A. Scope and Approach of this Note

1. This technical note provides an update on the German insurance sector and an analysis of certain key aspects of the regulatory and supervisory regime. The note has been prepared as part of the 2015 Financial Sector Assessment Program (FSAP). It has been drawn on discussions in Germany from November 3 to 18, 2015. The technical note refers to the Insurance Core Principles (ICPs) issued by the International Association of Insurance Supervisors (IAIS) in October 2011, as revised in October 2013. A separate technical note records the results of stress testing carried out on the insurance sector.

2. The note includes an analysis of German practice in relation to selected ICPs in the context of a wider discussion of key issues in regulation and supervision. The note does not include a detailed assessment of observance of the ICPs.² (The most recent such assessment, conducted on the basis of the 2003 version of the ICPs, was carried out in 2011.) The main focus of the note is on recent developments in the sector and key vulnerabilities, including, for life insurance, those associated with the continuing low interest rate environment; the preparations of the authorities and industry for the implementation of the Solvency II requirements (which took effect in full on January 1, 2016); and the supervisory approach to large insurance groups, including those that have been identified by the IAIS as Global Systemically Important Insurers (G-SIIs).

3. The note refers to laws, regulations and other supervisory requirements and practices in place at the time of the discussions in Germany, as well as the position under Solvency II. The note takes account of the major changes in regulations which took effect with Solvency II implementation as well as the development of supervisory practices. In respect to the 12 ICPs analyzed in the note, the authorities provided a full self-assessment, supported by anonymized examples of actual supervisory practices and assessments. The institutional arrangements for financial sector regulation and supervision are outlined in Section B of this note.

4. The selected ICPs are analyzed but without scoring the level of observance. ICPs selected for review are broadly those with macrofinancial relevance and with material regulatory changes. They include the ICPs on solvency requirements (valuation, investment and capital adequacy), supervisory approach (including supervisory authority, supervisory review, preventive and corrective measures) and cross-border co-operation. The focus of the work is on both current insurance regulation and the requirements that took effect in January 2016, reflecting the timing of the FSAP work in late 2015. To avoid a departure from the IAIS ICP assessment methodology, under which regulation and supervision are normally evaluated as at the time of assessment, no scoring of the level of observance of the selected ICPs is given in this note. The detailed ICP analysis, including comments, is set out in the Annex to the note.

5. The authors are grateful to the authorities and private sector participants for their excellent cooperation. The authors benefitted greatly from the inputs and views expressed in meetings with insurance regulators, supervisors, insurance companies and industry and professional organizations.

B. Overview—Institutional and Market Setting

C. Market Structure, Insurance Products and Industry Performance

14. There are 413 insurance companies supervised by BaFin.³ Many are small mutual companies (139 in total). The total investments of insurers in 2014 were EUR 1,569 billion, composed of life insurers (EUR 911 billion), health (EUR 232 billion), P&C (EUR 154 billion) and reinsurers (EUR 272 billion).⁴ The number of insurers has been declining since 2008, from 460 to 413. While most of the decline occurred through mergers or takeovers, a few firms failed or were suspended by BaFin every year.

15. The insurance industry remains profitable with high solvency ratios, although careful analysis is needed of these numbers, especially in the case of life insurers. Average ROEs in the last three years are 6.6 percent for life, 4.0 percent for P&C and 8.3 percent for reinsurers. The average solvency ratios at the end of 2014 were 163 percent for life insurers, 312 percent for P&C and 885 percent for reinsurers. In the past few years, life insurers have been required to generate profits to address additional reserving requirements in place since 2011 (ZZR—see Main Findings, section A below), and the majority of them appear to have been made by recognizing unrealized gains on fixed income securities. The underlying performance of life insurers could therefore be much lower than the published figures. P&C insurers are also facing growing pressures on profitability from competition and, in motor insurance, a pronounced underwriting cycle.

