Germany: Selected Issues
Author:
International Monetary Fund. European Dept.
Search for other papers by International Monetary Fund. European Dept. in
Current site
Google Scholar Close
Publication Date:
21 Jul 2014
eISBN:
9781498328524
Language:
English
Keywords:
ISCR; CR; Bundesbank; OECD product market regulation indicator; bank; FSC member; investment risk; reinvestment yield; fixed income; interest rate environment; risk-bearing capacity; Insurance; Solvency; Europe; Global
Download PDF (792 KB)

In recent years, the IMF has released a growing number of reports and other documents covering economic and financial developments and trends in member countries. Each report, prepared by a staff team after discussions with government officials, is published at the option of the member country.

Abstract

In recent years, the IMF has released a growing number of reports and other documents covering economic and financial developments and trends in member countries. Each report, prepared by a staff team after discussions with government officials, is published at the option of the member country.

VII. The German Life Insurance Sector: Confronting the Challenge of Low Interest Rates

On February 28, 2013, the European Insurance and Occupational Pensions Authority (EIOPA) issued an Opinion warning about the risk of a prolonged low interest rate environment to the European Union insurance industry. In its latest Financial Stability Report (May 2014) it emphasized the prominence of this risk, which puts particular pressure on life insurers’ ability to pay guaranteed rates of return and to maintain adequate profitability and financial profiles in the long-run. This risk looks particularly acute in Germany where sovereign interest rates are the lowest in the region and guaranteed rates of return in life insurers’ portfolios are relatively high. It has been recognized by the German authorities since at least 2011, and the government’s coalition program agreed in November 2013 promises that “appropriate measures to strengthen the risk-bearing capacity and stability of the life insurance sector” will be taken. Against this backdrop, this note takes stock of the situation of the German life insurance industry and discusses how it is positioned to confront the risk from a low interest rate environment.1

A. The German Life Insurance Sector

1. The German life insurance market is a mature market with little organic growth. At end-2012, it accounted for about 48 percent of the premium income and about 62 percent of the total investment of the German primary insurance market. There were a total of 113 companies operating in the market at end-2012 of which 95 were supervised by the Federal Financial Supervisory Authority (BaFin).2 The premium income of primary life insurers supervised by BaFin was €83.7 bn in 2012, making Germany a market of average size relative to GDP for an industrialized country but the sixth largest in the world in absolute terms. The growth in premiums was 2.2 percent a year on average between 2005 and 2012 with the period 2010-2012 showing a small decline in the context of the EA sovereign debt crisis. About 80 percent of premiums go to non-unit-linked products.

A07ufig16

Selected Countries: Premium Income of Primary Life Insurers

Citation: IMF Staff Country Reports 2014, 217; 10.5089/9781498328524.002.A007

2. Market concentration appears moderate. The top five companies represent a combined 37.4 percent market share (Table 1), although the market share of the top five insurance groups is larger because they own multiple subsidiaries. The dominant player is Allianz Leben, a subsidiary of Allianz Group, the largest German insurance company and one of the nine global systemically important insurers. The persistently low interest rate environment and regulatory changes discussed below are expected to act as catalysts for consolidation. All of the top ten life insurers are part of diversified insurance groups. Two are ultimately owned by German banks.

Table 1.

Germany: Life Insurance Market Shares, 2012

article image
Source: BaFin, Moody’s (December 2013), SNL, Companies’ websites.

Debeka Leben is a mutual insurance company.

72 savings banks from Bavaria, and 26 savings banks from Rhineland-Palatinate

3. Gross technical provisions and equity have grown somewhat faster than premiums. Total gross technical provisions were €813 bn at end 2012 after increasing by 3.5 percent a year on average since 2005. At the same time, capital and reserves plus bonuses and rebates provisions amounted to €13 bn and had grown at a yearly rate of 3.2 percent since 2005 (Table 2). Total eligible own funds amounted to about EUR 55 bn

Table 2.

Germany: Gross Technical Provisions, Capital, and Reserves, 2005-2012

(Billions of Euros)

article image
Source: EIOPA (2013)

Most of bonus and rebate provisions are eligible as own funds

4. Life insurers’ portfolios are geared towards loans, fixed income securities, and investment in funds. The total investment portfolio amounted to €936 bn (or 35 percent of GDP) at end-2012. The weight of fixed income securities has been trending up over the past several years while the weight of units in unit funds (together with shares and other variable-yield securities) has been stable (Table 3). The steady increase in the share of investments for the benefit of life-insurance policyholders who bear the investment risk reflects the growth in unit-linked policies.

Table 3.

