Section 132 of the VAG requires that, if an insurer’s financial position deteriorates such that its ability to fulfil its contractual obligations or its solvency is jeopardised, it must notify BaFin sufficiently early for counter measures to take effect. The provision of this section can thus be regarded as an important early warning tool for insurance supervision. In this context, BaFin’s pilot survey (see info box “Pilot survey”) has revealed inadequacies on the part of the respondent companies.

Insufficient process description

Most of the respondent companies do not have an independent system in place which would be able to show a deterioration in the financial position. Instead, such systems are usually integrated into other risk management processes. Moreover, the descriptions of these processes often do not indicate whether there is a clear definition of “deterioration in the financial position” and what exactly would trigger the reporting obligation to BaFin.

The coverage of the regulatory capital requirement gives an indication to all companies as to whether their financial position has deteriorated. Most companies also take into account various accounting parameters in accordance with the German Commercial Code (Handelsgesetzbuch – HGB). Some companies, however, only check whether the Solvency II coverage ratio of the solvency capital requirement (SCR) has decreased.

Companies not to focus on solvency ratio only

BaFin expects companies not to focus exclusively on the Solvency II SCR coverage ratio. When the legislature transposed Article 136 of the Solvency II Directive into German law, it expressly included the terms “jeopardy to the ability to fulfil obligations” and “risk to the ability to pay” in section 132 of the VAG as criteria for notification. These criteria do not only apply in cases where the eligible own funds fall below the SCR or where this situation is likely to arise. In these cases, the requirement for notification is based on section 134 (1) of the VAG. The notification requirement stipulated in section 132 is to take effect at an earlier stage. For this reason, the key figures on which companies base the assessment of their financial position must be complemented by broader criteria relating to HGB accounting, such as changes in the profit of the year, equity, liquidity or the provision for bonuses and rebates.

The HGB continues to play an important role for German insurers even after Solvency II entered into force on 1 January 2016. Life insurers, for example, calculate the profit participation of their policyholders based on the surpluses under HGB rules. Moreover, there are significant differences between HGB accounting and the valuation principles under Solvency II. This means that, while still complying with capital requirements under Solvency II, a company can be overindebted and/or insolvent under HGB rules, which would acutely jeopardise the fulfilment of its obligations.

In addition to current actual values, the companies also regularly use projected values to assess their future financial position. The range of projection horizons is very wide and depends on the relevant key figures. It ranges from very short-term projection values covering the coming months to very long-term periods of 10 to 20 years for certain HGB key figures.

Ongoing early identification

The systems the companies established under section 132 (1) of the VAG were not designed as an automatic early warning system but as review procedures carried out, for the most part, at different intervals. This means that the companies determine the relevant key figures at different times in the calendar year.

In BaFin’s view, the companies must ensure that their systems are able to identify any notifiable deterioration in their financial position promptly and without relying on fixed time intervals. They must then inform the supervisory authority without delay, as intended by the legislature. Postponing notification until the next regular report is not sufficient for compliance with section 132 of the VAG. Nor can the additional reporting requirements imposed by BaFin on life insurers under intensified supervision be regarded as a substitute for a notification in accordance with section 132 (2) of the VAG.

Conclusion and outlook

In times of volatile capital markets and low interest rate levels, preventive supervisory tools and early warning systems are becoming ever more important for BaFin. Supervisory practice and the pilot survey, however, have shown that there are a large number of companies that still need to significantly improve their implementation of section 132 of the VAG. It seems that the companies are not yet sufficiently aware of this provision. In addition, there is no uniform understanding of section 132 in the industry.

BaFin hopes that the findings of the pilot survey will help the companies to improve their understanding. It expects all companies to critically review their systems and processes in this regard. The planned survey of companies covering all insurance lines will show whether these reviews proved to be successful.