KDI - Korea Development Institute - RESEARCH - Research Areas

Summary

Research Monograph KOR Korean Unique Regulations in Housing Market

We study regulations in the housing market, which are very unique and have great influences in Korea. Due to COVID-19, the housing market have experienced rapid changes. Thus, the government responded boldly with unprecedented policies. Among others, 3 special regulations are on the table for discussion. The first is the Land Transaction Permit, which was implemented to reduce demand on housing in specific regions. Second, the Price Cap on New Houses is investigated for housing supply policy. The final is a regulation on the contract renewal claims in the housing rental market.

Chapter 2 analyzes the direct and indirect price effects of the Land Transaction Permit (LTP), a selective regulation introduced in 2020 for high-priced houses in Seoul to stabilize skyrocketing prices. The LTP is an administrative regulation that requires local governments to permit transactions in designated "areas," and as of 2022, the total area covered by the LTP is about 9% of Seoul's land area.Houses in the LTP zone can only be purchased by buyers who are either homeless or will eventually become single-family homeowners, and they must actually live in the houses for two years immediately after purchase. In this study, we analyzed the price and transaction volume of LTP regulated and unregulated houses, focusing on "Jamsil-dong, Samsung-dong, Daechi-dong, and Cheongdam-dong," which were designated in June 2020. In the regulated area, the LTP scheme directly reduced transaction volumes by 38.3% and prices by 4.3% compared to unregulated areas. However, the LTP scheme unexpectedly had a positive price appreciation effect on homes located closer to the regulated areas. When unregulated dwellings are categorized according to their distance from the regulated area, we estimate that dwellings closer to the regulated area increased in price by 2.3% relative to dwellings further away, and this effect is larger the closer they are to the regulated area. It appears that some of the demand in the regulated area shifts to nearby unregulated areas with higher substitutability. The different direction of the direct effect on regulated areas and the indirect effect on nearby areas suggests that selective regulation, such as LTP, may not be the right regulatory approach to achieve the goal of stabilizing the housing market.

The next chapter, Chapter 3, examines the effects of the Price Cap on New Houses. This price cap, which limits the price of new homes, is one of the controversial regulations that raises concerns that it may limit housing supply in the future. However, this study's analysis found no evidence that the price cap reduces the supply of new homes. Although the pre-sale price cap limits the profits of housing construction projects, it is operated by reflecting all the costs of land and construction for housing supply. Even if the prices of newly supplied homes are limited by the price cap during the period when the housing price is on the rise, the sales of new homes is likely to increase as well. Thereby housing development projects are profitable enough to cover all the costs. Therefore, there appears to be no empirical evidence for concerns that future housing supply will be reduced by this price cap implemented during the housing market boom. However, these results are contradictory to the results of existing studies, so caution needs to be taken when interpreting them further.

Chapter 4 investigates the price impact of the deposit control imposed on the housing repo contract in Korea, known as Jeonse. Jeonse is a unique housing repo contract in Korea where the landlord borrows a deposit from the tenant, using the house as collateral. The tenant is granted the right to occupy the house during the contract period at the expense of the deposit’s opportunity cost. In July 2020, the Korean legislature passed a law granting tenants the right to renew the Jeonse contract once, with the new deposit amount not exceeding a 5% increase from the original amount. While this new regulation has been heavily criticized as the primary driver of the surge in Jeonse deposits during the pandemic, its actual price impact has not been properly estimated.

We estimate the value of the Jeonse renewal option monthly using option pricing techniques, based on reasonable assumptions about the housing price process and information gathered from the current term structure of interest rates. Our estimation results indicate that the deposit control regulation raised Jeonse deposits nationwide by only 0.97% and by 4.80% in Seoul at the time of the introduction of the regulation, a magnitude significantly lower than previously discussed in both media and academic circles. Furthermore, we demonstrate that the renewal option does not have any intrinsic value over the past 10 years, suggesting that the option can be considered pure insurance against an unexpected increase in the equilibrium level of Jeonse deposits by the time of expiry. Based on the background of the regulation and the results of our analysis, we provide policy suggestions.

