Taiwan regulators are planning to introduce an additional capital adequacy requirement for domestic insurers next year that would overhaul their solvency regime.

The Financial Supervisory Commission (FSC) has proposed a new metric to evaluate an insurer’s capital adequacy to strengthen their ability to bear risks. The new metric – the ratio of net assets over total assets – will be used together with the existing risk-based capital (RBC) ratio.

Insurers will be required to strengthen their capital base if their net assets to total assets ratio falls below 3% for two consecutive six-month periods, the regulator said last week.

Insurer capitalisation levels in Taiwan are weaker than elsewhere in the region, while their equity investments are higher.

Regulators are proposing to introduce the new metric because they are worried that insurers may not have enough of a capital buffer if they have to realise losses on their equity investments when markets turn south, Kelvin Kwok, an analyst for financial institutions at Moody’s, told AsianInvestor.

The net assets to total assets ratio shows the capital buffer of a life insurer. Under the new rules, even bigger insurers like Shin Kong will be affected as its capital buffer is relatively weak, meaning it could  easily hit the minimum threshold, Kwok said.

"As a result, for insurers like Shin Kong, they may need to reduce their equity investments to lower their net assets' sensitivity to equity market movements if their shareholders are not willing to increase capital positions", he said.

Shin Kong Life was Taiwan's fourth-largest life insurer by premiums in 2018. According to Moody's, its net assets to total assets ratio fell below the proposed regulatory minimum of 3% at the end of last year, even though its RBC ratio was above the regulatory minimum of 200%. 

Shin Kong Life did not immediately reply when contacted by AsianInvestor over this observation from Moody's.

FSC is inviting market participants to give their feedback to the proposal within 60 days after announcing it on July 25. The new rules are slated to come into effect on April 1 next year.

NEW METRIC VS RBC RATIO

Capital adequacy level

Under current RBC rules

Under new metric

Inadequate 

150%≤RBC<200%

Net assets/total assets ratio is less than 3% for two consecutive six-month periods, but higher than 2% in at least one period

Significantly inadequate

50%≤RBC<150%

0%≤ net assets/total assets ratio <2% for two consecutive six-month periods

Seriously inadequate

RBC<50% or net assets<0

No additional requirement

Taiwan FSC and Moody's

The net assets to total assets ratio is more sensitive to short-term equity market volatility than the existing RBC ratio, so the new ratio can supplement the RBC ratio to better reflect the insurer’s exposure to equity price risks, Kwok said.

When calculating net assets, the market value of the equity investment at any end-period is captured and so any unrealised loss will be reflected. In contrast, the RBC ratio smooths the effect of equity price volatility by adopting a 180-day moving average.

In case equity prices shoot up at the end-period, the regulator will look at the lower of the new ratio or RBC ratio to determine its capital adequacy level. So the level won’t be inflated if the equity market is on the rise at end-period, he said.

STRENGTHENING CAPITAL

The type of capital that insurers can use to improve the capital adequacy are also different for the two metrics. Insurers can only strengthen their capital positions by issuing preference shares or ordinary shares to improve the new ratio, while they can improve their RBC ratios by issuing subordinated bonds.

Under the current RBC regime, this subordinated debt can be regarded as the insurers’ available capital. However, the loss-absorption capacity for subordinated debt is weaker than for equity.

In most cases, insurers still have to make coupon payments for subordinated debt even if their profits or solvency levels drop a lot. But if the insurers strengthen their capital through equity tools, it can choose not to pay out any dividends in similar cases, Kwok said.

Issuing preference or ordinary shares can better help insurers to preserve capital and absorb losses. So the new rules can improve the overall risk-absorption capabilities of insurers, he said.

The regulator is also considering segregating insurers’ available capital under the RBC ratio calculation into different tiering.

At present, Taiwan insurers do not have to classify their capital into different baskets according to their loss absorption features. In other solvency regimes, the available capital is usually divided into core and supplementary, which can better reflect the resilience of the whole capital structure, Kwok said.