPOs raise customer awareness and brand recognition, which could help the sales momentum for life insurance products. Furthermore, public listings improve disclosure transparency as well as corporate governance, as listed companies are under greater scrutiny from investors and the public. The expanded shareholder base, which can include foreign investors, may also push companies to align their internal practices closer in line with international standards. From a financial perspective, the improvement to capital adequacy resulting from an IPO will depend on the amount of new money brought in the magnitude will vary by company. For example, one of the recent IPOs did not sell new shares; hence, there was no injection of new capital and capital adequacy did not improve. Another positive of the life insurers IPOs is that they improve the insurers financial flexibility, as a public listing would provide them with an avenue of funding should they need capital. This will be especially helpful for the Korean life insurers, as under the current regulations they can issue only subordinated debt, and most of them have done so only in the domestic market. Upcoming Adoption of IFRS and Risk-Based Capital Regimes: Mild Impact International Financial Reporting Standards (IFRS) Beginning in 2011, all listed companies in Korea will be required to prepare annual financial statements using the Korean equivalent of the International Financial Reporting Standards (K-IFRS). Even though only a handful of life insurers have been listed so far, Moody s expects that a large number of both life and non-life insurers will adopt K-IFRS starting in FY2011 (starting in April 2011). 8 NOVEMBER 17, 2010 INDUSTRY OUTLOOK: KOREAN LIFE INSURANCE STABLE INDUSTRY OUTLOOK

9 Upon adoption, insurance companies must follow the principles of Phase I of IFRS 4 s Insurance Contracts. IFRS 4 requires a stricter definition of insurance contracts to refer to those that accept only significant insurance risk. As such, deposits from investment-linked contracts, for example, would not be classified as insurance contracts; their premium receipts would have to be classified as investment contracts. Another important change upon adoption of IFRS will be the requirement of a Liability Adequacy Test. This test would consider the current estimates of all future contractual cash inflows and outflows, and determine whether a liability recognized on the balance sheet is adequate or not. If not, the deficiency would have to be recognized on the income statement. Following discussions with insurance companies and the regulator, as well as our own assessment, Moody s believes the adoption of K-IFRS is not going to have a significant impact on the life insurance industry. From a credit perspective, the adoption of K-IFRS would not change the economic capital of an insurance company. It will, however, enhance companies transparency and comparability with other global players. Disclosures should be strengthened as well. The adoption of Phase II of IFRS 4 may have a larger impact on the industry. Phase II of IFRS 4 requires that companies present their insurance liabilities on a fulfillment value basis. (Although the International Accounting Standards Board has published its exposure draft, the standards had not been finalized at the time of this report.) Moody s believes that the requirements under Phase II may cause some life insurers to put up additional reserves, as the interest rate to be used to discount future cash flows could be slightly lower than what insurers are currently using. The interest rates currently being used by the Korean life insurers to discount cash flows is not unusually high, nonetheless, which give us some comfort that the impact of adopting IFRS would not be significant. However, the ultimate impact will very much depend on the principle used to determine the appropriate level of the discount rate. Europe may adopt Phase II of IFRS 4 in January 2013 at the earliest. Moody s expects Korea to implement it one or two years afterward. Risk-Based Capital Regime Starting in April 2011, Korean life and non-life insurers will have to follow the Risk-Based Capital (RBC) regime. Insurers are currently transitioning, reporting both their solvency margin ratios (which will be phased out) and RBC ratios in FY2009 and FY2010. The RBC regime measures market, credit, interest rate, and underwriting risk, in contrast with the solvency regime, which focuses mainly on underwriting risk. Moody s views the implementation of RBC favorably, as it would reflect an insurer s risk exposures more comprehensively. It would also raise awareness of the need for prudent risk management. Some smaller insurers may need capital injections or new investors/partners to meet the new requirements. Some insurers have adjusted their investment portfolio over the past year or so to accommodate the change. The larger insurers, however, should be able to meet the new requirements comfortably. 9 NOVEMBER 17, 2010 INDUSTRY OUTLOOK: KOREAN LIFE INSURANCE STABLE INDUSTRY OUTLOOK

10 Moody s Related Research Rating Methodology:» Moody s Global Rating Methodology for Life Insurers, May 2010 (123502) Credit Opinion:» Kyobo Life Insurance Co Ltd Company Profile:» Kyobo Life Insurance Co Ltd, March 2010 (123505) Sector Comment:» Proposed Revision of Korean Deposit Insurance Act: A Negative for Life Insurers; a Disappointment to Securities Industry, September 2010 (127502) Special Comment:» Cracks Appear in Korean Housing Market; Testing for Banks, September 2010 (126558) To access any of these reports, click on the entry above. Note that these references are current as of the date of publication of this report and that more recent reports may be available. All research may not be available to all clients. 10 NOVEMBER 17, 2010 INDUSTRY OUTLOOK: KOREAN LIFE INSURANCE STABLE INDUSTRY OUTLOOK

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