16. German life insurers invest conservatively. The largest shares of life insurers’ investments are allocated to government securities (25 percent) and mortgage bonds (21 percent), which are ultimately financed by the originating banks, followed by bonds of financial institutions (11 percent).⁵ Exposures to equity and other risky assets are limited (equity 6 percent of the total, alternative investments 1 percent). Loans and real estate also account for small shares (mortgage loans 6 percent, other loans 6 percent and real estate 4 percent). Investment allocation of non-life insurers (P&C and reinsurers) is similarly conservative.

17. Products with guarantees still dominate the life insurance market and non-life insurance comprises mostly traditional lines of business. Unlike insurance markets in other advanced economies, products with minimum guarantees (including participating policies) dominate the German insurance markets. Unit-linked and related products account for less than 10 percent of the total liabilities of life insurers. Data on premiums from new sales of unit-linked products (which account for about 15 percent of total premium income in the last five years) suggest that the share of such products will increase in the future but only gradually. Non-life insurance is also dominated by traditional lines of business (such as motor, property and liability). The share of less traditional business lines, such as credit and surety insurance is small (less than 1 percent of total premium income). Therefore, the potential risk is limited.

18. Distribution channels are mostly traditional, with the majority of sales being transacted through single-tied agents. The share of single-tied agents is more than 40 percent in life and P&C and 50 percent in health insurance. While the bancassurance channel is growing, it still accounts for less than 20 percent of the market, even in life sales. Tied agents are supported by relatively high levels of commission, although there is some expectation that this will start to fall as a result of recent regulatory changes (the Life Insurance Reform Act—see below).

19. Bank—insurance linkages and interconnectedness with other parts of the financial sector are limited, compared with neighboring countries. While complete details on ownership structures are not publicly available, there is only a small number of significant insurers which are part of a group that also includes significant banking, and the majority of small insurers are independent from other financial sectors. Because the traditional insurance products that comprise much of the German life insurers’ balance sheets require relatively limited hedging, material linkages to other parts of the financial sector are not through derivatives but through large holdings of mortgage bonds issued by banks. These accounted for 18 percent of the total assets of life and nonlife insurers at the end of 2014.

20. Linkages between German banks and insurers declined after the 2008 financial crisis and are mostly domestic. Bank liabilities financed by insurers fell from over 6.5 percent of the total at end-2008 to around 4.5 percent in mid-2015. Similarly, claims of banks on insurers fell from around 0.1 percent of the total to 0.04 percent over the same period. Almost all claims and liabilities of German banks towards the insurance sector in the EU result from linkages with German insurers.

A. Key Risks and Vulnerabilities

21. Despite a still generally conservative investment profile, evidence of search for yield has been emerging in the last few years (Figure 1). Against the backdrop of prolonged low interest rates, life insurers increased the share of corporate bonds in total investments from 4.3 percent in 2011 to 6.9 percent in 2014. The average ratings in the fixed income portfolio of life insurers have reduced, including through rating downgrades without active changes in asset allocation. The portion of securities with a AAA rating fell from 44.8 percent to 35.6 percent between 2011 and 2013, while the share of those with a BBB rating rose from 7.1 percent to 12.8 percent, reflecting rating migrations. German insurance groups have also stepped up their investment into non-German sovereign bonds. For example, investment in Italian government bonds increased by 5 percent and in Spanish government bonds by 25 percent from 2013 to 2014, albeit from a low base, while exposures to the German federal government fell somewhat at the same time.

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Evidence of Searching for Yield

Citation: IMF Staff Country Reports 2016, 192; 10.5089/9781498323710.002.A001

Sources: Bundesbank.

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22. German insurers have also allocated a significant share of investments into funds (Figure 2). As of the end of 2013, life, health and P&C insurers allocated 23 percent of their assets to bond funds and 3 percent to equity funds. Total investment in funds now exceeds 30 percent of their assets. Most of the securities (including securities lending transactions) in the funds can be looked through by insurers. Funds which cannot be looked through account for less than 2 percent of total assets. BaFin’s insurance supervisors do not have access to data on the derivatives used by the funds and have no scope to require additional reporting (the Solvency II reporting templates are stipulated by EIOPA). However, all derivatives are now covered by reporting required under the European Markets Infrastructure Regulation (EMIR) and BaFin’s insurance supervisors are cooperating with its securities supervisors on a reporting system for EMIR data that will enable insurance supervisors to access information and analysis on all derivative to which insurers are a party, whether directly or through any type of investment fund.

