Reports claiming that mortgage loans are a new asset class for insurers are thus inaccurate, as is the claim that insurers are increasingly competing with banks in the lending business. On the contrary: this line of business has even seen a sharp decrease in volume over recent years. To illustrate this, this article examines the development of this traditional line of business and the regulatory conditions.

History

Even before the German Insurance Supervision Act (Versicherungsaufsichtsgesetz – VAG) entered into force in 1901, insurers were already investing in mortgage loans. At the time, these were among the most important asset classes, along with sovereign bonds and fixed income securities. Around 1900, nearly every life insurer in Germany had its own mortgage department. In the second half of the 20th century, they played a considerable role in rebuilding Germany's private housing stock after the Second World War through lending. Given such a long history, it is always surprising to hear talk of this as a new line of business for insurers.

When the schedule of investments was introduced under section 54a of the VAG in 1975, this gave rise to increasingly more individualised investment opportunities and the volume of mortgage loans declined as an asset class – particularly due to the broader diversification of investments. Yet insurers did not completely abandon mortgage loans.

The Investment Regulation (Anlageverordnung – AnlV) entered into force in 2002, and represented the heart of investment regulation in Germany until the European supervisory regime, Solvency II, entered into force in early 2016. Loans secured by immovable property were classified under a category of their own in the schedule of investments, which today is contained in section 2 (1) no. 1 of the AnlV.

Sharp decrease

At the time, loans secured by immovable property accounted for approximately 7.5 percent. In recent years, this figure has fallen to around four percent. The majority are loans secured by residential property. Commercial properties account for 0.5 percent of insurers' investments (see chart on page xy ).
The sharp decrease in loans secured by immovable property is due to the persistently low interest rate levels. In light of the expense associated with investments in mortgage loans, the return is barely adequate. In order to sufficiently diversify their portfolios, however, a majority of insurers continue to invest in this asset class.

Share of mortgage loans in insurers' investment portfolios (2003 to 2015)

Share of mortgage loans in insurers' investment portfolios (2003 to 2015) BaFin

Volume of mortgage loans

Although insurers have a history of lending, this nevertheless remains a traditional line of business for banks. Comparing the volume of loans issued by banks against the volume of loans issued by insurers makes this clear.

The total volume of residential property loans financed by insurers was EUR 49.3 billion at the end of 2015. The volume of loans issued by banks to employed and other private persons for residential construction was EUR 887.1 billion during the same period. Consequently, roughly one in 20 loans for residential property was issued by an insurer. This refutes reports of insurers increasingly making inroads into banks' lending business.

Regulatory requirements

Lending insurers are subject to separate requirements of insurance supervisory law which have been continually adjusted to reflect new market conditions.

Until the end of 2015, all primary insurers were required to comply in particular with the provisions of the previously mentioned Investment Regulation when investing their guarantee assets (Sicherungsvermögen). These requirements continue to apply to occupational pension schemes (Pensionskassen), funeral expenses funds and smaller insurance undertakings which are not covered by the new Solvency II supervisory regime.

To some extent, the requirements placed on insurers are based on banking supervision standards. For instance, when investing in loans secured by immovable property, they must calculate the loan value in order to ensure that they comply with the principles set out in the Pfandbrief Act (Pfandbriefgesetz – PfandBG). The calculation must factor in the permanent characteristics of the property and the sustainable return granted to any owner of the property if the property is properly managed. Pursuant to section 14 of the PfandBG, the loan may not exceed 60 percent of the calculated loan value.

Solvency II

The entry into force of Solvency II on 1 January 2016 marked a change in general conditions for the majority of insurers. One new condition is that insurers are now required to use own funds to back investments in mortgage loans.

A further material change is that, pursuant to section 124 of the VAG, insurance undertakings must invest the entirety of their assets in accordance with the prudent person principle. That principle states that they may only invest in assets whose risks they can properly identify, measure, monitor, manage and control. In addition, all assets must be invested in such a manner as to ensure the security, quality, liquidity and profitability of the portfolio as a whole.

While these requirements do not explicitly stipulate the application of lending policies, insurers are nevertheless required to create individual guidelines governing the granting of mortgage loans (Article 261 of the Delegated Regulation supplementing Solvency II). These guidelines must also take into consideration the borrower's creditworthiness and the value of the real estate securing the loan.

Mortgage Credit Directive

Last March, the Act Implementing the European Mortgage Credit Directive entered into force (see BaFinJournal April 2016, only available in German). This act also resulted in amendments to the VAG. Insurance undertakings which grant such loans are thus also required to comply with the supervisory and civil-law obligations set out in the Directive.

The newly added section 15a of the VAG, which references section 18a of the German Banking Act (Kreditwesengesetz – KWG) is relevant from a supervisory perspective. This section sets out specific requirements with which insurers must comply if they grant consumer mortgage loans. For instance, they may not enter into any consumer loan agreements if a review of the client's creditworthiness is negative.

Furthermore, the employees involved in lending to consumers must have sufficient expertise and abilities specifically for this purpose. The specific requirements as to qualifications will be set out in a separate regulation. In addition, it is now a statutory requirement that both internal and external appraisers who value the relevant property during the lending process have the necessary professional competence. Furthermore, they must be sufficiently independent of the lending process that an objective and impartial valuation of the property is ensured.