Deteriorating Investment Income Amid High-Interest Environment: The Impact of the First Rate Cut Post-IFRS 17

As the U.S. Federal Reserve enacts a significant rate cut, the Bank of Korea faces mounting pressure to follow suit. 

As the U.S. Federal Reserve enacts a significant rate cut, the Bank of Korea faces mounting pressure to follow suit. This marks the first potential interest rate decrease since the introduction of the new international accounting standard IFRS 17. This blog explores the implications of this change for the insurance industry, particularly in light of declining investment income.

On September 18, the U.S. Federal Reserve implemented a 0.5 percentage point rate cut, reducing the federal funds rate from 5.25-5.50% to 4.75-5.00%. This decision signals the beginning of a rate cut cycle not seen since the emergency measures taken in March 2020 in response to the COVID-19 crisis. 

As the Fed moves forward, the Bank of Korea (BOK) is under increasing pressure to lower its interest rates, with its monetary policy meeting scheduled for October 11. Should the BOK proceed with a rate cut, the insurance sector will experience its first reduction in rates since the introduction of IFRS 17, which mandates the evaluation of insurance liabilities at market value rather than cost.

The financial stability of the insurance industry is now a critical concern. Investment returns for insurance companies have already started to decline, with the overall investment income for the first half of the year falling by 13.8% compared to the previous year. Specifically, life insurance companies have reported a 24.2% decrease in investment income.

Under IFRS 17, a rate cut could complicate asset management for insurers. Currently, the operating asset yield for life insurers stands at 3%, down 0.4 percentage points from last year. Predictions indicate that further reductions in the base rate could bring this yield down to around 2%.

While interest rates have remained high for the past 18 months since the introduction of IFRS 17 in January 2023, the shift in monetary policy raises questions about the sustainability of investment profits in the insurance sector. As the industry navigates these changes, stakeholders must prepare for a challenging landscape ahead.

The potential for a rate cut by the Bank of Korea introduces a new set of challenges for the insurance sector, particularly in terms of investment income and asset management under IFRS 17. With the financial stability of insurance companies at stake, careful consideration of market conditions and regulatory changes will be crucial for maintaining profitability in the evolving economic environment.