The insurance industry, particularly life insurers and Pensionskassen, is still battling the incessant low interest rate environment. In 2020, the difficulties were unexpectedly intensified by the coronavirus pandemic, which also prolonged the Solvency II review by six months. BaFin Chief Executive Director Dr Frank Grund takes a look back over recent events and a look forward to the future.

Dr Grund, what is your assessment of the current situation for life insurers, taking into account the discussions that took place during the recent Annual Insurance Supervision Conference in April 2021?

The coronavirus crisis is having a sustained impact on life insurers and Pensionskassen, just as it is on society as a whole. This impact can be seen not only in investments but also in sales. It goes without saying that social distancing does not make meetings between an insurance agent and a potential customer any easier. The low interest rate environment – which has been the main challenge for life insurers and Pensionskassen for a number of years – has been exacerbated by the pandemic. In a situation such as this, our main objective is to closely monitor and support the companies in our role as supervisor.

How did BaFin do that during 2020, a year shaped by the coronavirus pandemic?

The preventative aspect of ongoing supervision is of particular importance at BaFin. Last year, we emphasised to the responsible actuaries at life insurers and to actuarial function holders that they must critically examine, and if necessary reduce, interest guarantees in new business. In July 2020 we issued a letter to companies in the insurance industry to offer advice on this. The most important point of this letter was that the maximum technical interest rate must not be automatically taken as the guaranteed interest rate for new business without further thought.

In regulated Pensionskassen, there were even some tariffs, still open to new business, that had a guaranteed interest rate of over 0.9 percent – even higher than the current maximum technical interest rate. We asked the providers to reduce their interest guarantees for new business. This was successful in almost all Pensionskassen. There are just a few specific cases in which the relevant parties have yet to make a decision about the tariffs.

What are the most significant results of BaFin’s prognostic survey as at 30 September 2020?

The results are still being evaluated. Nevertheless, we can already tell that life insurers are robust enough to continue to meet their current obligations in the future – if we take the Commercial Code (Handelsgesetzbuch – HGB) as the basis. It is also already clear, however, that companies may find it more difficult to continue to build up the ZZR buffer (Zinszusatzreserve) in the future. In 2020, this buffer grew by more than 10 billion euros to just under 86 billion euros, and by 2024 insurers will have been required to dedicate a further 33 billion euros to it. It is too early for me to comment on the Solvency II survey, which should give us information about insurers’ ability to continue to write new business in the future.

Pensionskassen are still being hit particularly hard by the low interest rates, as is clear from our current prognostic survey. On a positive note, however, many Pensionskassen are being given financial support by their sponsoring undertakings or shareholders.

At the end of last year, the European Insurance and Occupational Pensions Authority, EIOPA, issued a statement regarding the Solvency II review. What do the recommendations mean for German life insurers?

EIOPA’s proposal was a compromise. We have had to make concessions, too. As an overall package, however, I think it is a reasonably acceptable compromise. While the proposal makes Solvency II even more market-orientated, it still allows for long-term business, such as is typical for life insurers. This was an important aspect for us. Nevertheless, if interest rates remain at their current low levels, this will put a strain on German life insurers.

Are you referring to the proposed changes to the yield curve extrapolation?

Precisely. For German life insurers, with their particularly long contract terms, these changes would lead to a significant increase in their capital requirements.

The background to this is as follows: the alternative extrapolation method is intended to include interest rate information relating to the time after 20 years have passed. If interest rates remain at their current levels, the extrapolated part of the yield curve will tend to be lower¹. While EIOPA is proposing an equalising mechanism intended to ensure that the level of the provisions remains manageable even in difficult market conditions, this mechanism would be for a limited period of time. I therefore expect this issue to be the subject of further discussions.

A proposal I am in favour of is the redesign of the volatility adjustment. This tool proved its worth in 2020 in the real-life stress scenario caused by the coronavirus pandemic. When the pandemic hit, markets plummeted. The newly designed volatility adjustment would be even more powerful and even more tailored. This would continue to bring stability to solvency capital in unstable times. Moreover, the fact that the illiquidity of obligations is also to be taken into account makes it possible for long-term insurance business to be better reflected under Solvency II.

In 2020, BaFin focussed on inspecting life insurers’ technical provisions. What was the outcome of this?

Unfortunately, the coronavirus pandemic meant that we were not able to conduct on-site work as frequently as we would have liked. Nevertheless, we carried out assessments of the stochastic valuation model for technical provisions (the BSM²) of certain life insurers that use the standard formula under Solvency II.

In 2020, we found a small number of weaknesses in this simulation model. The BSM is not able to provide a suitable model for certain insurance tariffs, such as dynamic hybrid insurance. A similar problem was found with certain investment products, including both special investments such as derivative products and 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 insurers had not sufficiently assessed the validity of the underlying assumptions or future management measures. In other cases, they had not put enough time and effort into understanding the weaknesses of the programs and the data provided by external providers. This all needs to be improved.