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Investment in Funds by German Insurers

Total investment in funds exceeds over 30 percent of their assets.

Citation: IMF Staff Country Reports 2016, 192; 10.5089/9781498323710.002.A001

Source: BaFin.

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23. Life insurers are exposed to the risks from offering significant guarantees on the longest term policies (Figure 3). According to the European Insurance and Occupational Pensions Authority (EIOPA), the average rate for existing products guaranteed by German insurers is one of the highest among European countries. In addition, the duration of liabilities is high compared with other European countries (Figure 4). While the average duration of insurance liabilities is hard to estimate owing to complex contingencies inherent in insurance products and longer duration could entail a degree of resiliency resulting from the promise of future discretionary bonus, it is clear that high guarantees are a key feature of the balance sheet of German life insurers and they need to continue to cover the guarantee costs for substantially longer periods than insurers in other countries.

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Share of Products with Minimum Guarantees

Both the share of guaranteed products and the guaranteed rate of existing policies in Germany are high.

Citation: IMF Staff Country Reports 2016, 192; 10.5089/9781498323710.002.A001

Sources: S&P and BOE.

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Duration of Liabilities

The duration of German Life insurers’ portfolios is high compared with other European countries. It shows sensitivity of insurance liabilities under the change from baseline to the Japanese-like scenario (“LYA”) used by EIOPA in its 2014 EU-wide stress test. The duration of liabilities of German life insurers could be estimated as approximately 11 years.

Citation: IMF Staff Country Reports 2016, 192; 10.5089/9781498323710.002.A001

Sources: EIOPA.

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24. Owing to the dominance of guaranteed products, prolonged low interest rates are affecting the financial soundness of life insurers. While maximum rates for valuation purposes are set by the Ministry of Finance (effectively setting a maximum rate on the guarantee that can be offered on new product sales) and have been reduced gradually in accordance with market rates to 1.25 percent, the maximum rate applies only to new policies and the guarantee rates for existing policies remain as when they were sold and cannot in practice be reduced. The average guarantee rate has gradually reduced to 3 percent. However, the average investment return has declined more rapidly. According to the internal measures of German insurers participating in the 2014 EIOPA stress test, the effective investment spread has already turned negative (-0.4 percent).

25. The authorities have sought to reduce some of the pressures on life insurers through legislative change in 2014 (the Life Insurance Reform Act), although the overall impact has apparently been limited. Legislators amended the regulatory framework to improve the soundness of life insurers. Key measures were:

• A reduction of the maximum valuation interest rate for new insurance contracts from 1.75 percent to 1.25 percent as of January 1, 2015;

• The limitation of policyholders’ dividends from unrealized gains from fixed income instruments; policyholders may now participate in their respective valuation reserves of fixed-income securities only if the valuation reserves are greater than the amount needed to safeguard the interests of continuing policyholders; and

• Flexibility for insurers to offset loss from investments with gain from insurance risk assumptions (such as mortality), when determining amounts to be allocated to policyholder dividends.

However, these reforms were balanced by measures to increase the minimum allocation of policyholders’ dividends from insurance risk assumptions from 75 percent to 90 percent. The reduction in the planned participation of policy-holders when policies mature seems to be particularly significant. On the other hand, as the insurance risk component is the main source of current profit, market participants identify a mixed, though overall net beneficial impact of the reform measures on the long term financial soundness of life insurers.

26. The national GAAP-based valuation requirements under Solvency I are requiring life insurers to build additional reserves (ZZR) to reflect the low interest rate environment. Since 2011, insurers have been subject to an Additional Interest Provision (Zinszusatzreserve or ZZR), which requires them to hold a reserve for each policy that guarantees a return above the reference rate for expected asset returns. The required reserve equals the interest rate shortfall that is expected to arise over the next 15 years. The reference rate is set as the 10-year average of the zero-coupon euro swap rates with a duration of 10 years.

