The average life insurance saver calls the secure interest on the savings portion of the life insurance premium the guaranteed interest rate, which will last be a maximum of 1.25 percent p.a. in 2015. This limit is the maximum actuarial interest rate used to calculate the actuarial reserves, above which no life insurer is currently allowed to go in new business, even if it could do so without any problems – it should remain below that, but that is rare. The Federal Government now wants to abolish this limit.
At the end of the day, after the costs of the insurer, the guaranteed interest rate of 1.25 percent today will only bring the premiums that are guaranteed back together again after 30 years – and after a loss of purchasing power, rather less. After all, the money could be safer with the life insurer than under the pillow or in a stocking. But this is not really convincing. In this sense, some people sympathetically accompany the decision of some larger life insurers to no longer offer guaranteed products. Or only under the counter upon special request and after having been informed that the insurer advises against it. In the future, life insurers may well find themselves in fierce competition for economic survival with far higher guarantees for customers who demand them.
Solvency II requires more expensive equity for existing and new business
Whichever life insurer wants to offer a higher guaranteed interest rate on new business in the future can do so – but only if it can prove that it has the necessary equity capital for this risk in accordance with Solvency II. Some insurers will then have their backs to the wall because they lack the necessary equity capital – on the one hand for old portfolios, and on the other hand for new business that involves more profitable but also riskier investments in order to be able to offer customers higher guarantees and higher overall interest rates than today. Free equity capital and higher solvency are necessary foundations for being able to offer the guarantee products in demand with the highest possible guaranteed interest rate and thus become a decisive competitive factor.
Classical life insurance – those who are declared dead live longer
Under the conditions of Solvency II, only particularly capital-strong life insurers will be able to offer traditional life and annuity insurance with a higher guaranteed interest rate in the future. They have to cover themselves with equity capital in the event that the high guaranteed interest rate is not reached in the future. And it is only with equity capital that they can risk the possible temporary losses if they invest their capital in a more risky and thus more profitable way, thus offering their customers not only a higher guaranteed interest rate but also higher surpluses. The potential demand for classic products with an attractive guaranteed interest rate is still high – but at only 1.25 percent, which is the maximum permissible rate, they remain a dead letter. By means of a higher guaranteed interest rate for each individual company, capital-strong life insurers can thus achieve a real competitive advantage in new business over those with weaker capital.
Collective Action Clauses (CAC) require new portfolios
With regard to government bonds in the European currency area, there has been a change since 2013 from bail-out at the expense of the taxpayer (FSCS, ESM) to bail-in at the expense of the creditors (haircut), in particular through the instrument of debt rescheduling clauses to restructure public finances. Under the current regulatory framework (Basel II/III, Solvency II), there is not yet any obligation with supervision to hold risk capital for this variant of (up to total) default risk.
In addition, since the political announcement of the euro, the safe capital market interest rate of government bonds has moved towards zero, globally as a result of the oversupply of investor money and their demand for supposedly safe investments. Not only alternative assets with higher risks and better yield prospects in the cover pool, but also the offer of more attractive guarantee products require a strong equity base in the competitive environment.
What to do with the old stocks that eat up equity?
Life insurers with large old portfolios would have to increase their equity considerably in order to keep up with attractive guaranteed interest offers in new business. Because of the equal treatment they can not only secure the riskier invested savings capital of new customers with a higher guaranteed interest rate with stronger equity capital in order to achieve a higher return. Because of the requirement of equal treatment, the yield must be shared with the old stock on a fraternal basis. Sufficient equity capital must therefore ultimately also be available to cover all investments, which means that it is completely useless for the bulk of the old portfolio and therefore also for new business – but expensive.
If one could get rid of the unloved siblings in a cuckoo’s way, a lot would be won. And indeed, life insurers can sell their old portfolios and thus free themselves from this burden. Even if they don’t even get a purchase price for it, but only the symbolic one-euro coin – or even a little something on top of it: with the equity capital that has been freed up, thanks to Solvency II they will then shine in the competition for new business with a guaranteed interest rate that is no longer fixed by law. It is also much less expensive to meet the necessary capital requirements only for the business remaining without the old portfolios. The classic life insurance was probably declared dead too soon.
How do life insurers survive the cut-throat competition?
It is hardly to be feared that cut-throat competition is imminent, which many life insurers will not survive. However, large life insurers with high capital requirements that can currently only be met by investing in very secure low-interest securities may well become small competitors in terms of premium income, but they will be successful in new business and will have relatively much more capital. The brokers will also benefit from attractive classic guarantee products, because they are in demand. There are enough supervisory resources available to ensure that the sale of stocks to investors does not damage the reputation of the industry. Existing customers also benefit from cost savings through pure processing platforms with efficient administration.
Ultimately, however, there is no other choice. Life insurers cannot see their point in holding high levels of equity capital just to wind up their old portfolios and let others run away from them in new business, with classic guaranteed products that are still popular and have a higher guaranteed interest rate. These may invest up to more than 30 percent of their capital investment in shares and about 20 percent in infrastructure/real estate – while the others find it difficult to wind up old portfolios with safe fixed-interest securities at still high average guaranteed interest rates.
Utilisation of old stocks as a strategic question of survival in competition
Even life insurers often show returns on equity of over 30 percent – have higher profit expectations on their business than other investors, including those from China. The capital gained from the sale of the portfolio and the equity saved can often be used more profitably elsewhere in the group – for example for investments in digitisation. It can also be returned to the shareholders, for example through share buybacks, thus increasing the return and price of the shares. The Management Board is responsible to its shareholders. Keeping the old stocks themselves may therefore be the worst solution. Thanks to the Federal Financial Supervisory Authority, customers need not suffer any damage.
Placing shareholders’ interests behind customers’ interests leads to liability of the management board
No Management Board can simply ignore the interests of the shareholders. As a board member, you can say a lot about how you stand up for customer interests – but if you put these above those of the shareholders, you have a problem. A director who loses sight of the interests of the company risks personal liability. Recently, for example, the board of a primary insurer claimed that customers still receive more surpluses than legally required – and later had to justify whether he was not putting his own shareholders at a disadvantage.
Strengthening the idea of provision
Today, the customer has to save up to more than three times this amount in guaranteed products for an equally high annuity because there is hardly any compound interest left. Many therefore say to themselves that precaution is no longer worthwhile. Due to low guaranteed interest rates, the precautionary principle is in danger overall – poverty in old age is threatening. So if there is now a means of offering attractive guaranteed products with a higher guaranteed interest rate and increased surplus expectations, a life insurer must already have a very good justification for refraining from doing so. The high capital requirements for this due to the carrying along of large old stocks are not a good reason. In the end, when you look at it in the light of day, neither the old portfolios really have anything to gain from this, nor the company – and new business or those who do not make any provisions at all pay the price.
If life insurers want to strengthen the idea of provision and reduce poverty in old age, they can achieve this by offering more attractive guaranteed interest products. This has worked in the past – so it is a way forward. A properly understood sense of responsibility should lead to this. Sticking to old stocks without any real benefit helps no one and harms masses of future pensioners who today make too little provision.
by Dr. Johannes Fiala and Dipl.-Math. Peter A. Schramm
by courtesy of
www.experten.de (published in Expert Report on 20.11.2015)
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About the author
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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