Germany: Life Insurers’ Investment Assets, 2005-2012

(Share of total, unless otherwise indicated)

article image
Source: EIOPA (2013)

5. The coverage ratio is significantly higher than one but is lower than most European peers’ while profitability is poor. The coverage ratio—i.e., the ratio of own funds to the regulatory minimum1—has been on a declining trend since 2007 and stood at 169 percent at end-2012, which looks poor in international perspective. Profitability measured by profits over total assets has been stable but low since 2005.

A07ufig17

Germany: Life Insurers’ Solvency and Profits-to-Assets Ratio (2012)

Citation: IMF Staff Country Reports 2014, 217; 10.5089/9781498328524.002.A007

Source: EIOPA

B. The Challenge of Low Interest Rates1

6. The German life insurance industry stands out in international perspective for its heavy exposure to low interest rates. Interest rates have fallen to the lowest levels in a generation which has brought down investment income.2 Weak economic conditions across the euro area and an inflation rate projected to remain below the ECB’s target over a three year horizon imply that monetary conditions are likely to remain very accommodative for the foreseeable future. Although large insurers are in general well diversified in geographical and business terms and many have also already significantly adjusted their business models to the new environment, some life insurers may be squeezed by a thin or even negative margin between investment returns and minimum guarantees made to policyholders in the past. A similar phenomenon took place in Japan in the late 1990’s and led to several failures (see Box 1). Low yields also constitute a key medium-term solvency risk through liability valuation.

A07ufig18

Selected Bond Yields

(Jan. 2007-May 2014, percent)

Citation: IMF Staff Country Reports 2014, 217; 10.5089/9781498328524.002.A007

A07ufig19

Germany: Maximum Life Insurance Guaranteed Rate

(Percent)

Citation: IMF Staff Country Reports 2014, 217; 10.5089/9781498328524.002.A007

Sources: Deutsche Bundesbank, Moody’s Investors Service.

7. More specifically, the vulnerability of German insurers to prevailing low rates is due to:

  • High historic guarantees relative to reinvestment yields. Reinvestment yields have been declining over the past several years and hover now around 3 percent. German life insurers provided guarantees to their policyholders above 2.75 percent until 2006. Although guarantees on policies underwritten since 2007 have fallen substantially, the average guaranteed rate on the in-force business remains high, at 3.2 percent at year-end 2012 (Bundesbank, 2013). As shown in Table 4, this is one of the highest levels of guarantees in Europe.

  • High duration gap between assets and liabilities. German life insurance liabilities only achieve total run-off over more than 60 years, and only around 50 percent of the total cash flows are served before 20 years. Moody’s (2013) estimates a weighted average maturity for German life liabilities cash-flows of around 20 years versus a weighted average maturity for assets of around 6 years. Therefore the duration of German life insurers’ assets is significantly lower than the duration of their liabilities. As a result, they are subject to a large reinvestment risk.

Table 4.

Selected European Countries: Guaranteed Rate in Life Insurance Policies, 2013

(Percent)

article image
Source: Moody’s.
A07ufig20

Germany: Insurers’ Cash Flow Mismatch Ratio 1/

(2011, Percent)

Citation: IMF Staff Country Reports 2014, 217; 10.5089/9781498328524.002.A007

Source: EIOPA(2013)1/ The mismatch ratio is defined as the discounted value of yearly cash flows shortfall divided by best-estimate liabilities. Numbers are based on the results provided by only 38% of the undertakings participating in the EIOPA Long-Term Guarantee Assessment exercise.

8. This vulnerability is heterogeneous across market players. Although the characteristics of the guaranteed liabilities are likely to be similar for most companies, asset-liability management practices are likely to differ across several key dimensions:

  • The duration of the assets. Three large players (Allianz, AXA, and ERGO) reported asset duration of between 8 and 9 years at end-2012 (or end-2013H1), which was higher than the Moody’s estimate for the average of the market (6 years), resulting in a lower risk for these large companies.

  • The weight of deferred profit participation reserves and of capital in the balance sheet. German life insurers’ balance sheets include, in addition to conventional policyholder reserves, deferred profit participation reserves that are not yet allocated to policyholders and which do not bear any specific guarantee. These buffers can bolster insurers’ ability to meet policyholders’ guarantees. Deferred profit participation reserves represent on average between 5 and 6 percent of an insurer’s assets, but this varies by individual insurer.

  • The risk and expense results. According to German profit sharing rules, risk results (premiums received to cover mortality, disability and other insurance risks minus the amount of claims related to these risks) and the expense results (the part of premiums used to cover expenses minus administrative expenses) can offset pressure on investment margins and as such be available to serve interest guarantees.