27. Additional ZZR will be needed in coming years (Figure 5). As a consequence of the steady downward movement of rates during the past decade, the reference rate may keep falling for some time in the future. In 2014, a further EUR 8.4 billion was added to ZZR, resulting in over EUR 20 billion having been allocated to the ZZR on a cumulative basis at year-end 2014. If the reference rate moves higher, the ZZR reserves which have been set aside for the policies whose guarantee rate is lower than the reference rate will be released and made available to policyholders.

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Estimation of Additional Premium Reserve (ZZR)

Additional Premium Reserve will be increased significantly in the next few years if the current low interest rate environment persists.

Citation: IMF Staff Country Reports 2016, 192; 10.5089/9781498323710.002.A001

Sources: BaFin.

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28. In the near future, some life insurers face a risk that their financial situation under national GAAP will worsen and diverge from the Solvency II-based measurement. The existing valuation requirements, including the ZZR, continue to apply after January 1, 2016 for accounting purposes. If the current low interest rate environment persists, life insurers are expected to be required to continue to add to the reserve by more than EUR 10 billion annually from 2016, with cumulative reserves reaching over EUR 70 billion in 2018.

29. Insurers may face increasingly difficult choices on how to finance the additional reserves in the future. The majority of allocations to the ZZR appear to have been financed by realizing previously unrecognized gains on the assets side of the balance sheet. Some insurers are facing difficulties in finding liquid assets on which to realize gains and are conducting costly transactions (such as the sale and lease back of real estate) to generate gains to meet ZZR requirements.

30. While primary insurers’ claims on banks make up a significant share of assets, most are internationally diversified, secured claims, bringing limited contagion risk (Figure 6). Life insurers are the largest investors in bank claims, accounting for 67 percent of the total of primary insurance companies. A large share of these are secured investments (e.g., Pfandbriefe/covered bonds). Contagion risks from banks to insurers are limited, unless collateral values deteriorate significantly. About 25 percent of total investments are in German banks and others are invested internationally. These investments constitute about 5 percent of total liabilities of German banks (excluding derivatives). About 50 percent of investments from insurers into banks are claims on the major German banking groups with an international focus. A significant share of total claims is through Pfandbriefbanken.

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Liabilities and Claims of German Banks Toward Insurers in the EU 2004–2015

(In percent of total assets)

Citation: IMF Staff Country Reports 2016, 192; 10.5089/9781498323710.002.A001

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31. BaFin and the insurance industry are aware of cyber risks. Some market participants see a business opportunity for the insurance industry. The global cyber risk market may now be worth some US$ 2 billion in annual premiums and German reinsurers are active in the market. On the other hand, cyber risk also brings hidden exposures in general liability household insurance. For example, power outages due to a cyberattack may be covered by such policies. Insurers are seeking to evaluate this exposure and reduce the risk by redesigning policy terms. Insurers are also seeking to improve their IT systems to improve their own resilience to cyberattack and BaFin is monitoring progress, including through the internal model approval process of Solvency II.

B. The Implementation of Solvency II

32. The authorities have been in the process of implementing Solvency II for a number of years ahead of its 2016 effective date. BaFin has worked within the 2014 guidelines of the EIOPA, in particular its two-year preparation phase, which established four key areas of work:

• Requirements for business organization and risk management;

• Forward-looking assessment of own risks;

• Pre-application for internal models; and

• Reporting.

The approach applies to all insurers, reinsurers and groups to which Solvency II applies (around 90 percent of all insurers with a much larger aggregate share of the total market).⁶ Even before 2014, BaFin took account of the likely demands of Solvency II in supervisory discussions with insurers, for example on their approach to establishing the control functions required by the final legislation.

