BaFin’s Insurance Supervision Sector has identified and published the issues relevant to risk-based forward-looking supervision for the 2019 financial year in its supervisory programme. It now presents its findings in BaFinJournal – as it did in 2019 for the 2018 financial year (see expert article on the BaFin website dated 18 March 2019).

Sustainability in capital investments of insurance undertakings and Pensionsfonds

At the end of 2019, BaFin published a Guidance Notice on Sustainability Risks, which was also addressed to institutions for occupational retirement provision (IORPs).

To build up expertise and support undertakings in the integration of environmental, social and governance (ESG) criteria in their risk management for investments, BaFin conducted numerous supervisory interviews with selected insurers and IORPs and hosted several workshops for undertakings and associations. The focus was primarily on climate stress tests and scenario analyses (see expect article on the BaFin website dated 8 November 2019 ). The exchange of information with the undertakings showed that many insurers and IORPs have given considerable thought to sustainability already, even if they are at different stages where implementation is concerned. Overall, it became clear that the insurance industry sees itself as a pioneer, and that companies are actively following the regulatory developments at European level, in particular within the EU Commission’s Action Plan “Financing Sustainable Growth”.

Analysis of possible search for yield behaviour by insurance undertakings and Pensionsfonds with regard to new investments

Against the backdrop of the low interest rate environment and the regulatory changes brought about by Solvency II, BaFin carried out several targeted on-site inspections in order to investigate investment trends within the insurance industry. One important finding was that the undertakings have strengthened their investments in risky assets. By investing in new, alternative assets, undertakings aim at diversifying their portfolios, which means increasing portfolio yields with a similar level of portfolio risk. Over the last three years, investments in private equity, infrastructure, real estate and private debt have increased slightly at the expense of liquid fixed income investments. Small and medium-sized insurers in particular increased their investments in the real estate sector, with which they are familiar.

Individual undertakings deliberately increased their non-financial investments. They believe that direct or indirect loans – i.e. loans via funds – to industrial or real estate companies offer attractive return opportunities. Most of the new investments made continued to focus on corporate bonds and investment funds. Lower investment grade ratings were accepted for fixed-interest bonds. High-yield investments, however, continued to account for only a small proportion; only few undertakings increased their investments in such assets.

More intensive monitoring of premium developments at non-life reinsurers

In 2019, as part of its two-year market analysis of the situation with regard to premiums, BaFin held discussions with major reinsurers about premium development. It also participated in various industry conferences and started to analyse qualitative and quantitative reporting data.

In the past, there was a global reinsurance cycle that led from a soft market with low premiums to a hard market with rising premiums – the transition being triggered by major loss events. For some years now, the effects of this cycle have weakened and price movements are becoming increasingly regional. One example of this is the extreme natural catastrophe events of 2017 and 2018: although the reinsurance undertakings surveyed reported price increases in affected regions, these had only a limited impact on global reinsurance prices.

In addition, the macroeconomic environment led to increased capital availability on traditional and alternative reinsurance markets. In 2019, these again were characterised by oversupply and increased competition. The first signs of a revival in demand were already seen in 2019. In 2019, market participants paid particular attention to growth areas such as cyber insurance, the insurability of intangible assets such as patents and licences, and the question of how existing protection gaps could be closed.

Examination of non-affirmative cyber risks in insurance policies

In a survey conducted on non-affirmative cyber risks, only two of 27 insurers and insurance groups reported known losses. It was noted that many insurers had not yet reported any relevant claims. However, about half of the surveyed insurers pointed out that it was not easy to identify such cases in the first place. Non-affirmative cyber risks are risks that can lay dormant in traditional insurance products (therefore also called silent risks) because, unlike cyber policies, traditional policies do not expressly state the extent to which cyber damage is covered. The massive increase in hacker attacks and other forms of cyber incidents can cause disruptive loss experiences, in particular for property/casualty insurers. By making this a priority, and by using the survey to intensify supervisory contacts, BaFin aimed at raising awareness of the problem in the industry.

