Financial crisis: Insurance bankruptcies despite or because of bank bailouts?

Risks from subordinated loans to banks jeopardise the level of retirement benefits


Even if the banks are rescued by the state, the life insurers may have to pay for it with their own insolvency. At the very least, however, there is a threat of a reduction in surpluses and thus a lower pension provision for privately insured persons. In the portfolios of some insurers, in addition to genuine toxic paper, there are also high-risk loans to banks, which these insurers still value as “safe fixed-interest securities”. In a “Special on the financial crisis”, the insurance information service “map-Report” points out the low proportion of American junk mortgages and shares in the financial investments of life insurers.

Bottom line:

“Concern is unfounded”. However, the risk is definitely in subordinated loans from insurers to banks, which offer a minimally higher interest rate compared to the conceivable risk of total default. Such investments are based on the belief that one can gloss over real risk and thus securely earn any return, no matter how high it may be in the end.
Such structured promissory note loans and subordinated investments were readily purchased by life insurers. These “safe fixed-interest securities” were intended, among other things, to generate the returns necessary to be able to pay a surplus participation in addition to the guaranteed interest rate.

80% loss – no balance sheet truth Now these papers are worth on the average only 20 cent per euro nominal value and partly less, which the insurers do not like to balance so and also do not have to, as long as the interest is paid and the papers can be held up to the end, in order to be redeemed then at the end also “presumably” by the banks.
Today, however, this is not even certain in the case of other bank bonds, which are also unsecured and have to be serviced on a priority basis. The insurers justify this hope-based accounting quite legally on the grounds that there is (so far) no run on their money by insurance customers and that benefits to customers – instead of being paid from the sale of securities – can also be paid from current premium income.


Besides, the banks would be saved. This would be just like a craftsman not getting the drain of the new bathtub tight and pointing out that you could fill up with fresh water at will. Whether the customers accept it in the long run that their real fresh contribution money is paid out immediately to others and they receive shares in meanwhile nearly worthless papers for it?

Suspension of payments on subordinated loans by insurers

Now it is becoming apparent that, although the banks are being rescued in general, executive salaries and dividends are being cut or suspended and – to the surprise of the insurers – the subordinated investments are also no longer being serviced with interest and repayments for the time being – and may not be redeemed at all in the end. Subordinated bonds* are risk capital provided by banks – in return for the risk that they will not pay interest and be redeemed if necessary, a slightly higher return is promised.
Other market participants, who have also provided banks with billions in equity capital, are now faced by the state with the alternative of voluntarily surrendering their shares at a fraction of the billions originally paid for them, or being expropriated by laws quickly created for this purpose. It would be very difficult to explain if insurers invested in risky subordinated bonds were the only ones to be exempted from the consequences of the risks they deliberately took.

In the case of Bayerische Landesbank, for example, Brussels has already intervened. The state aid is approved, but only on condition that the distribution of subordinated loans is prohibited.
It is therefore precisely the bailout of the banks that is leading to the subordinated loans possibly becoming not only almost unsaleable, but also almost worthless in real terms. Insurance association announces benefit cuts The insurance industry’s reaction now is not to dump incompetent financial managers and install sound risk management. Finally, to this day, as in the banks, internal auditing is still unable to provide information on the exact extent of the risks in the banks’ own investments.

On the contrary, the insurers are threatening the banks and, more or less indirectly, the state, to restrict their refinancing options if the interest and redemption payments on their subordinated loans are not serviced. In addition, the old-age provision of policyholders would be reduced, which the state is just about to convert to increased capital cover with billions in tax subsidies.


Investors will have to ask themselves whether they want to continue to expose themselves to the considerable risks associated with investments in life insurance policies. Nobody told these customers beforehand that numerous financial directors of the insurers would carry the money directly to the casino – the insurance savers could have done this themselves. According to supreme court rulings, such developments can even lead to the terminability of contracts that are contractually non-cancellable in and of themselves.
Which Riester or Rürup customer likes to watch his pension being burned – or accepts that he will only get his money back once he, as a taxpayer, has paid a multiple to save it?

Bottom line:

Even if the banks are rescued, the insurers’ subordinated loans to banks in particular are by no means safe. Yes, in the course of a bank restructuring, it is rather possible that the interest and redemption payments on subordinated loans will be cancelled. German policyholders will have to come to terms with the fact that they, too, will indirectly participate in the bank bailout with a lower pension.
*Subordinated loans / hybrid funds Hybrid funds are financing options that can be flexibly adapted to the needs of the company. In terms of their character, they are a hybrid between debt and equity, so that an optimum can always be found in the balance of interests between the desire to assume risk and the restriction of entrepreneurial management. Typical representatives of hybrid funds are: Subordinated loans, hybrid bonds, silent participations or profit participation certificates.


by Dr. Johannes Fiala


by courtesy of (published in ETF Intelligent Investing, issue 02/2009)

and (published in Computers in the Trades, issue 05.2009, pages 5-7)

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Dr. Johannes Fiala Dr. Johannes Fiala

Dr. Johannes Fiala has been working for more than 25 years as a lawyer and attorney with his own law firm in Munich. He is intensively involved in real estate, financial law, tax and insurance law. The numerous stages of his professional career enable him to provide his clients with comprehensive advice and to act as a lawyer in the event of disputes.
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