Summary

Policy Study KOR Inflation Expectations Through the Lens of the Slack in the Real Estate Asset Market

This study examines inflation expectations implied in the real estate asset market. Land is an asset that accounts for more than half of South Korea's national wealth and, like labor, is an essential input factor despite its inelastic supply. Based on this idea, we examine whether a similar regularity as the Phillips curve observed in the labor market is also observed in the real estate asset market. The main results are as follows. First, an increase in the relative price of land can be a pass-through, transferring inflationary pressure over the years. Second, comparing the existing expected inflation indices, an expected inflation rate extracted from the real estate asset market can provide additional information. Third, theoretical analysis shows that the relative price of land and expected inflation can be positively correlated in general equilibrium.

Summary

Policy Study KOR Analysis of the Effect of Management Education and Consulting on Small Business Owners

This study examines the impact of management education and consulting on small businesses in Korea. It focuses on whether such support improves business performance (employee numbers and sales amounts) and reduces the likelihood of financial delinquency (payments overdue by more than 90 days). The analysis compares these outcomes to those of businesses that did not receive such support. Through propensity score matching, a control group was selected to closely resemble the treatment group, and the Difference-in- Difference method was then employed to assess the impact.

The results indicate no significant differences in employment growth or delinquency rates between businesses that received this support and the control group. However, an exception was observed in the wholesale and retail sectors, where supported businesses experienced a notable increase in sales relative to their counterparts.

To effectively enhance business performance through management education and consulting, broadening the expertise of instructors and consultants is crucial for meeting the diverse needs of different businesses. Furthermore, diversifying the content and methodologies of these services could offer business owners a wider range of options, potentially leading to a greater impact and improved efficacy of the support provided.

Summary

Research Monograph KOR Foreign Exchange Policy in Response to Changes in Macroeconomy and Financial Markets

This study analyzes the relationship between cross-border capital flows and the foreign exchange market in Korea. It aims to propose revisions to the Foreign Exchange Transaction Act to facilitate international transactions and maintain external financial stability in light of changing macroeconomic and financial market environments.

The foreign exchange system is shaped by historical contexts, typically introduced to minimize the negative impact of currency fluctuations during events such as economic recessions or wars. However, as economies develop and financial markets grow, there is an increasing demand for the relaxation of regulatory measures on foreign exchange transactions.

As an open economy highly dependent on external trade, Korea encounters considerable risks to its economic stability from rapid fluctuations in exchange rates. Therefore, understanding the relationship among cross-border capital flows, interest rates, and exchange rates is crucial in crafting an effective foreign exchange system. Despite the projected increase in fiscal spending to address the aging population and enhance the quality of life, Korea's overall savings are expected to grow for the time being. With the domestic potential growth rate declining, it seems that the demand for private external financial investments will persist, indicating an expected increase in cross-border capital movements. The growth in private external financial investments presents an opportunity to ease regulations in the foreign exchange market, as the private sector can serve as an automatic stabilizer against exchange rate volatility by actively participating in the foreign exchange market and restoring normal rates.

Chapter 2 examines the impact of increasing domestic and international capital flows on Korea's financial markets. Analyzing the effects of foreign capital inflows using the Flows Implied by Rebalancing (FIR) index (Pandolfi & Williams, 2019), this chapter indicates that global passive fund inflows are associated with significant increases in bond prices (lower interest rates) and a strengthening of the Korean won (weaker exchange rate). These effects are more pronounced for non-reserve currency emerging market countries like Korea. Furthermore, the study investigates the impact of domestic funds' overseas investments on the foreign exchange market. It uses a synthetic control method to assess the effects of the 2017 policy that recognizes asset duration irrespective of insurance companies’ hedging practices. The findings show that an increase in domestic securities investments abroad leads to a decrease in the real effective exchange rate, resulting in a depreciation of the Korean won. However, there is no evidence that excessive demand in the foreign exchange market rises as swap rates increase, suggesting Korea’s foreign exchange market has gained stability compared to the past. An examination of the correlation between the won-dollar exchange rate volatility and the amount of net foreign assets reveals that more recently, as net foreign assets increase and the ratio of won-denominated liabilities rises, the amplitude of the net foreign asset increase due to non-trading factors tends to rise when the won depreciates, indicating the operation of an automatic stabilizer.

