Lotte Insurance's early redemption of subordinated bonds worth 90 billion won issued 5 years ago has been postponed due to intervention by the Financial Supervisory Service (FSS), causing a crisis for the company. It is a long-standing market practice for subordinated bonds issued for a 10-year term to be redeemed early after 5 years. Investors also invest with the expectation that they will be redeemed after 5 years. However, the FSS's refusal to allow early redemption has shattered that trust. This has highlighted the perception in the market that Lotte Insurance is a company unable to repay 90 billion won on time. JKL Partners, the largest shareholder that has been pushing for the sale of Lotte Insurance since last year, is now shouldering the burden of this bad news.
The reason the FSS denied early redemption for Lotte Insurance is due to the solvency ratio indicator, known as the Key Indicator of Solvency (KICS). KICS is a measure that evaluates whether an insurance company can pay out insurance claims on time. If this ratio declines, policyholders may suffer losses. For this reason, financial authorities recommend maintaining the KICS above 150%, and only allow early redemption of subordinated bonds when it is above that threshold. Lotte Insurance's KICS fell from 154.6% at the end of last year to below 150% at the end of March, failing to meet the requirements.
Lotte Insurance has announced that it will commence early redemption procedures, even if it means taking an adversarial stance against the FSS to quell market concerns. The FSS expressed regret and firmly stated that early redemption is not possible unless Lotte Insurance meets the requirements through capital increase. Ultimately, Lotte Insurance will have no choice but to pursue a capital increase if it wishes to execute early redemption, as there are no viable solutions without FSS approval.
Lotte Insurance must maintain a KICS of over 150% even after redeeming the 90 billion won. KICS is calculated by dividing available capital by required capital. If the required capital remains unchanged, increasing available capital is necessary to raise the KICS. Based on the business report from the end of last year, for Lotte Insurance to raise its KICS by 1 percentage point, it would need to increase its available capital by 17.6 billion won.
As of the end of March, Lotte Insurance's KICS is below 150%, though the exact figure has not been disclosed. Assuming it is 148%, it would need to increase its available capital by over 125 billion won, including the 90 billion won for early redemption. If the KICS is 145%, it is estimated that 170 billion won would be needed, and if it is 140%, about 260 billion won would be required. The FSS said Lotte Insurance's KICS is "significantly below" the standard of 150%, while Lotte Insurance stated it "slightly complies."
Lotte Insurance is reportedly planning to raise capital through the issuance of private subordinated bonds aimed at institutional investors. The capital raised through this issuance will be recognized as available capital that increases KICS. This means that Lotte Insurance intends to refinance the 90 billion won using the funds raised from issuing subordinated bonds. However, Lotte Insurance has not disclosed specific plans.
A larger problem is that Lotte Insurance must increase not only its available capital but also its core capital. Core capital includes issued capital and retained earnings, and at the end of last year, Lotte Insurance's core capital was -27.5 billion won, a sharp drop from the previous quarter's 198.8 billion won. The KICS calculated using only core capital is -1.6%.
Given that financial authorities are promoting a plan to introduce core capital KICS as a mandatory compliance standard in management evaluations, Lotte Insurance will inevitably be faced with the need to increase its core capital. To increase core capital, it must improve operations to increase net income, conduct a rights offering, or issue contingent convertible bonds. Capital raised through the issuance of subordinated bonds is not recognized as core capital.
Considering that a sudden surge in net income is unlikely, the practical only option is a rights offering. However, a rights offering conflicts with the interests of the largest shareholder, a private equity fund, which is in the process of selling. This is because it would require injecting additional funds into Lotte Insurance.
Lotte Insurance's application of an exception model also adds to the burden. Lotte Insurance is the only insurance company that applied its own favorable exception model rather than the principle model proposed by financial authorities at the end of last year during its financial year-end settlement. If Lotte Insurance were to apply the principle model, the KICS is estimated to drop to 127.4%.
The postponement of Lotte Insurance's early redemption is not expected to have significant ripple effects. However, it is anticipated that this early redemption issue will raise concerns about Lotte Insurance's capital adequacy, which could negatively impact its creditworthiness. Korea Credit Rating said on the 9th, "This postponement of early redemption will not be considered a credit event," but noted, "It could lead to a decline in trust and ultimately worsen access to the capital market."