BaFin uses an internal classification procedure to assess the risks that insurance companies, pension funds and insurance groups currently face or might face in future. The procedure enables BaFin to manage its supervision, facilitating decisions such as how frequently, extensively and intensively companies are to be analysed or inspected on site.

To date, BaFin has only published aggregated results of its risk classification in its annual reports. In future, it will communicate and explain the individual risk scores to the supervised entities and groups in bilateral discussions. This will provide the supervised entities with even more clarity about where BaFin sees their main weaknesses and strengths.

The additional information will make supervisory action more transparent and more understandable for the companies and groups. It will also stimulate the dialogue between supervisors and companies. Companies will be given the opportunity to respond more quickly to BaFin’s assessments of company-specific developments. Importantly, however, supervised entities are not allowed to publish the risk classification results or to use them for advertising purposes.

How risk classification works

The risk classification procedure is based on the guidelines of the European Insurance and Occupational Pensions Authority (EIOPA) on the supervisory review process. It takes into account the nature, scale and complexity of the business activities conducted by the companies and groups, as well as the risks associated with such business activities. BaFin bases the score on two factors: market impact and quality.

To analyse market impact, BaFin applies a four-tier scale to assess the effects that the problems of a company or group could have on the stability of the financial system. The impact for tier 1 is low; for tier 2, medium; for tier 3, high; for tier 4, very high. BaFin generally uses thresholds for this assessment. Depending on the segment, this may be the total of all investments or of the gross premium income written, for example.

BaFin classifies the quality of the companies and groups on a scale from A to D, with A being of high quality and D of low quality. The supervisors determine the overall score on the basis of the following categories: “net assets and financial position”, “results of operations”, “system of governance”, “future viability” and “holders of significant holdings”. For insurance groups, instead of using the category “holders of significant holdings”, BaFin uses the category “group-specific factors”.

BaFin determines the scores for the first two categories using insurance-specific indicators. The two categories “system of governance” and “holders of significant holdings” are assessed with the help of qualitative criteria, such as shortcomings in the risk management system. The “future viability” category comprises quantitative or qualitative criteria for specific classes of insurance that are suitable for assessing the company’s/the group’s prospective development. In addition, for “group-specific factors”, BaFin assesses all group-specific aspects going above and beyond the first four categories.

IT-based assessment system

For a consistent approach, BaFin uses an IT-based assessment system. The system is calibrated using long-term industry values and proposes scores based on the key indicators. In addition to these indicators, supervisors take into account various additional indicators and information for the overall score. Should supervisors consider individual aspects to be of particular importance, they may give greater weight to those aspects.

In order to understand the risk classification, it is important to consider that the scores only reflect the status as at the most recent regular assessment. In most cases, this is 30 September. If BaFin subsequently receives new information about a supervised entity or a group that significantly changes its assessment, it can carry out an ad hoc risk classification. This may also give rise to a change in the risk classification score between two reference dates.

Essential information may include the approval or discontinuance of a business line, changes in ownership structure, portfolio transfers as well as significant new findings regarding the financial situation or the system of governance in place at an entity or group.

When does BaFin inform companies of their scores?

BaFin decides when it will inform the companies and groups of their risk classification results. However, BaFin is careful to ensure that the scores are as up-to-date as possible. In the case of insurance groups, BaFin aims to report the results of the group and those of the group’s individual entities at the same time.

BaFin’s explanations of the score may be more or less comprehensive, depending on the risk situation of the company or group. At a minimum, BaFin explains the overall score and its main reasons for the result. As to the level of detail used to explain the scores for individual categories, this is left to the discretion of the competent supervisor. The focus will be on the weaknesses, i.e. the categories with a score of C or D, as well as decisive and/or particularly poor indicators with a score of C or D.

In the event that scores are good (A or B), BaFin will probably only briefly mention the key indicators. BaFin will not publicly disclose details of the calculation and weighting of the indicators or the weightings of the individual categories.