Chapter 3 puts forth the direction and key policy recommendations for the revision of the Foreign Exchange Transaction Act. The focus is on enhancing the efficiency of foreign exchange transactions while pursuing external stability. It suggests recognizing the Foreign Exchange Transaction Act more as a trading law than a business law, aiming to reduce overlaps with individual financial laws arising from its business law characteristics.

More specifically, Chapter 3 explores the history of Korea’s foreign exchange management policies and analyzes their characteristics and problems. Initially designed to curb the outflow of foreign exchange, these policies have since transformed to liberalize foreign exchange transactions across both current and capital accounts. However, the foreign exchange authority has maintained a conservative stance, prioritizing external soundness. Notably, the Foreign Exchange Transaction Act is recognized as a business law, maintaining a bank-centric approach while regulating the foreign exchange operations of non-banking financial institutions. Furthermore, the Act adopts a listing and delegation legislative approach. As a result, the current law is not only vulnerable to changes in the external environment but also faces issues of low legal systematicity, leading to high compliance costs.

Currently, most developed nations operate without legal restrictions on foreign exchange transactions. Countries that initially introduced regulations as a response to economic crises or wars have either eliminated or considerably eased these regulations to improve national competitiveness and foster the growth of their financial industry. Japan, whose foreign exchange system has historically resembled Korea’s, opened up foreign exchange operations to non-banking financial institutions and even non-financial companies as part of its financial big bang in 1998. However, Japan has retained a regulatory role in terms of information collection and monitoring for foreign exchange transactions. It continues to inspect and supervise foreign exchange operations of individual financial institutions under the applicable financial industry laws or laws governing financial product transactions.

This study proposes revisions to Korea’s Foreign Exchange Transaction Act based on international case studies. First, the Foreign Exchange Transaction Act, presently skewed towards business law characteristics, should shift its focus to underscore its role as a trading law rather than a business law. To invigorate foreign exchange transactions, the Korean government should move away from classifying foreign exchange operations as regulatory subjects and instead strengthen the monitoring and reporting systems for transactions. It is advisable to delegate regulation of foreign exchange operations to financial authorities under individual financial industry laws, with the Foreign Exchange Transaction Act stepping in only where foreign exchange operations are not covered under the relevant financial industry laws.

Second, this study recommends transitioning the regulatory approach for foreign exchange transactions under the Foreign Exchange Transaction Act from institutional to functional regulation. Functional regulation involves categorizing operations by their function and applying consistent regulations to identical activities, laying the groundwork for adapting to future changes, such as the digital transformation of finances.

Third, in response to the relaxation of foreign exchange regulations, the study suggests reinforcing liquidity and soundness for non-bank financial institutions. This compensatory measure addresses concerns associated with the shift toward functional regulation, which might essentially eliminate bank-centric practices, posing potential risks to financial stability due to the risk-taking practices of non-banking financial institutions. Specific measures include applying foreign exchange liquidity coverage ratio (LCR) requirements for financial investment firms, enhancing the effectiveness of Net Operation Capital Ratio (NCR) regulations, strengthening the responsibilities of boards and CEOs as licensing conditions for foreign exchange operations, and ensuring continuous supervision and inspections post-authorization. This approach mitigates concerns about functional regulations compromising external soundness by adopting a ‘same taskssame riskssame regulations’ rule at the financial regulatory and supervisory level to respond to systemic risks.

Finally, the study proposes imposing prompt corrective action measures on financial institutions handling foreign exchange transactions to enhance the effectiveness of safeguards before emergencies arise. Corresponding to the extent of regulation relaxation on foreign exchange operations, the Korean government strengthens the liquidity and soundness of financial institutions engaged in foreign exchange operations by enforcing prompt corrective action when various regulatory ratios are exceeded. Such measures not only minimize the broader systemic impact in case of early-stage insolvency but also incentivize companies to uphold sound management practices.