9. Stress tests suggest that several life insurers could face difficulties in coming years. The Bundesbank estimated in November 2013 that in a severe stress scenario with a prolonged period of low interest rates3, more than ten percent of life-insurers would breach regulatory own funds requirements (under Solvency I) by 2018, and more than one third by 2023. Measured in terms of their premium revenue, this latter group holds a market share of 43 percent. Separately, Moody’s (2013) estimates that the German life insurance industry would ultimately suffer economic losses on in-force business if reinvestment yields remained permanently below 2.6 percent. A small number of companies closed their new business operations and are in run-off mode.

10. The forthcoming implementation of Solvency II may accelerate the process. The current capital requirement framework (Solvency I) is mainly based on historic cost accounting and is not risk-based. As a result, the immediate potential solvency impact of low interest rates under Solvency I is limited. However, the implementation of a new EU-wide framework (Solvency II) from January 1, 2016 (with a phase-in period of 16 years) will see a gradual move to a market value and a risk-based solvency requirement that will explicitly calculate the interest rate risk capital surcharge and will discount insurance liabilities using risk free rates as a basis. As a result, any problem in meeting own funds requirements owing to low interest rates will come to light sooner.

11. The German authorities have taken an important policy action in 2011. They introduced the interest rate reserve (Zinszusatzreserve, or ZZR) which works as follows. If a life insurer holds reserves associated with a technical interest rate above a given reference rate (the rolling 10 year average of the ECB AAA 10-year rate), then the insurer has to constitute an additional reserve. The ZZR represents the difference between the value of the liability cash-flows (for the next ten years) discounted with the reference rate and the value of the liability cash flows (for the next 15 years) discounted with the technical interest rate. In 2011, funds had to be set aside in additional provisions for the first time as the reference interest rate, at 3.92 percent, was lower than the guaranteed return for certain outstanding policies. A sum of €1.5 bn was thus allocated to additional provisions. In 2012, the reference rate fell to 3.62 percent, leading to further inflows of €5.7 bn to the additional interest provisions. A similar level of accrual is expected in 2013.

12. However, this new reserve may prove insufficient. The ZZR accelerates the recognition of the expected loss. In practice, insurers have offset the negative accounting impact of the ZZR requirement by realizing capital gains. The current low interest rate environment has generated unrealized capital gains amounting to around €100 billion at the end of 2012 and this amount is expected to decrease as investments mature. Furthermore since 2008 German life insurers have to share part of their unrealized capital gains with policyholders terminating their contracts, via the policy holder profit-sharing mechanism, which over time will further erode the amount of unrealized gains available for insurers to finance the ZZR. As pointed out by the Bundesbank (2013), this requirement is economically unsound as the valuation reserves are computed using a market interest rate while no allowance is made for hidden losses as the technical provisions are determined using the original maximum technical interest rate.

13. Policy-makers are aware that further action is needed and the government has proposed a policy package in early June. The Bundestag started working on amendments to the provisions governing the participation of policy holders in the valuation reserves in November 2012, but the issue was postponed soon after. The amendment originally discussed by the Bundestag would have eliminated the current mechanism for automatic participation in the valuation reserves so as to be able to safeguard the interests of the remaining policyholders. A new Finance Ministry proposal presented in June 2014 has four main components: (i) adjusting the participation of exiting policyholders in hidden reserves of fixed-income investments; (ii) prohibiting dividend payments if guarantees are not yet fully funded; (iii) reducing the guaranteed interest rate for new business (as recommended in January 2014 by the German Association of Actuaries); and (iv) adjusting acquisition costs. This set of measures need legislative approval before they can be implemented.

14. Until a policy package is approved, insurers can keep making adjustments to their strategy, including:

  • raising fresh equity, although the uncertainty about their ability to pay dividends under the latest policy proposal may make that option difficult to implement in practice.

  • lowering the rate offered on new business and promote new types of policies, with, for example, a reset of the guaranteed rate according to market conditions at certain dates, or with a guarantee only on a portion of the premium.

  • adjusting asset duration and search for higher yields. However, the yields available on longer maturity assets in the current environment may still be lower than the average guaranteed rate and insurers may not want to lock in such low rates. Increasing yields may also come as a result an increase in asset risk, which could be associated with a higher level of impairments in the future.

  • changing the profit sharing policy. An increasing number of insurers are reducing or deferring the policyholders’ participation in profits in order to build long-term buffers. German insurers have to share at least 90 percent of their investment margins with policyholders. In practice, the share of profits distributed to policyholders has been higher than the required minimum because of competitive pressures. In addition, insurers in recent years have used their stock of deferred profit participation reserves to boost returns credited to policyholders and offset declining investment margins.

