Evaluation of Target Deposit Insurance Fund Based on Credit Migration Approach for the Non-Life Insurance Sector in Korea

Abstract

Purpose: In the case of non-life insurance business, the rate for the accumulation of fund in non-life insurance has fallen every year, making it difficult to reach the target fund level. Thus, we evaluate the appropriate target fund level for non-life insurers. Design/methodology/approach: The portfolio of the deposit insurer was constructed for 21 non-life insurers which were licensed non-life insurance businesses under the Insurance Business Act 4 (1) in Korea. We attempt to analyze the default probability using the Credit Migration method rather than the Merton. We derive the joint distribution for change in credit ratings and a loss distribution of the deposit insurer in non-life insurance sector by performing the Monte-Carlo simulation. The average value of the worst loss with a 0.5% probability in the loss distribution, TVaR99.5%, was adopted as an appropriate target fund level. Findings: The value of TVaR99.5% in this study was between 67 billion won and 2.434 trillion won. This amount of money is from 4.71% to 171.71% of the current deposit insurance fund for non-life insurers, and from 4.06% to 147.52% of the target fund level for non-life insurers. However, if a rather extremely conservative case that reflects the loss of deposit insurance funds due to the bankruptcy of up to 7 insurers among non-life insurers that consists of the portfolio is excluded, the distribution of the TVaR99.5% was between 67 billion won and 402 billion won. This money is from 4.71% to 28.28% of the current deposit insurance fund, and from 4.06% to 24.37% of the target fund level for non-life insurers. These results indicate that additional funding is unnecessary because the current level of deposit insurance funds will sufficiently cover future losses. Research limitations/implications: The limitation of this study is to evaluate the deposit fund under the RBC system, since it is controversial whether the RBC system adequately reflects the risk of non-life insurers. The risk of minimum guaranteed interest rate, catastrophe risk and liquidity risk are needed to be considered through further study. In particular, comparing the loss distribution for individual insurers under Solvency II and the RBC system is a future task of research. Originality/value: This study contributes to the evaluation of the target deposit insurance fund for non-life insurers by applying the credit migration method unlike the existing studies. This attempt is meaningful in that it provides an objective and practically easy-to-use alternative to the market participants such as the deposit insurer and non-life insurers.