While Korea's foreign exchange system has evolved to reflect changes over time, the pace of these changes has been notably slow. While Korea actively engages with the international community, its efforts to liberalize foreign exchange transactions are constrained as a non-key currency nation. Nevertheless, the need for reform in the current conservative foreign exchange system persists for the sake of economic and capital market development.

Despite Korea’s orientation toward an open economy, its view on openness has traditionally centered around trade. From the early stages of economic development, exports have served as the primary engine of Korea’s economic growth, leading to minimal regulations on current account transactions. Consequently, foreign exchange transactions related to current account activities have been freely permitted. On the contrary, foreign exchange transactions for capital account activities have faced stringent regulations. While strict control over foreign exchange transactions might initially boost financial stability, it could also lower overall economic efficiency and potentially decelerate economic growth. Furthermore, ensuring financial stability requires collaborative efforts and coordinated actions among monetary, fiscal, financial, and financial supervisory authorities to enhance the stability of the financial system.

In conclusion, the study advocates for a significant easing of the regulations on foreign exchange transactions in Korea, recommending adjustments to match the current economic conditions and national competitiveness strategy. Korea’s financial institutions are positioned to lead the development of the financial system, especially as global portfolio diversification emerges as an economically efficient choice. This shift is happening against a backdrop of declining potential growth rates and rising demand for both domestic capital investments abroad and foreign capital investments within Korea. Therefore, it is imperative for the Korean government to comprehensively reassess restrictive regulations that hinder the global expansion of financial institutions, with the restrictions imposed by the Foreign Exchange Transaction Act as a prime example of such regulation in need of thorough reevaluation.

Summary

KDI FOCUS Strategies for Refining the Jeonse Deposit Return Guarantee System

Jeonse, a housing lease model unique to Korea, has long served as a cornerstone of housing security for many families. However, recent significant fluctuations in housing prices have highlighted concerns such as underwater jeonse and reverse jeonse, amplifying calls for reform. A crucial step in addressing these challenges and ensuring the stability of the jeonse system is to expand the scope of the Guarantee for a Return of Jeonse Deposit. In pursuit of this, it is important to accurately reflect risks in return guarantees and to consolidate jeonse guarantees under the unified framework of the Guarantee for a Return of Jeonse Deposit.

- As a uniquely Korean housing rental system, jeonse has enhanced housing stability for ordinary families, but recent fluctuations in the housing market have exposed the risk of tenants not getting their deposits back.

- Approximately 8 million general households in Korea reside in properties owned by others under lease contracts. Of all jeonse and wolse transactions, jeonse takes up nearly half, underscoring its sustained significance for the foreseeable future.

- Jeonse prices started to decline in the latter half of 2022, a trend expected to persist through 2024, accompanied by increasing concerns about reverse jeonse.

- While the jeonse-to-price ratio based on the publicly disclosed value decreases as the property value increases, multi-household units consistently show higher ratios than apartments, implying that the former households are at a greater risk of not recovering jeonse deposits.

- The deposit return guarantee system ensures that if leaseholders fail to meet their return obligations, a guarantor agency will refund the deposit. Presently, guarantees from public guarantor agencies amount to around 170 trillion won.

- Due to a marked rise in guarantee-related incidents from 2022 onwards, the application requirements for the refund guarantee were tightened in May 2023.

- Low-priced houses are mostly excluded from the deposit refund guarantee due to stricter eligibility requirements.

- Regrettably, the jeonse deposit return guarantee system does not adequately shield vulnerable tenants from the risk of not retrieving their deposits, as the guarantee fee rate does not accurately reflect the actual risks involved.

- The Guarantee for a Refund of Jeonse Deposit (HUG) has a lower guarantee fee rate compared to other products, especially against the actual incidence rate of guarantee defaults. Hence, guarantee fee rates should be recalibrated to accurately represent risks, taking into account the actual default rates.

- Since recalibration of guarantee fee rates might increase the rates for lower-priced houses, short-term remedies targeting vulnerable households are necessary.