In order to be able to monitor trends in claims and loss experience more closely, BaFin considers it necessary for insurance undertakings to examine more thoroughly whether cyber incidents were the actual cause of damage. Virtually all insurers rightly included non-affirmative risks in their 2019 risk management and monitored loss experiences and market developments. Insurers have also begun to analyse their general policy conditions with regard to silent risks. There were, however, no plans for major changes to existing policies.

Examinations of stochastic valuation models (SUM/BSM) of life insurers that use the standard formula

In 2019, BaFin examined the complex simulation models used by life insurers to value their technical provisions under Solvency II. In the case of life insurers that use the standard formula instead of an internal model, the examination of the valuation models was carried out in the course of ongoing supervision. This examination covered the “Branchensimulationsmodell” (BSM), a software programme provided by the German Insurance Association widely used in the German life insurance market, and the stochastic cash flow projection model (SUM). The objective was to identify weaknesses that could result in undervaluation or incorrect valuation of the technical provisions. There was also a regular exchange of information between BaFin and the German Insurance Association, which developed the BSM.

Weaknesses in the application of the BSM were noted when it was used to map certain insurance tariffs, such as dynamic hybrid insurance or special investment products, for instance derivative products or yield-oriented investments with a high risk profile. In extreme cases, these weaknesses meant that the BSM was unsuitable for valuing the technical provisions. In many cases, the informative value of the technical provisions was limited by the fact that the undertaking had not sufficiently validated the underlying assumptions or future management measures. BaFin also criticised the fact that undertakings paid only little attention to the weaknesses of programmes or data from external providers.

In-depth examination of how insurers that use the standard formula deal with economic scenario generators (ESGs) when valuing their technical provisions

Economic scenario generators are complex capital market models used by insurers for the stochastic valuation of the technical provisions for products with interest guarantees and profit participation. BaFin encourages insurers to further develop their ESGs and expects them to take great care in the individual adaptation of purchased ESGs.

A non-representative random sample carried out by BaFin in 2019 indicates that small insurance undertakings lack the human resources to operate ESGs and adapt them to their specific needs. In the case of larger insurers, it is questionable whether these could independently implement a completely different but more suitable model. Major insurers that use a stochastic company-specific ESG seem to have the necessary personnel.

In 2019, BaFin will extend its examinations to the entire life insurance industry because the sample showed very heterogeneous results that cannot be generalised. For this purpose, it can use data and documentation already held by the institutions and evaluate these centrally.

Examination and quality assurance of technical claims provisions in the solvency statements of property/casualty insurers

BaFin also examined the market-consistent valuation of the technical provisions of property/casualty insurers (best estimate under Solvency II) in the 2019 financial year. For this purpose, it used a special software tool that assists its examiners in their reserve risk analysis. BaFin takes conspicuous features in data quality and data validation as an opportunity to highlight the need to ensure that data are appropriate, complete and accurate, particularly with regard to the use of external data or different IT systems.

In some cases, the scope of validation and the validation methods applied were insufficient. In general, it was found that although most of the undertakings verified the sufficiency of the assumptions and the methods applied, retrospective comparisons between the expected and the actual claims expenditure often required improvement. In cases where undertakings used expert estimates for analyses and adjustments of their reserving, stringent rules were usually missing, for example in the form of a materiality concept that shows which developments require action. A common problem was the verification of results achieved from outsourced or expert activities. The undertakings must ensure that supplied data is accurate and relevant. Documentation often was insufficient and the data not significant enough to provide an adequate overview of the reserving to expert third parties within a reasonable time. Documentation deficiencies in the valuation concept and the calculation process of the best estimate were particularly frequent.

Priorities in 2020

At the beginning of the year, BaFin’s Insurance Supervision Sector published its priorities for 2020. These include sustainability, investments in a low interest environment, cyber risks and provisions.