New light on disputed IPO's for Samsung & Kyobo Life

The former head of GE Capital in Korea explains why the foreign media are missing a key point in the battle between the life insurers and their policyholders.

Michael Hong runs an investment advisory boutique in Seoul called Red Herring and is the former country manager of GE Capital in Korea. He was one of those who attended a conference FinanceAsia held on the IPO of the Korean life insurers a couple of months ago in Seoul. The conference debated the rights and wrongs of whether Korean policyholders should get a share of the proceeds when Samsung Life and Kyobo Life conduct their IPOs. Their claim to a share has repeatedly held up the IPO process. Here Hong explains why, on further investigation, he feels the foreign view misses a vital point in supporting the insurers against the policyholders.

I am writing this to clarify a serious misunderstanding which the foreign investor community, including FinanceAsia (see article dated August, 2003), has had about the dispute between the Korean life insurers and various NGOs and civic groups concerning whether a portion of the former's IPO proceeds should be paid to designated charity and non-for-profit foundations.

I used to be sympathetic toward the Korean life insurers until I did some research and found out certain information from MOFE and FSC, which sheds light on the reasons why NGOs/civic groups have been insisting on claiming money for policyholders.

This goes back to 1989-90 when the two life insurers undertook a series of asset write-ups. Assets that had previously been recorded at book value were adjusted upwards or downwards to their market value. Given that the lion's share of the life insurers assets are real estate, the revision was mainly upwards and a large capital surplus was generated.

The exercise was undertaken voluntarily by the life insurers as they hoped they would gain a higher IPO valuation on the back of it. At the time, they signed an agreement with the government supervisory agency to divide the surplus between shareholders and policyholders in a 30%/70% split.

Out of the 70% designated for policyholders, 40% was paid out immediately and 30% was kept as a capital surplus by the life insurers. It was further agreed that the remaining 30% would be used as a cushion against potential future losses at the life insurers, or as a reserve for future dividends.

This means the surplus has the same risk profile as shareholders' capital and is the basis on which the NGOs/civic groups have been advocating for an allocation from potential IPO proceeds.

The capital surplus can also be found in the life insurers' financial statements as part of the shareholders' capital. They have, therefore, been enjoying the accounting and many other economic benefits of balance sheets that seem stronger than they actually are. This is because the 30% surplus capital would have been classified as a liability if the insurers had treated it under their general reserves.

Indeed, the main argument put forward by the foreign community and press in favour of the life insurers has focused on the reserves. In order to protect their ability to pay policyholders, it is argued that the life insurers need to maintain adequate reserves and therefore the undistributed surplus capital should be accounted for as part of the general reserves. On this basis, the policyholders do not have any claim over IPO proceeds.

But, the key here is that the life insurers have not accounted for the surplus in their general reserves, but in their shareholders' order to demonstrate stronger capital bases. Further, the fact that the surplus capital can be found in the shareholders' equity on the balance sheet indicates that the surplus is truly capital.

In other words, the capital surplus generated from asset write-up has the same risk/reward profile as regular capital. If or when the company suffers a loss, it will reduce the size of capital surplus, including that belonging to policyholders.

This is the root of the debate that has been going on for the past several months between Samsung Life and Kyobo Life on the one side and the NGOs and civic groups on the other.

Why do I think Samsung Life is refusing to accept the position of NGOs? For one thing, it will likely threaten the Lee family's strong grip on the company, which acts as a virtual holding company for the entire Samsung group. Shares for the non-for-profit foundations would amount to a substantial stake that could pose a potential threat to the well-entrenched management and shareholder group of the Lee family.

I did not previously know the government had forged an agreement with the two life insurers in 1989-90 and was biased against the position of NGOs/civic groups as a result. I understand the agreement had a legally binding effect and is thus enforceable.

The foreign investor community and foreign press including the Financial Times and FinanceAsia, have misunderstood this and have so far supported the position of life insurance companies.