- As the Guarantee for Jeonse Deposit Loan can drive up jeonse prices by expanding jeonse loans, mitigation is necessary by mandating the purchase of deposit refund guarantees during jeonse loan acquisition process.

- A hybrid guarantee system that utilizes escrow not only ensures the protection of the tenant’s deposit but also allows for the application of LTV regulations, typically exclusive to home mortgages, across all housing types.

- In addressing the inherent weaknesses of the jeonse model, all related guarantee products should be consolidated within one unified framework while adjusting and differentiating guarantee fee rates.

- It is essential to expand the scope and availability of market price data for jeonse properties and strengthen the duties and responsibilities of realtors.

Summary

Research Monograph KOR Housing Market Regulations and Housing Supply: Focusing on LTV, DSR, Property Tax, and the Improvement of Pre-Sale Housing

The Korean government often implements financial regulations, such as the Loan-to-Value (LTV) and Debt-Service-Ratio (DSR), ratios, to stabilize the housing market. This study investigates the effectiveness of these policies in the housing market and, if effective, determines whether they enhance the utility for housing consumers.

Additionally, the government employs housing supply policies, which greatly impact the housing market. Housing provision is a lengthy and capital-intensive process. Korea supplies most of the new housing through a system known as the pre-sale policy. In fact, this system has consistently faced the challenge of overheating subscriptions for over 40 years. In light of the current housing market dynamics, Chapter 3 explores possible improvements to the existing housing supply policy.

As for the effect of financial regulation, the policy that lowers the upper limit of the LTV ratio from 70% to 40% reduces household loans by more than 31% while increasing the relative price of housing by 0.005%. If the upper limit on LTV ratios is lowered, households experience a low productivity shock, making it difficult to maintain consumption levels by increasing mortgage lending when incomes fall. As a result, they are motivated to increase savings. When the capital stock in the model economy increases due to the increase in household savings, the real interest rate falls. Wealthy households with relatively large amounts of assets reduce the share of financial assets in their asset portfolios and increase the share of housing because the real interest rate, which is the rate of return on investment in financial assets, has fallen.

The analysis in this study reveals that policies tightening household lending regulations do not effectively curtail housing prices in the long run. If the goal is long-term price stabilization, the study suggests that increasing the supply of new housing is more effective than suppressing housing demand through stricter lending regulations.

Lastly, the study proposes a new policy model for improving housing supply, especially for the younger demographic. This model seeks to address both the housing service and investment needs of younger people. Regarding public offerings and transactions of fractional ownership, housing demand is categorized into the demand for residential services and the demand for investment in housing assets. In the current pre-sale subscription method, the share of the house is divided, and public offering subscriptions are received. This method distributes shares to each subscriber in proportion to the competition rate for subscriptions. In this scenario, new housing is provided to young adults as rental properties in line with the existing subscription method to meet the need for residential demand.

Summary

Research Monograph KOR Financial Innovation and Reform in the Era of Digital Transformation

Since the financial sector restructuring after the 1997 crisis and the international financial reform after the 2008 global financial crisis completed with a well stabilized system, the main policy attention has shifted towards financial innovation. In general, financial innovation refers to a series of deregulation or redesigning to enhance the convenience of financial services, strengthening the competitiveness of the financial industry. In contrast, financial innovation in the era of digital transformation is characterized by more specific and practical attempts to drive profound changes in financial services than the general financial innovation. With the convergence of ICT and finance, transaction costs are drastically reduced, and the processes constituting financial services are subdivided into detailed tasks which are combined and synthesized to new services, Such a new type of services are sometimes not subject to or even contradicting to the existing financial regulatory system.

The so called unbundling and rebundling of financial services in the process of financial innovation have brought about a large legal gray zone in financial activities, That is, newly attempted activities are not clearly judged as lawful because of its absence of the stipulated financial codes so as to be often unduly checked. Also, financial innovation where platform and data-based technology companies enter the financial markets makes the boundaries of the financial industry blurred (Big Blur) and shifts customer contact points with non-financial firms, weakening an intermediary function of traditional financial ones. Ultimately, innovation to converge ICT and finance requires changes in the financial markets, industry, and system itself so that financial authorities confronts with a situation in which they must decide switching to a new system. In this sense financial innovation in the era of digital transformation is not just deregulation in the existing sphere, but means a reform and redesign of regulations at the micro and macro level.

