The financial authorities have decided to reconsider the timing of expanding the final observation period to 30 years. By extending the final observation period, they accepted the insurance industry's view that the financial soundness of insurance companies would worsen in the short term. However, why are the financial authorities pushing for an expansion of the final observation period, which adversely affects the soundness of insurance companies? The financial authorities talk about principles and fairness.
To understand the meaning of the principles mentioned by the financial authorities, one must first know the discount rate. The core of the new accounting system (International Financial Reporting Standards 17) is to mark liabilities to market. If an insurance company expects to pay 100 million won in insurance benefits to customers in 10 years, then 100 million won becomes the insurance company's liability. So, what is the value of 100 million won in 10 years? The discount rate is used to calculate this. Literally, as the discount rate increases, the size of the liability decreases. For insurance companies, a higher discount rate is preferable.
The discount rate is linked to market interest rates. Generally, if interest rates are high, the discount rate is high; if interest rates are low, the discount rate also decreases. The insurance industry has estimated the discount rate by reflecting only the 20-year government bond rates. The maximum that can be directly observed and monitored in the market is up to 20 years. This is called the final observation period. Until now, the final observation period was 20 years.
After 20 years, since direct observation is impossible, estimates and conjectures must be made. However, there is a standard. It must converge on the long-term leading interest rate designated by the financial authorities each year. The long-term leading interest rate is the estimated rate for after 60 years, which was 4.55% last year. It is assumed that the interest rate gently rises from 20 years onward to ultimately reach the long-term leading interest rate of 4.55%.
However, the financial authorities state that the 30-year bond rate must also be reflected in the discount rate. Insurance companies are perplexed because the current 30-year bond rate is lower than the 20-year bond rate. It is generally considered that the longer the maturity, the greater the risk, so longer maturities usually have higher interest rates. However, the opposite phenomenon is occurring in Korea. As of the 15th, the 30-year bond stood at 2.757%, lower than the 20-year bond's 2.865%.
Insurance companies have been estimating that the interest rate will gently rise after 20 years, but if the lower 30-year bond is incorporated, the interest rate graph will bend downwards. As mentioned earlier, the interest rate affects the discount rate. Ultimately, a lower discount rate negatively impacts insurance companies.
In particular, if the discount rate falls in the 20-30 year range, the liability duration of insurance companies increases. Conversely, the asset duration remains unchanged. This leads to a result where the gap between asset duration and liability duration widens. Many domestic insurance companies have a liability duration greater than asset duration, resulting in a negative gap. If the liability duration increases further, the negative gap widens, and the risk of capital plummeting during a decrease in interest rates also increases.
At first glance, it is difficult to understand the intentions of the financial authorities. They have been guiding and supervising to bring the asset and liability duration gap to '0'. If there is no gap, the capital of insurance companies will not fluctuate even if interest rates change, which maintains soundness. However, on the other hand, they are pursuing an expansion of the final observation period, which will increase the asset-liability duration gap.
The financial authorities hold that the reduction of the asset-liability duration gap and the extension of the final observation period to 30 years cannot be considered together. Insurance companies have an obligation to fairly assess their liabilities. The 30-year bond has sufficient trading volume to adequately represent market prices, and failing to reflect this could be problematic. The financial authorities have already determined through simulations, etc., that the 30-year bond meets the criteria for the final observation period.
However, the financial authorities explained that since a situation where the 30-year bond rate is lower than the 20-year bond rate has occurred, expanding the final observation period would increase the impact, so they are re-evaluating the timing of its implementation. A financial authorities official noted, 'Expanding the final observation period is aimed at accurately evaluating the fair value of insurance liabilities,' adding, 'If the interest rate situation changes such that the 30-year bond rate is higher than the 20-year bond rate, the situation will change.'