Insurance
Korea is ranked one of the top ten insurance markets in the world in terms of premiums received. After the wake of the 1997-98 financial crisis, Korea’s insurance industry has undergone major restructuring in two separate phases (phase 1 - 1998; phase 2 - 1999-2000) in which a total of 12 life insurance companies were forced out of the market, and one life insurer converted to a state-run insurance company. In addition, a number of ailing non-life insurance companies have also been required to either be closed or absorbed by larger companies. The current economic situation in Korea emphasizes the need to restructure the insurance industry, to eliminate non-viable companies, to move toward international solvency standards and to maintain the pace of deregulation.
Today, there are no barriers to the establishment or purchase of an existing insurance company by a foreign investor. The Korean government is to be commended for its actions that have led to this development. However, FSS (Financial Supervisory Service: the implementing arm of the FSC) must continue to set priorities for the deregulation of the industry. In this regard, AMCHAM considers the following areas - which if properly addressed, will greatly enhance the business climate for all insurers in Korea, both foreign and domestic - to be vital.
Our objectives are to:
- Protect the interests of the Korean insurance consumer.
- Upgrade the Korea insurance market to more closely reflect international standards, which will improve the attractiveness of the industry to foreign investors and reduce the financial strain on public funds.
- Create an internationally competitive marketplace through innovation, professionalism and increased efficiency.
In order to accomplish these objectives, the following areas should be addressed:
1. Investment Climate
The industry is currently suffering from a capital shortfall necessary to meet minimum solvency standards. The gradual adoption of international standards is putting further pressure on weak insurance companies. The ability to attract both foreign and domestic capital to the industry is imperative for lifting the industry out of its current dependence on public funds, and for assuring the safety of policyholder obligations.
The insurance industry shares with many other segments of the economy common problems in attracting investment. These include the unwillingness of current owners to properly value existing companies, the inability to write-off bad loans, lack of accounting transparency and concerns over the ability of new investors to reduce labor costs.
Resolving the solvency crisis in the industry will require an allocation of priorities. First and foremost is the protection of the policyholders. It is unrealistic to assume that capital infusions or conventional Merger &Acquisition (M&A) activity will rescue all insolvent companies. In the interest of protecting policyholders, other remedies such as encouraging healthy companies to acquire blocks of policyholders without having to assume the burden of acquiring the company, should be encouraged. This benefits the consumer and minimizes the potential requirement for public funding, while offering an opportunity to attract foreign investment.
A further issue is the delay in finalizing the terms for the listing of life insurance companies. While this does not directly affect AMCHAM member companies, it does have an indirect negative impact through diversion of FSS resources, and through regulatory changes, which may facilitate this listing but which at the same time disregard the interests of the smaller foreign companies (for example, the retroactive change in 1998 in par policy profit sharing ratio from 70%-30% (policyholder-shareholder) to 90%-10%).
Prudent regulation of insurance company assets and liabilities require that those assets that are linked to the accumulation of policyholder benefits be segregated from the general assets of the company. Current regulations permit this, but to date have only been promulgated with respect to tax-qualified individual annuity plans. Separate accounting should be required for all policyholder funds to avoid concerns on surplus, reevaluating reserve guidelines, and grouping investment income and gain on capital with the participating dividend account paid to policyholders. The advent of market-sensitive interest rate products and the group pension product requires this accounting change. The ultimate beneficiaries are the consumers who have entrusted an insurer with their funds.
Recommendations
- Finalize the listing terms for life companies;
- Resolve the issues of transparency and cost of doing business in line with the required changes affecting the entire Korean business structure;
- Encourage foreign investment by adopting remedies that would permit the acquisition of policyholders without the financial burden of acquiring company infrastructure and employees;
- Implement regulations requiring separate accounting for policyholder funds to promote sound investment practices and returns to policyholders.
2. Product Development and Distribution
One of the positive trends over the past several years has been the progress made in deregulating the insurance industry. An industry that is based upon open competition for product design, pricing and distribution combined with prudential regulation, best serves the insurance consumer and the larger society.