33. Revised insurance supervision legislation is in place. The Act to Modernise Financial Supervision of Insurance Undertakings, enacted in April 2015, sets out the new valuation requirements, own funds rules, provisions on the calculation of the Solvency Capital Requirement (SCR), governance requirements for insurers, a new framework for supervision of insurance groups, adjustments available to insurers offering long-term guarantees and Solvency II’s transitional arrangements, aimed at cushioning the impact of the new requirements in the 16 years out to 2032.

34. BaFin required insurers to use standardized status reports to track implementation progress. These reports were used to assess the progress being made by individual insurers on each element of the preparatory work, which BaFin further divided into 15 thematic blocks, and to focus supervisory, including on-site work. The standardized reports were also used to test whether insurers’ managements were aware of and responding to issues in their implementation programs.

35. A particular emphasis has been placed on the reporting and disclosure requirements. The extent of these new requirements has presented challenges for insurers in ensuring the accuracy and completeness of reporting, at group and company level; and for BaFin in building the required database, analysis and supervisory capacity to make appropriate use of the reporting in its supervisory processes from January 2016. During 2015, BaFin required insurers—on a voluntary basis—to submit both annual narrative and quantitative reporting, as well as third quarter quantitative reporting. Most German insurers submitted their reports in the required new quantitative templates (Quantitative Reporting Template—QRT) using the transmission standard XBRL (eXtensible Business Reporting Language). Furthermore, most of the German insurers also submitted narrative reporting which consisted, similar to the quantitative reporting, of a subset of the envisaged future reporting requirements (Regular Supervisory Report (RSR)).

36. Preparatory work for internal models work has also been a major focus. BaFin established a separate central unit on quantitative issues (now 18 staff, up from 13 in 2010) and worked since 2009 on the pre-application process of the six groups planning to apply for internal models. The objective was to conduct a full review of key model features (together with the other responsible supervisors), including qualitative requirements such as model governance and the “use test” (whether the model is used in key business decisions and controls) ahead of the formal application process, which is limited to six months under the Solvency II directive. The adequacy of documentation was a key focus, as was model validation. The process involved extensive on-site work at the applicant groups.

37. For international groups, the internal models work has been carried out jointly with other supervisors. BaFin has worked with supervisors from the EU and other countries to review models, usually through a core team of supervisors responsible for the most significant parts of the group. BaFin has also participated in EIOPA’s Solvency II internal models committee which provided a forum to compare experience (it has no role in respect of individual model approvals). Internal model approval decisions were being made in late 2015 under the collective decision-taking arrangements established by the directive. BaFin has the leadership role in decisions affecting applicant groups for which it is group supervisor, and access to the process and the decision on approving group internal models at groups for which it is host supervisor.

38. In addition to internal models, the new requirements give insurers a number of other options requiring BaFin approval:

Models may be used on a full or partial basis;

• There is provision for the use of undertaking-specific parameters in the Solvency Capital Requirement (SCR) standard formula;

• The use of transitional measures for the calculation of technical provisions;

• The use of the volatility adjustment for deriving the risk-free rate curve; and

• An allowance of ancillary own fund items.

BaFin has made clear to insurers that applications for internal model approval should be made only by companies with the most advanced risk management frameworks. Relatively few insurers were applying for internal model approval compared with some other EU countries, but more were applying for approval to use the volatility adjustment and transitional measures. BaFin has discussed with some life insurers whether they should consider applying for use of such approaches, where they do not already plan to do so, to reduce the likelihood of not meeting their SCR. BaFin’s approval is still required.

39. While implementing the new requirements, BaFin has identified issues requiring guidance to insurers. BaFin considers that the specific features of the German insurance market require further explanations to ensure a consistent application of the requirements. It has in particular issued guidance about how to adjust components of own funds (specifically the surplus fund and future discretionary benefits) to avoid double-counting of loss absorption capacity arising from a potential reduction of potential dividends to policyholders. The need for this guidance reflects the arrangements for the allocation of surplus between policyholders and shareholders on traditional life insurance policies in Germany.

