Korean financial authorities use the Liability Adequacy Test (the “LAT”) to evaluate whether insurers’ liability reserves are sufficient, by converting future cash flows, including insurance liabilities arising from insurance contracts, into present values.  If such liability reserves are insufficient, the authorities require insurance companies to accumulate additional liability reserves (“Additional Reserves”).  With the upcoming implementation of IFRS 17 in 2023, the basis for converting future insurance liabilities to present value will be changed from “historical interest rates” to “current interest rates.”  This will likely place a financial burden on insurers who may have to accumulate a large amount of liability reserve in a relatively short time.  The LAT allows for a soft landing of IFRS 17 by introducing a gradual adjustment of discount rates before IFRS 17 actually takes effect in Korea.

In the LAT, Additional Reserves are treated as current expenses on the income statement and as liabilities on the balance sheet.  Under the current law, if Additional Reserves increased from a fall in the benchmark interest rate, such increase would be reflected in the liabilities, but if Additional Reserves decreased from a rise in the benchmark interest rate, there would be no way to reflect such decrease as profit.  This is mainly because the financial supervisory authorities feared that an uptick in profit in such manner may later impose additional liabilities on the insurance companies if the benchmark interest rate declines in the future.  Therefore, the net profit of insurance companies has generally been undervalued despite the recent trend of rising benchmark interest rate. 

Kim & Chang has recently represented a foreign life insurer in front of the Korean financial supervisory authorities by explaining the problems of the LAT system and the need for its improvement.  As a result, the financial supervisory authorities revealed a proposed amendment to the Detailed Enforcement Rules of the Insurance Business Supervisory Regulations (the “Amendment”) on July 30, 2021 by updating methods to calculate “Additional Reserves” under the LAT system.

Per the Amendment, if the Additional Reserve for the current fiscal year under the existing estimation assumptions of the LAT is less than the Additional Reserve of the previous year, the new method will allow such difference to be reflected as retained earnings in the insurer’s capital account.  Following the Amendment, insurers can expect to more accurately book their Additional Reserves, which may be adjusted according to shifts in the benchmark interest rate.