  • using the flexibility in the profit sharing rules regarding when profits can be allocated to policyholders. Hence insurers can decide either to distribute these profits immediately or at a later stage.

  • reducing their discretionary bonuses. The total return offered in the market for endowment insurance contracts was 3.51 percent on average in 2013, lower than 3.8 percent in 2012 and 3.95 percent in 2011.

  • reducing the sales force and other costs.

15. Forthcoming supervisory measures will also help bring greater clarity about individual insurers’ vulnerability to a low interest environment. BaFin will launch an exercise this summer that will run in parallel with the preparations for the Fall 2014 EIOPA stress tests. BaFin will ask insurers to compute and report their solvency ratio under Solvency II at end-2013 and end-2015, and ask them to discuss the adequacy of their capital position based on these calculations. Periodic supervisory reports are also being analyzed with greater scrutiny.

16. A guarantee scheme for life insurance has been in place since 2003. In case a distressed company is not able to propose a credible recovery plan, its assets and liabilities can be transferred to the German Insurance Guarantee Scheme for life insurance. There is currently one company run down by the Scheme. The Scheme is financed by annual membership fees. According to its rules, these fees amount to 0.02 percent of the net technical provisions and are to be collected until a total of 0.1 percent of net technical provisions is reached. The scheme has been fully funded since 2010. Should these funds prove insufficient, special contributions could be levied up to an additional amount of 0.1 percent of net provisions. If this amount were still insufficient, the Scheme could borrow additional funds because the German life insurers have voluntarily committed to make 1 percent of their net technical provisions (i.e. ten times the amount required under the Scheme’s rule) available in case of need. The Scheme should therefore be able to safeguard the financial stability of the sector should problems remain contained to a few small institutions. In case a problem of larger proportions developed, BaFin could decide to make use of its statutory powers that allow it to impose a reduction in guaranteed rates.

References

  • AXCO (2014), “Insurance Market Report – Germany: Life and Benefits”, January.

  • Bundesbank (2013), “Insurance Companies: Bridging Low Interest Rates and Higher Capital Requirements”, Financial Stability Review 2013, pp 69–85

    • Search Google Scholar
    • Export Citation

  • EIOPA (2013a), “Opinion of the EIOPA of 28 February 2013 on Supervisory Response to a Prolonged Low Interest Rate Environment”.

  • EIOPA (2013b), “Technical Findings on the Long-Term Guarantees Assessment”.

  • EIOPA (2014), Financial Stability Report, May.

  • Moody’s (2013a), “Germany Life Insurance Industry Faces Losses If Interest Rates Stay Low”, October 24 2013 Special Comment.

  • Moody’s (2013b), “German Insurance: P&C Outlook Changed to Stable; Life Outlook Maintained at Negative”, December 12, 2013 Industry Outlook Report.

    • Search Google Scholar
    • Export Citation
1

Occupational pension schemes are also impacted by the low interest rate environment through similar mechanisms, but represent a smaller share of German financial assets. At the end of 2012, occupational pension entitlements amounted to €444 bn (or 9 percent of German households’ financial assets).

2

The other companies are branches of EU/EEA countries and are supervised by their home country authorities.

1

The regulatory minimum is called the solvency margin.

1

This section draws from Moody’s (2013).

2

The Figure attached to this paragraph shows the yield on Bunds with a residual maturity of six years because this yield has the greatest explanatory power with regard to developments in the net return on investment of the life insurers according to Bundesbank (2013).

3

In the Bundesbank scenario, the yields on 6-year Bunds are extrapolated using historical yields on Japanese government bonds from 2003 onward and excess returns (i.e. returns on investment higher than the interest paid on 6-year government bonds) converge to their historical minima.

Same Series

Other IMF Content

Other Publishers

  • Collapse
  • Expand
Cover IMF Staff Country Reports
Germany: Selected Issues
Author:
International Monetary Fund. European Dept.
Volume/Issue:
Volume 2014: Issue 217
Publisher:
International Monetary Fund
ISBN:
9781498328524
ISSN:
1934-7685
Pages:
72
DOI:
https://doi.org/10.5089/9781498328524.002

Selected Countries: Premium Income of Primary Life Insurers

Germany: Life Insurers’ Solvency and Profits-to-Assets Ratio (2012)

Selected Bond Yields

(Jan. 2007-May 2014, percent)

Germany: Maximum Life Insurance Guaranteed Rate

(Percent)

Germany: Insurers’ Cash Flow Mismatch Ratio 1/

(2011, Percent)