40. Surveys have been used to assess the impact of the new solvency requirements on life insurers. A survey based on balance sheets at December 31, 2013, with projected numbers as of January 1, 2016, was conducted in 2014, and insurers were asked, in response to further falls in interest rates, to submit updated numbers in mid-2015 based on their end-December 2014 positions. The results were used by BaFin to identify insurers with less strong solvency positions under the new requirements (below or near the level of the SCR), leading to discussions on potential measures that could be used by these companies in the transition to Solvency II. Life insurance was targeted for this work because of the pressures faced by the sector in the low interest rate environment and all life insurers subject to Solvency II had to submit reports.

41. The surveys showed that significant numbers of insurers were likely to be dependent on the application of transitional measures to meet the minimum requirements from 2016.

• In the initial survey, only a few insurers with a collective market share of less than 1 percent were unable to show that they could meet the new requirements despite having applied the transitional measures. Without these measures, however, about 25 percent of insurers, with a collective market share of about 10 percent, would not meet the SCR as of December 31, 2013.

• In the second survey, based on end-2014 positions, the number of life insurers unable to show they could meet SCR had not increased, but because of the further falls in interest rates, almost half of all insurers were dependent on use of the transitional measures to meet their SCR and would have had a collective shortfall of some EUR 12 billion in own funds (which compares with some EUR 60 billion in total life sector own funds).

42. BaFin has made the aggregate results of its surveys public, emphasizing the challenges for some insurers in a low interest rate environment. A summary of both surveys was published. As well as noting the small number of insurers unable to meet the minimum requirements at 2016, BaFin noted that, as the transitional measures will be gradually phased out over 16 years, insurers will have to make major efforts to strengthen their capital in that period. The survey was conducted on the basis that insurers could take into account their preferred use of long term guarantee measures—in practice the volatility adjustment was the measure most chosen by German life insurers (see Box 1).

43. Health insurers have been surveyed by their trade association and appear likely to meet the new requirements. In 2014 and 2015, the Association of Private Health Insurers surveyed private health insurers on a basis similar to BaFin’s survey of life insurers. Almost all took part and all were able to meet the new requirements, despite the impact of low interest rates. Unlike life insurers, they are able to adjust premium rates to compensate for the effect of low interest rates.

44. P&C insurers and reinsurers have not been subject to surveys of the same type as life insurers, either by BaFin or other bodies. BaFin took the view that the impact on these types of insurance company was more limited than on life insurers. For major companies, supervisors have held discussions with management and many large and listed companies have made disclosures about the expected impact. While P&C insurers and reinsurers have not been subject to surveys, the majority of insurers have participated in voluntary quarterly and annual reporting exercises and some were included in the EIOPA group level stress test in 2014. In particular, reporting on end-2014 financial positions under the QRT process covered about 90 percent of all insurers.

C. The Supervision of Groups

61. The FSAP mission also had discussions on the evolving approach to major insurance groups. Solvency II implementation has driven significant development of a more risk-based approach to supervision that has allowed for increased resources to be focused on the large insurance groups.

62. BaFin’s approach to group supervision differentiates between three overlapping sets of groups:

• The 14 insurance groups which it regards as significant. (A number of other groups comprise only a few small firms.) For these groups, BaFin is now applying its framework of risk-based supervision on a group basis, including its risk classification system, although the practical application of this system is still in development. (The framework is applied to solo legal entities in parallel.) The risk classification system now classifies companies and groups by impact (Very High, High, Medium and Low) as well as quality.

• The 17 insurance groups which have subsidiaries incorporated outside Germany. BaFin leads colleges of supervisors of these groups, as is now a requirement under EU legislation and German supervisory law, wherever there is a subsidiary in another EU country. It also participates as host supervisor in colleges of supervisors of a further 14 groups based outside Germany. A number of key processes apply to these groups under the EU colleges of supervisors’ framework, including group risk assessment, crisis preparedness work and, most significant in recent years, Solvency II internal models approval, where the group has made an application. Implementation of the supervisory approach for these groups is relatively well-advanced. Although the detail of college work relies on the European framework (EIOPA has issued extensive guidelines), BaFin is also involving non-EEA supervisors in the few cases where relevant, subject to being assured of their ability to protect confidential information—which has not been possible so far in all cases.

