Kim Yong-beom, vice chairman of Meriz Financial Group, publicly criticized during a conference call on the 14th that some insurance companies set their expected loss rates optimistically, inflating their profits, causing a stir in the insurance industry. Kim noted, "While the actual loss rates among companies are similar, it has been confirmed that the trends for expected loss rates are completely opposite," and added, "Through such irrational estimates, profits are realized in the current period while losses are passed on to future generations."
In the insurance industry, opinions ranged from "that doesn't make any sense" to a cynical remark suggesting, "It seems that Meriz Fire & Marine Insurance also needs to play the role of the Financial Supervisory Service this time." This is not due to the criticism itself, but because there are inconsistencies in Vice Chairman Kim's argument.
To determine the truth, it is essential to understand the controversial concept of expected loss rates. The loss rate refers to the ratio of premiums received from customers to the insurance payouts made. If 1 million won is collected in premiums and 700,000 won is paid out in insurance claims, the loss rate would be 70%. The profit taken by the insurance company would be 300,000 won.
The issue is that it is impossible to know how much an insurance company must pay out in claims at present. If an epidemic suddenly arises in the future, requiring many customers to visit hospitals, large insurance payouts must be made, but if customers are healthy, the payouts decrease. Insurance companies can only predict the future payouts based on statistics from the past five years. The expected loss rate is determined based on these predictions and assumptions.
The expected loss rate is, as the name suggests, an expectation. The actual insurance payouts made by the insurance company may be less or more than the expected amount. The difference between this estimate (expected loss rate) and reality (actual loss rate) is referred to as the estimated-actual difference.
The crux of the controversy is that actual performance varies depending on how insurance companies set their expected loss rates. Vice Chairman Kim claims that some insurance companies intentionally set their expected loss rates low to inflate profits. By setting the expected loss rate low, liabilities (best estimate liabilities) decrease, and the contract service margin (CSM), a future profitability indicator, increases.
Meriz Fire & Marine Insurance stated that it set its expected loss rate high. It is interpreted as reflecting unforeseen future risks as much as possible, even at the cost of forgoing CSM. Kim Jung-hyun, president of Meriz Fire & Marine Insurance, explained that if the expected loss rate increases by 1 percentage point, the CSM decreases by 700 billion won.
However, the insurance industry assesses that Vice Chairman Kim's claims are excessive. While it is true that lowering the expected loss rate increases the CSM, there is a risk that the estimated-actual difference could turn negative. If the anticipated payout amount is 1 million won but the actual expenditure becomes 1.2 million won, the net income from insurance profits and operating income will decrease. Thus, it is argued that there is no need to lower the expected loss rate, risking a reduction in net income.
On the other hand, if the expected loss rate is set high, as in the case of Meriz Fire & Marine Insurance, the future revenue from CSM may decrease, but the current net income increases. Other profitability indicators, such as return on equity (ROE), also rise, and dividends become easier to manage. It suggests that Meriz Fire & Marine Insurance is realizing substantial profits by conservatively setting its expected loss rate. Last year, the estimated-actual profit of Meriz Fire & Marine Insurance was 169.9 billion won, accounting for about 10% of net income.
The fact that Meriz Fire & Marine Insurance set its expected loss rate high ultimately means that it charged customers a higher premium. Because this assumes higher future claims, to balance the books, more premiums must be collected.
In the insurance industry, it is believed that expected loss rates should not reflect any intentions, regardless of whether they are set low or high. The essence is to accurately predict future payouts represented by the expected loss rate. Byun In-cheol, executive director at Samsung Life Insurance, noted during a conference call on the 16th that setting estimated-actual differences conservatively, as Meriz Fire & Marine Insurance does, is contrary to the intent of accounting systems. Academia also concludes that "minimizing estimated-actual differences is the right course of action."
Ultimately, this controversy seems likely to be resolved only if the Financial Supervisory Service intervenes and presents clear guidelines. It is reported that the Financial Supervisory Service will investigate whether there are any issues in the expected loss rate calculation processes of each insurance company. Vice Chairman Kim has provided an opportunity for regulatory authorities to intervene by making the expected loss rate a matter of controversy. The insurance industry, which has been calling for autonomy, has effectively tied its own hands.
An insurance industry official stated, "Every time a new issue arises, if the regulatory authorities intervene, it only diminishes the industry's self-sufficiency," adding, "While a certain level of guidelines is necessary, it seems most desirable for the industry to reach an agreement and implement self-regulation."