Solvency II News: Prolonged low interest rates threaten German life insurers

The German life insurance industry is heavily exposed to a prolonged low interest-rate scenario, a report from Moody’s warns today.

“With interest rates having fallen to the lowest levels in a generation, we estimate that the industry would ultimately face losses in a scenario where interest rates remained at their current level,” the report, German Life Insurance Industry Faces Losses If Interest Rates Stay Low (subscription), states. The industry’s vulnerability is a result of historic high guarantee levels and a high duration mismatch between assets and liabilities. According to Moody’s, German insurers have some of the highest guarantee rates in Europe (about 3.3% for in-force business) and, based on results of the EIOPA LTGA report, the largest duration mismatch. The exposure to low interest rates is currently not captured in the ‘Solvency I’ regulatory ratios, but will be under Solvency II. “We believe that if Solvency II was implemented today without any measures discussed in the LTG package, many German players would struggle to cover regulatory capital requirements,” Benjamin Serra, VP-Senior Analyst, Moody’s, said. “However, it appears increasingly likely that some of the measures tested in the LTGA will apply, including a long transition period which will give time for German insurers to adapt to the new solvency regime.” One expert familiar with the German insurance market said the report’s findings come as no surprise as the state of the life insurance industry has been subject to public debate in recent months, including discussion in the Parliament.

SMEs vulnerable

Moody’s notes that exposure to the low interest-rate environment varies between firms. According to the industry expert, small and medium size mutual insurers were most exposed to the risk. Larger firms have already began to address the problem for some time. One of the regulator’s main concerns is early redemption. “Although policies have very punitive early redemption charges, if doubts about the soundness of the industry becomes an issue policyholders may rush for the exit,” the expert said.

Can Solvency II help?

The report states that many insurers are acting to mitigate the risk of prolonged low interest rate environment by introducing new products with lower guarantees and modifying or deferring policy holder participation in profits. But it adds, “Competitive pressures, however, have thus far limited insurers’ ability to carry out these initiatives,” the report states. Mitigating the industry’s exposure is closely linked to developments around the Solvency II regulatory framework. Thorsten Wagner, Audit Financial Services Director at KPMG in Germany, said finding a solution to dealing with LTG under Solvency II was crucial for the German life insurance industry. “As a result, the German supervisor BaFin is discussing several topics which impact the valuation of technical provisions under Solvency II, especially long-term interest rate assumptions.” Solvency II as it is proposed today would help prevent some of this future risk, but given the duration of German liabilities, the risk of the existing business will remain on insurers’ balance sheets for a very long time, according to Mr Serra. “The implementation of Solvency II capital requirements with a very long transition period would probably slow down the changes in the design of new products and therefore slowdown the reduction in risks for German insurers.” However, Mr Serra highlighted the importance of the qualitative aspects of Solvency II. “The new solvency regime will also foster a culture of risk management, for example by fostering the matching of assets and liabilities, which should contribute to reduce the risk in the future.” A spokesperson for the German Insurance Association (GDV) said it did not believe the analysis in the report will have implications on the Solvency II Long-Term Guarantees package. “The artificially low interest rates are having considerable impacts on the life insurance industry. The rapidly changing business environment since 2007 was the main reason why main features of Solvency II have been reviewed and revised many times, combined with ongoing quality impact studies to test the effect of changes on the calculation of solvency. It is the common objective of EU legislation, supervisors and the industry that the future rules will still make long-term guarantees to policyholders possible.” — To subscribe to the Solvency II Wire mailing list for free click here.]]>