• The one G-SII for which BaFin is the group supervisor. BaFin has established both a college of supervisors and a Crisis Management Group (CMG) in accordance with the Financial Stability Board’s framework for Global Systemically Important Financial Institutions. It also participates, as host supervisor, in similar arrangements for one other G-SII—and one former G-SII, to which the G-SII arrangements continued to apply as at late 2015. For these groups, college work has also in practice focused heavily on internal models approvals in recent years, but progress has been made on recovery and resolution planning through the CMG, which also provides a forum for discussing other more sensitive issues amongst the small number of supervisors of the largest entities in the group.

63. A number of insurance-dominated financial conglomerates also fall broadly within this framework. There are six financial conglomerates of which BaFin is the coordinating supervisor, four of which are insurance dominated. There are also two financial conglomerates with large insurers in Germany where other EU supervisors are the coordinating supervisors. BaFin invites the non-insurance supervisors to the colleges that it leads for the four insurance-dominated conglomerates.

64. BaFin has recently reorganized supervisory resources to support a group wide focus to supervision. Since July 2014, one team now supervises all or most elements of each group. All three largest groups (Allianz, Munich Re and HDI/Talanx) are supervised by a single unit each, while other units supervise a varying number of companies depending on scale. The three largest groups and the German operations of the foreign G-SII (and former G-SII) are all supervised in a single department, enabling supervisors to exchange views on supervisory practices and key supervisory issues arising on these groups. Supervision units comprise between 9 and 14 staff supported by a wide range of specialist functions, including the internal models unit. The core supervisory team consists of at least one legal expert, an economist and a mathematician or actuary.

65. For the largest groups, a distinctive approach to group supervision has been developing. This includes core supervisory processes but also puts particular emphasis on:

• A supervisory plan that draws on the risk classification, BaFin’s priorities and key risk issues for the insurance sector, the college agenda, and workstreams such as the ORSA review;

• A particular focus on internal management information—an internal group risk report is received quarterly, for example;

• Regular contact with senior management, including the heads of control functions and the responsible actuary;

• Attendance, on an annual basis, at meetings of the group’s supervisory board and receipt of papers sent to the board, and minutes of its meetings; and

• Working through the college of supervisors.

66. A common regulatory framework applies to all the groups. The approach until January 1 2016 has been based on the European supplementary supervision framework, which essentially provides an overlay to solo level supervision. In practice, BaFin has built on this to apply requirements on governance and risk management to the group level as well as requirements on intra-group transactions and risk concentrations. Solvency II implementation has deepened the regulatory approach with a much extended reporting framework for insurance groups and providing for internal models to be recognized at group level. BaFin already has direct powers over insurance holding companies, which hold interests only in insurers and mixed financial holding companies (a parent company within a financial conglomerate group), which enable it to take a comprehensive approach to groupwide supervision. There is extensive internal guidance and specialist expertise on group supervision issues.

67. There are no provisions in the law explicitly recognizing a separate status of G-SII. BaFin’s work to date on G-SIIs has been undertaken without using specific powers and relying on using its authority over the regulated entities in the group. It has no power, for example, to impose additional capital requirements on a G-SII (to reflect the characteristics that make it a G-SII), as is planned under the developing IAIS framework for higher loss absorbency capacity (HLA). Nonetheless, as groupwide supervisor, BaFin has implemented elements of the IAIS framework for G-SII supervision agreed to date, including the application of the initial assessment methodology (for identifying G-SIIs) and the requirements of G-SII supervision including requiring a Systemic Risk Management Plan, Liquidity Risk Management Plan and establishment of a CMG.

68. There is scope further to align BaFin’s approach to the one German G-SII with other larger groups. Germany’s largest insurance groups include reinsurance operations with global reach. BaFin is waiting for outcome of the current IAIS review of its G-SII assessment methodology (including consideration of the approach to reinsurance) before deciding how to develop its approach to these groups. Notwithstanding the different supervisory objectives applicable to reinsurance under German law and the outstanding issues being considered by the IAIS, BaFin could consider the application to reinsurance-led groups of macroprudential tools used in the case of primary insurance, including regular stress tests and recovery and resolution planning.