Development of new types of insurance products is a positive trend, which benefits the Korean consumer. There have been positive developments in announcing the deregulation of the various life insurance product-pricing assumptions (loadings and interest rates) and this is commendable. Also the change of the product approval process to use and file was undoubtedly intended as a move towards allowing life insurance companies greater scope for product innovation.
However, the actual implementation of these liberalizations has been frustrated. Some examples include:
- Within days of announcing life insurance pricing interest rate deregulation in 1999, insurance company actuaries received telephone calls from the FSS in with they were given instruction on which rates they should use for which type of product.
- Even though life insurance product loadings were deregulated in 2000, the FSS continues to reject new products based on ‘inappropriate’ loadings structures.
- Even though a ‘use and file’ life insurance product approval system was introduced in 2000, the FSS recently held a meeting for life company actuaries in which they were instructed that they should ‘discuss’ (ask for prior approval) all new products with FSS before ‘using’ (selling) them.
The unfortunate result of the above is that almost no innovative life insurance products have been introduced in Korea since 1997.
We believe that the FSS should focus its energies on establishing a regulatory framework that assures the financial viability of the companies and protects the consumer through proper disclosure, rather than by becoming involved in product design. It is up to the life insurance companies themselves to design and sell products that meet the regulatory requirements, while permitting free market mechanisms to decide which product the consumer prefers.
The current required pricing structure for non-life policies, which was imposed in 2000, is unfair to foreign companies and restricts competition.
The larger domestic companies have a distinct advantage due to economies of scale and their close associations within their group.
Beyond the competitive aspects of this procedure, there is a social impact in eliminating risk-based pricing, as there is no incentive for the insurance consumer to employ practices that would reduce the possibility of losses. The concepts of loss engineering, loss prevention and preventive maintenance as tools to reduce insurance costs may be invalidated.
In addition, the consumer choice of product and price is enhanced by choice in how to purchase a product or service. In the last two years, progress has been made in improving the distribution channels for brokerages and agencies. However there is a definite need to clarify the responsibilities between brokers and agents in line with international best practices.
Confusion still remains over regulations and enforcement related to the use of telemarketing, direct mail and other non-traditional methods of distribution, such as sales through bank branches. Included in this issue are restrictions on the payment of commissions to other financial institutions. A related issue is the ability of life insurance agents to sell other financial products such as mutual funds. Expansion of distribution carries with it an obligation that individuals who sell insurance and other financial products must be properly trained and licensed, and that direct response methods provide the purchaser with full disclosure.
Recommendations
- Restructure the product approval process/department within the FSS;
- Enact the necessary regulations and clarify enforcement in order to permit insurance companies to market products through other financial institutions and non-financial organizations. This includes permitting insurance companies to pay commissions to other financial institutions and organizations. The issue of who can market mutual fund products also needs to be clarified;
- Amend product filing regulations and procedures to improve the development of more competitive products;
- To assist in full disclosure and transparency, non-life brokers and agents should disclose to the customer what revenue they receive from the underwriters by the way of commission, etc.
3. Consumer Choice, Competition and Safety
While the AMCHAM member insurance companies fully support consumer protection, safety and choice, there is a clear difference in philosophy on how this protection can best be achieved.
AMCHAM member companies believe that the best way to protect the consumers’ interests is by ensuring insurance company solvency, transparency, competition/choice and clear disclosure of product/service features and risks.
While the government and the FSS leadership promote the same basic approaches, actual implementation seems to vary and actually eliminates consumer choice. The unhealthy result of this approach is illustrated in the following examples:
Waiting periods (delay in receiving the benefit) in insurance products are not allowed by law even though these are common in all developed insurance markets. This law is depriving Korean consumers of very valuable products (such as private unemployment insurance) because companies will not develop products, which without a waiting period, can be easily abused by dishonest customers.