When digital finance becomes commonplace, the financial regulatory system will also face serious challenges. For example, virtual assets are not underpinned with a clear legal foundation but are traded like securities and geared with leverage, mimicking conventional banking and brokerage in the name of innovation. The ICT companies, which are ambiguous to be classified as financial firms under the current system, function as service providers in the financial markets, or even pursue a decentralized finance platform where financial service intermediary firms do not necessarily exist. Thus, it is not so early that policymakers set the agenda for financial innovation which is fulfilling and harmonizing with policy objectives such as consumer welfare and protection, financial industry competitiveness as well as systemic stability.

This study examines the development of financial innovations related to recent digital transformation and resulting emergence of new tasks and services, and proposes the direction of financial policies focusing on regulatory and supervisory challenges and reforms. It proposes detailed policy suggestions on how to regulate electronic payment industry and security token markets. It then deals with regulatory and supervisory issues on systemic stability and consumer protection in the prevalence of digital platform. It also argues the divergence of production and sales of financial services in the digital transformation and consequently long-time controversial debates over banking and commerce separation. Finally, it discusses a legal framework and financial policy approaches consistent with regulatory paradigm shift in the digital transformation.

Summary

Research Monograph KOR Digital Payment Innovation and Financial Consumer Protection

○ Even with weak legislative support, the digital economy is gaining momentum, propelled by the recent progress in contactless financial services and digital finance’s growing convergence with other sectors.
- As the primary legal framework for digital finance, the Electronic Financial Transactions Act (EFTA) had an amendment proposal in November 2020, but the bill is still pending at the National Assembly.
- Despite its vital importance in the Korean economy as a legal foundation for financial innovation, the EFTA has remained largely intact since its enactment in 2006 and has not been sufficient institutional support for critical technological changes like the rise of fintech and big tech.

○ Key point of the amendment is opening up payment services to non-banking financial institutions, such as tech firms (big tech) and credit card firms.
- Payment services are an essential amenity in our everyday life, encompassing payment for goods and services, cash deposit and withdrawal, salary transfer, domestic and foreign remittance, and utility bill payment.
- The amendment bill introduces a license of Comprehensive Payment Service Provider (CPSP), which is allowed to provide all payment services by directly offering a checking account like banks.
- Once the bill passes, some big tech firms as well as conventional nonbank financial institutions like credit card issuers are expected to get the license of CPSP.

○ The significance of payment services lies in that this sector is the basis for nonbank entities to expand into other areas, such as banking, insurance, and financial investment in the mid-to-long term.
- Because every economic activity involves the act of paying, CPSPs can accumulate vast user data.
- Also, these operators can bring in a massive amount of funds that customers deposit for payment transfers. Such funds can be used to launch new customized investment products or expand their business to other financial markets.

○ In the longer term, opening up digital payment services may thrust the financial industry to the next level by stimulating competition from within.
- A single app or metaverse platform is all it takes for users to carry out the whole array of financial services and e-commerce, not to mention payment transfers. Also foreseeable are crumbling barriers between different subsectors within the broad financial sector and spurring competition across the entire industry.

○ Some are rather pessimistic about the open-up because they perceive it as flinging open the door of banking; however, this study does not regard it as harming financial stability.
- The required regulatory level should be on par with banking regulations when deeming CPSPs as banks, but as nonbank payment service providers the degree of restrictiveness and protection would decrease.
- This study views the core function of banks as financial intermediation, which transfers customer deposits into illiquid loans. Since payment service operators cannot provide loans, it is reasonable to regard them as nonbank payment institutions (refer to Chapter 4).

○ On the other hand, financial consumer protection remains crucial agenda.
- Since most payment service users place their funds in demand deposit accounts, protecting these funds and guaranteeing service users’ rights are critical.
- The amendment bill contains some protective measures, but in the UK, where a similar scheme has been in operation, several payment service providers went bankrupt without returning customer funds.