A. Key Recommendations

• BaFin should continue to maintain a watchlist and continue to require action plans where companies face difficulties in meeting the new solvency requirements or maintaining a surplus under the national GAAP.

• BaFin should ensure that companies using the transitional measures under Solvency II have a robust and credible plan for meeting their SCR requirements by the end of the 16 year-period and, where possible, earlier. This process should include stress testing to ensure that such insurers would meet the SCR even after a plausible shock.

• The calibration of ZZR requirement should be kept under review within a framework of close attention by the authorities to the national GAAP framework as it applies to insurers given its continuing importance in relation to insurance regulatory objectives, including fair treatment of policyholders.

• Supervisory priorities following full implementation of Solvency II should shift to the assumptions used by insurers using the standardized approach and on investments.

• Supervisory and specialist resources should be maintained at their current high level to manage the continuing challenge of implementation and risks that will arise during the early period after the new requirements come fully into effect.

• Given the multiplicity and high transparency of Solvency II numbers that will be available (particularly from 2017 when public disclosure requirements take effect), planning should be undertaken to ensure a high degree of public understanding of the different measures.

• BaFin should consider a more formal approach to intervention in case of a deterioration in the financial position of an insurer as measured under the national accounting framework.

• BaFin should also consider a more systematic approach to communicate requirements based on the ORSA review; and a policy framework for the imposition (and removal) of formal capital add-ons, making use of its powers in the insurance supervisory legislation.

• BaFin could consider the application to all the larger groups of macroprudential tools used in the case of the one German G-SII, including regular stress tests and recovery and resolution planning.

• BaFin should be empowered to place additional regulatory requirements on G-SIIs, including the requirements for higher loss-absorbency capacity being developed by the IAIS.

B. Other Recommendations

More details of these recommendations are provided in the Annex under the section on the applicable Insurance Core Principle.

• The federal government should review BaFin’s extensive reporting requirements to the BMF and provisions for dismissal of BaFin Executive Board members to ensure they continue to support robust operational independence in the future.

• BaFin should further develop its supervisory approach to place increased emphasis on peer group analysis and peer review, especially on larger institutions; and to take a more risk-based approach to the allocation of supervisory resources to conduct of business work, for example by including more explicit conduct-related issues in its risk classification system.

• The authorities should review whether the procedures to effect transfers of insurance portfolios to guarantee schemes allow for more complex portfolios readily to be transferred; and whether it would strengthen BaFin’s ability to address weak insurers if it were to have a power to require a portfolio transfer to another (willing) insurer as well as to an insurance guarantee scheme.

• In the long term, there would be advantages, from the perspective of insurance supervision, in aligning national GAAP with Solvency II valuation as much as possible to help the authorities and insurers communicate the industry’s performance more clearly and to avoid unnecessary uncertainty in the market over valuation and solvency.

• Insurance supervisors should continue to coordinate with securities supervisors to monitor derivatives activities used by investment funds in which insurers are investing, given the significant share of investment allocation by insurers.

• BaFin should use the analysis developed in internal model validations to assess the SCR under the standardized approach, for example whether the assumptions on policyholder dividend reduction under certain scenarios or of taxable income for deferred tax are realistic.

• If the volatility adjustment is to be widely used by insurers, BaFin should encourage them to build up capital resources during periods of low volatility so that the volatility adjustment is used solely for countercyclical purposes.

• The FSC and German government should consider the scope for giving the FSC wider scope to take macroprudential action without the need for legislative change—to address the risk that necessary measures are delayed or not implemented owing to the political cycle.

• BaFin should make use of its powers to require significant insurers to develop recovery plans, starting with higher risk insurers under the risk classification system; and address gaps in the regulatory framework in relation to requiring companies to be ready to report necessary information in case of a crisis and to maintain contingency plans.