Insurers are required to carry out effective asset-liability management processes. BaFin asked 30 life insurers about their ALM processes. The supervisor also took this opportunity to ask insurance companies how they take account of sustainability risks in their asset-liability management. It was revealed that all but one of the life insurers surveyed deliberately permit mismatches, which they are allowed to do under certain conditions. All of the companies reported that they use stress tests and scenario analyses in their asset-liability management. However, only half of those surveyed take account of sustainability risks.

The asset-liability management process involves insurers systematically coordinating their investments (assets) to their insurance obligations (liabilities). In this way, insurers are able to ensure that their assets and liabilities are matched and are suited to their risk strategy. As part of their asset-liability management, companies also identify and record all material risks resulting from their assets and liabilities and from the interactions between their assets and liabilities. For insurance companies, asset-liability management is an essential component of risk management. It supports the management board in its decision-making processes.

Requirements heightened by Solvency II

With the entry into force of the principles-based supervisory regime Solvency II at the beginning of 2016, the requirements with regard to asset-liability management have increased significantly (see infobox). This is due to the greater freedom that the regulatory framework grants with regard to investments – in contrast to the old Investment Regulation (Anlageverordnung).

BaFin therefore wanted to gain an overview of how insurance companies that are subject to Solvency II implement the principles-based requirements and make use of the flexibility provided by the regulatory framework. In order to find this out, BaFin began by surveying life insurers, since the assets and liabilities sides impact one another more strongly in this segment than in other branches of the insurance industry.

Objectives must be clearly defined

Insurers must clearly define the specific objectives they wish to achieve through their asset-liability management. These objectives must be consistently derived from the specifications of the risk strategy (see margin no. 172 (a) of BaFin Circular 02/2017 (VA) ). BaFin asked the companies about their objectives. A little less than 90 percent of life insurers responded that identifying a strategic investment policy was an important objective. For 70 percent of companies, objectives included compliance with the statutory solvency requirements, while 60 percent reported being able to fulfil insurance obligations at all times as an important objective of asset-liability management.

Insurers also reported which business units they involve in asset-liability management. The most common answers given here were representatives of the investment management, risk management and actuarial departments. But the companies also reported involving employees from their product development departments, members of the management board and employees from their controlling departments in their asset-liability management teams.

Managing mismatches

Almost three quarters of the insurers surveyed manage mismatches between investments and liabilities with the aid of limit systems. Just over two thirds of companies use forward-looking models to identify and assess mismatches. Half of the insurers reported making use of software solutions and internal stress tests or sensitivity analyses.

Insurers are allowed to deliberately permit mismatches between investments and liabilities if this complies with their risk strategy and the limits derived from this risk strategy. BaFin therefore also asked life insurers whether they permit mismatches and, if they do, what kind of mismatches they deliberately permit. All but one of the insurers permit mismatches. Almost three quarters of companies named duration gaps, just under two thirds specified currency risk and a little more than 40 percent cited interest rate risks. In some cases, insurers permit mismatches with regard to liquidity, real estate, spread and lapse risks.

The results also show that all of the insurers make use of stress tests and scenario analyses. Two thirds of the companies reported that they base their stress tests and scenario analyses on a drop in interest rates and more than half use fluctuations on the capital markets as a basis. Around one third of companies used spread widening, decreases in lapse rates and liquidity as bases for their stress scenarios.

Importance of sustainability risks in asset-liability management

For insurers, it is becoming increasingly important to identify, assess, monitor, manage and control climate-related risks (see expert article on the BaFin website dated 8 November 2019). This has an impact on asset-liability management since it forms part of risk management, which plays a particularly important role with regard to sustainability risks (see section 6.8.3 of BaFin’s Guidance Notice on Dealing with Sustainability Risks). Companies are obliged to review whether material sustainability risks are suitably represented in their asset-liability management.

BaFin’s review of the situation revealed that most insurance companies are increasingly gearing their investment portfolios towards ESG criteria. The abbreviation ESG stands for Environmental, Social and Governance. In order to determine how, for example, sustainability risks could impact cash flows, it is advisable for insurers to also include sustainability risks in their stress tests and scenario analyses. The survey has shown that so far less than half of all life insurers asked take account of sustainability risks in their stress tests and scenario analyses. However, BaFin expects this number to rise and that, in future, an increasing number of companies will measure sustainability risks with the aid of stress tests and scenario analyses. BaFin will continue to monitor insurance companies with regard to their requirements under supervisory law, and will observe whether and how they continue to make progress.

Survey of 30 life insurers

For its review of the current situation, BaFin surveyed the 30 biggest life insurers – measured according to gross premiums earned – about their asset-liability management. The companies surveyed explained how they comply with the regulatory requirements. In practice, insurers make use of various processes, methods and models cumulatively, meaning they often gave multiple answers for each individual point (see info box “BaFin’s review of the current situation”). BaFin’s questions were limited to qualitative considerations. Quantitative and methodological questions, for example regarding valuations related to solvency capital requirements, were not part of the survey.