- Published 2026.11.04 11:47
Accounting detour that inflated liability discount rates blocked at source
15% floor on 10-year long-term average spread to apply
Small and midsize insurers with high non-investment-grade assets expected to be hit
The Financial Supervisory Service (FSS) is moving to block an accounting illusion in the insurance industry, where insurers understated the credit risk of their investment portfolios to push up liability discount rates and defend capital ratios. With the introduction of a floor based on long-term averages in calculating credit risk spreads, insurers will no longer be able to keep discount rates high and understate liabilities even when losses accumulate on high-risk assets.
The FSS announced on Nov. 4 the standards for applying discount factors to insurance liabilities for next year. Until now, insurers have mainly reflected only expected losses from individual asset default rates or credit rating downgrades when calculating credit risk spreads. But starting next year, they must compare 15% of the long-term average spread (LTAS) — the average risk spread over the previous 10 years — with the simple default and downgrade loss spread, and use the larger of the two as the credit risk spread. In effect, 15% of the LTAS will serve as an absolute safeguard, a so-called credit risk floor.
This change matters for credit risk management because of the mechanism for calculating the liquidity premium. The discount rate for insurance liabilities is derived by adding a liquidity premium and volatility adjustment to the risk-free Korea Treasury Bond yield curve. The liquidity premium is calculated by subtracting the pure credit risk spread, which is not directly related to insurance contracts, from the total risk spread of the asset portfolio, and then multiplying by a certain ratio. The less credit risk spread is subtracted from the total risk spread, the larger the remaining liquidity premium becomes, and the final discount rate shoots up.
When the discount rate rises, the present value of long-term insurance liabilities to be paid to policyholders in the future shrinks sharply. As liabilities fall, net assets (available capital) expand, and the K-ICS ratio — the financial authorities' key measure of soundness — is favorably dressed up. Because of this structural flaw in the formula, insurers were tempted to quantify portfolio default rates and downgrade risks as low as possible even during credit crunches. The lower the credit risk spread, the larger the liquidity premium, which was advantageous for defending capital ratios.
In fact, even when credit risk flared up in capital markets and risk spreads on corporate or financial bonds spiked, if insurers' calculated credit risk spreads did not reflect this in a timely manner, the spread widening from risky asset investments was absorbed entirely into the liquidity premium. This is why, when investments in high-risk assets failed or the credit quality of credit portfolios wobbled, insurers' equity should theoretically have been reduced, but instead the discount rate rose and insurance liabilities shrank even more, producing the abnormal phenomenon of an improved K-ICS ratio.
The new standard, introduced to prevent such distortions, breaks away from the previous approach of relying only on temporary figures or short-term estimates for the current year, and lays down an objective historical statistical indicator — a 10-year long-term time series — as the floor, thereby institutionally blocking the possibility of artificial spread compression.
According to the FSS, looking at the liquidity premium calculation for a representative portfolio as of September 2026, for financial bonds the final liquidity premium was derived by applying asset weights to 57.8 bp, which is the risk spread of 63.7 bp minus the credit spread of 5.9 bp. Based on this, the total liquidity premium as of September was calculated at 39.2 bp. Even if risk spreads fluctuate due to future market shocks, the credit risk spread to be deducted will not fall below 15% of the LTAS, fundamentally narrowing the room for the liquidity premium to expand arbitrarily.
As a result, insurers will no longer be able to enjoy the accounting cushion effect of reducing credit risk to raise liability discount rates. If the discount rate is adjusted downward due to the introduction of the credit risk spread floor, the assessed value of insurance liabilities will increase accordingly, which directly translates into downward pressure on the K-ICS ratio. A financial authority official said, "We set the credit risk spread floor by referring to overseas cases," and explained, "Some insurers may be burdened by lower discount rates, but simulation results show that the immediate impact on the industry as a whole is manageable." However, for small and midsize insurers or latecomers with a high proportion of risk-weighted assets such as non-investment-grade corporate bonds, real estate project financing (PF), and alternative investments in their portfolios, the burden of liability revaluation is expected to be considerable.
Going forward, simply relying on discount curve techniques to maintain capital ratios will no longer work. With the financial authorities having now built the credit risk spread floor, following the expansion of the ultimate forward rate maturity and the realization of long-term forward rates, the work of stripping artificial bubbles from liability discount rates is moving toward completion. In the end, insurers are left with the task of focusing on fundamental risk management: improving the actual credit soundness of their portfolios and precisely matching liability duration with asset cash flows.
※ This article is an AI translation of the Korean original published by Korea Credit News; it was checked by automated quality guards and published by the English edition desk.