Summary

Research Monograph KOR A Study on Insurance Resolution

This study theoretically and empirically analyzes key issues to be considered in improving the resolution system for insolvent insurance companies and offers policy implications. The coming adoption of the new International Financial Reporting Standard (IFRS) 17 as well as enforcement of the new capital regulation named Korean-Insurance Capital Stand (K-ICS) will likely expose the latent risk factors in domestic insurance firms and harm their financial soundness. Although a sudden, large rise in bankruptcy filings is improbable, there should be a sound institutional framework that could effectively handle the insolvency resolution in case of a default or bankruptcy of insurance firms considering the importance of the insurance industry in the financial system.

The existing approach for insolvency resolution heavily relies on government support. When an insurance company collapsed in the past, Korea usually responded with the "total portfolio transfer" (or run-off) method. In other words, a reinsurer assumed and accepted the insolvent insurer's contracts without modifications, and in the process, the government provided support like financial bailouts for the losses incurred to the reinsurer. The drawback of this government-dependent process is that it may lead to moral hazards among insurance policyholders and carriers and a fiscal burden to the government. That way, insurance consumers are not sufficiently motivated to care for the financial soundness of their insurers, and thus, the insurers have little incentive to improve their financial health. As a result, the government's fiscal burden increases as the probability and severity of insolvency grow.

The empirical analysis in this study also shows that insurance companies worldwide are highly reliant on their government. Per the analysis, should their countries' sovereign credit rating drop, so will the financial soundness of these insurers due to the accompanying reduction in the government's tacit protection for the insurance carriers. The insurance industry exhibits greater dependence on government in countries like Korea in particular, whose fiscal soundness is projected to deteriorate henceforth, or that do not issue a reserve currency, or whose insurance industry is large relative to the size of the national economy or public finance. The lesson learned is that Korea needs to improve its insolvency resolution system with stronger vigor.

Therefore, this study suggests the adoption of a new insolvency resolution regime in which policyholders are obliged to share some losses in case an insurance company collapses. As insurers' financial condition will become an important factor for consumers to consider before signing an insurance policy, the new regime can induce insurers to race for better financial health.

However, the loss-sharing regime may trigger a phenomenon called "insurance run," in which policyholders terminate their insurance contracts en masse. When a considerable number of policyholders end their contracts and exit the contractual relations altogether, it may negatively affect the business normalization of the insolvent carrier or the financial fitness of the firm acquiring the bankrupt company. The situation may exacerbate when the exit is more prevalent among relatively low-risk policyholders.

This study recommends the following policy responses in an overview of the theoretical and empirical analysis findings. First, caution should be taken not to seriously damage the continuity of original insurance contracts due to the loss-sharing requirement. In essence, insurance contracts are long-term contracts. Insurance premiums are paid at present to prepare for future insurable accidents. Especially for disease risk later in life, people purchase an insurance policy from a young age. The theoretical analysis revealed that it is desirable to set insurance premiums relative to expected risks, higher for younger and lower for older persons, for maximum social well-being. Thus, this premium structure should not be extensively altered under the loss-sharing regime. In this context, loss-sharing measures geared towards contract termination with less-profitable older policyholders in case an insurance firm goes out of business deserve reconsideration. That is to say, rather than terminating original insurance contracts with insolvent insurers, it would be advisable to keep them with minor modifications such as increasing premiums or reducing indemnity payment amounts in order to retain the contract continuity and share the losses.

Second, the loss-sharing ratio should be set at an appropriate level. The theoretical analysis shows that a higher ratio leads to contrary results: insurance firms can bring in more premium income (or pay less insurance money) from consumers retaining original contracts, but some policyholders bring them to an end. Such a trade-off should be taken into account when setting a proper ratio.

Third, a maximum of 10% requirement for loss sharing seems not to cause serious alarm for an insurance run. According to the survey analysis, it is highly probable that many insurance consumers regard the 10% requirement as lower than anticipated. Accordingly, only a few have expressed the intent to terminate their insurance contracts if so required.

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