Does the situation seem any better for claims provisions in property and casualty insurers?

These insurers need to make improvements, too. Data quality and data validation need to be improved in particular, but additional modifications are also needed to ensure that the data that are used in the calculations are appropriate, complete and accurate. When insurers use external data or when several IT systems are employed, this does not make the calculations any easier. In our view, the scope of the validation and the methods used to validate the data are also insufficient in some cases. And for some insurers, the documentation regarding the evaluation and calculation of the best estimate³ was in disarray.

For technical provisions and claims provisions, the same thing applies to both: if possible, we hope to catch up on the missed inspections in 2021.

Are there any other supervisory priorities that are being carried over from last year into this year?

Not many challenges just come to an end when a new year starts. The low interest rate environment is a good example of this, as is the coronavirus pandemic. We expect the pandemic to have a greater effect on investments in 2021 than it did in 2020. While rating downgrades were not an issue in 2020, there is a risk that the ratings and quality of corporate loans will deteriorate in 2021.

There could also be a drop in the commercial property market. In 2020, although a significant proportion of insurers wrote down the value of their directly held commercial real estate assets due to changes in the market value, in accordance with Solvency II, real estate exposure was ultimately a manageable risk for insurers’ capital resources. This was shown clearly in our analyses. We will watch closely to see how things develop.

Insurers’ and pension funds’ IT security and cyber security systems were and still are another important issue.

You are absolutely right. The coronavirus pandemic has accelerated the digitalisation of workflows. This has highlighted once more the importance of IT and cyber security for these companies. The coronavirus restrictions meant that we had to postpone many of our on-site inspections relating to the implementation of BaFin’s Supervisory Requirements for IT in Insurance Undertakings (Versicherungsaufsichtliche Anforderungen an die IT – VAIT). For the companies that we have not yet inspected, this means: postponed is not the same as cancelled. We expect the 16 companies that we have inspected since the VAIT was issued in summer 2018 to submit action plans to us showing how they intend to rectify the shortcomings and IT security gaps that were identified.

In 2021, we will closely examine the extent to which insurers are able to finance and implement their own digital transformation processes. To this end, we will send a questionnaire to an estimated 45 or so insurers from all insurance classes. The aim is to find out the planned investment volume, the sources of funding and the time frame for the implementation of digitalisation projects.

Let’s go back to the recent annual insurance supervision conference: a further area of focus was the institutions for occupational retirement provision, the IORPs, which were also a supervisory priority last year. What have you found out?

Just before the end of last year, we finally published two long-awaited circulars: the Minimum requirements under supervisory law on the system of governance of institutions for occupational retirement provision (“MaGo for IORPs” – MaGo für EbAV) and on the own-risk assessment of institutions for occupational retirement provision (“ORA circular” – Rundschreiben ERB). Both circulars are intended to help companies: if a question arises regarding how IORPs can make use of the principle of proportionality, assign key functions or outsource activities, the MaGo for IORPs can help. For questions relating to the own risk assessment as prescribed by law, we would recommend consulting the ORA circular first. The actual quality of the ORA reports and which further measures are to be taken in light of these reports will be a priority issue for us this year.

The current developments in consumer protection are another topic on your agenda. What are the important issues here, in your view?

We are currently focussing on the amount of commission charged. In Germany, the Insurance Supervision Act (Versicherungsaufsichtsgesetz – VAG) already contains a provision stating that commission must not conflict with an advisor’s duty to act in the best interests of their clients. We take this very seriously. We first collected data on payments made to insurance intermediaries for new business in 2017. In 2019 we updated the survey regarding commission payments among life insurers. We will build on this in 2021 by, for example, going into the issue in more detail in our inspections.

And finally, another topical issue to conclude our conversation: at the start of the year, an article on the BaFin website reported that insurtech companies must now be fully funded right from the start. Can you understand the industry’s resistance to this?

Of course I can understand why insurtech companies are not exactly celebrating this news. But our priority is to protect policyholders. We cannot allow insurers to constantly depend on being able to collect the capital they need by means of funding rounds. That is why we are careful to ensure that insurtech companies, just like other insurance undertakings, have robust business plans and adequate organisation funds. To date, we have granted authorisation to six insurtech companies. Some business plans have not worked as well in reality as had been hoped. The estimates for the expected costs and claims and for the premium income were often too optimistic. The capital required to ensure the sustainability of the business model, meanwhile, was much higher than anticipated. Incidentally, BaFin did not create any new capital requirements; we just clarified the existing rules.

But one thing I would like to say is that a dialogue with new market participants is certainly something we are interested in – especially when it comes to truly innovative ideas. We have already had some conversations with such companies, in fact. And we are certainly open to new applications.

Thank you for your time, Dr Grund.

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