Certain laws are rewarding dishonest customers and thus increasing the cost for the great majority of honest clients. An example of this is a case where a customer makes a claim on a policy and during the claim investigation, it is discovered that the customer did not disclose some important information about his/her health condition on the application. If the claim is not related to this original health condition, the insurance company must pay the claim PLUS pay back 100% of the past client’s premiums if it wants to cancel the policy (i.e. dishonest customer receives free insurance). Thus, the law encourages a dishonest customer to lie on the application, rewards him for it, and penalizes the insurance company - consequently making insurance more expensive for the honest customers.
The FSS strongly suggests that companies resolve all of their customer complaints in the customer’s favor irrespective of policy terms or conditions. While it is in the companies’ interest to resolve most customer complaints to the customers’ satisfaction, invalid or fraudulent complaints should be investigated and rejected with a full explanation.
Recommendations
- Establish a task force of FSS and insurance companies’ senior representatives, including representation from foreign companies, to undertake a review of the effects of the current insurance regulations on competitiveness, consumer choice and protection;
- Abolish the ban on decreasing death benefit in the life product regulation and the practice of refunding past premiums in cases where policies are cancelled for clear and material misrepresentation of fraud.
4. Other Issues
Communication is another area where AMCHAM member companies are experiencing ongoing difficulties. The format of official communications from the FSS does not take into consideration the management processes, plans or costs of the insurance companies. Some examples illustrate this point:
Almost all formal communications (changes in regulation and FSS directives) give insufficient lead-time for implementation. The period that the FSS gives insurance companies to implement its directives is usually 2-4 weeks (in case of the suspension in November 1999 of product development due to Y2K, the directive was received after the effective date), where in other mature insurance markets this lead-time is at least 3 months. Proper lead-time is necessary for the insurance companies to implement the required changes efficiently, effectively and at lowest cost.
AMCHAM insurance company members also disagree to the previously mentioned practice of applying unofficial pressure to the insurance companies, often in contradiction to the spirit of deregulation. A probable recent example of this is the directive sent by the KLIA to its member companies, asking them to relax the underwriting standards for disabled insurance applicants. Since discrimination based on risk is the foundation of the insurance industry, this type of a directive is an unreasonable interference in the management of the insurance companies. It is a social policy issue and thus should be handled by the government directly.
Gathering of ID numbers and employment history of all employees on the basis of possible undefined issue of insurance fraud.
While AMCHAM members fully support high compliance standards for the Korean insurance industry, rather than dictating how the compliance function should be managed inside the company, the FSS should simply set the compliance standards and then audit compliance.
On the issue of the Appointed Actuary, AMCHAM member companies believe that this is an important step in professionalising the management of the insurance industry and building up advanced actuarial standards in Korea. Ideally, the company should seek actuarial advice prior to the Director’s approving any premium rates and each year’s dividend distribution. Such actuarial advice could be in a required format such as the Pricing and Financial Condition reports required in other parts of the world. This will require the local actuaries to raise their standards but also put the responsibility where it belongs - on the Directors. Such reports would be open to the scrutiny of the FSS (post event) to ensure they are prepared professionally and that the directors have not applied undue influence on the actuary. Many of the recommendations made by the Canadian consultant who was hired by the FSS were excellent bases to work from and establish an agreed process.
Recommendations
- Establish a formal process by which foreign expertise, resident in foreign-invested companies operating in Korea, is included in the policy making process by the Financial Supervisory Commission and other regulators for the development of the insurance industry;
- Establish a proper communication process for changes in regulation and regulatory authority directives. This needs to include a circulation of drafts, pre-notice periods and sufficient time to implement such new regulations;
- Recognize that foreign insurers operate in an international compliance environment and withdraw the detailed management requirements for the execution of the compliance officer function;
- Implement the Appointed Actuary system according to the international consulting recommendations made to the FSS as a first step.
5. Conclusion
The adoption of the recommendations in this paper will create an insurance industry that is financially sound, provides insurance consumers with access to properly priced products and elevates the regulation and operation of the industry to international standards. It is recognized that it is not practical to implement all of these changes immediately, and that a phased approach may be required for some of them.
Recommendation
- Develop a priority list and timetable for the implementation of the recommendations contained within this section. It is desirable that they be completed within a three-year period.
