German Life Insurance Research Articles

Lethal Lapses: How a Positive Interest Rate Shock Might Stress German Life Insurers

Life insurers typically grant policyholders a surrender option. We demonstrate that the resulting lapse risk could materialise in the form of a \policyholder run if interest rates were to increase sharply. An inverse stress test based on a unique set of regulatory panel data suggests that German life insurers have become less resistant to an upward interest rate shock in the course of the nancial and sovereign debt crisis from 2007 to 2011. Despite the challenges presented by the low-interestrate environment, the situation has not deteriorated since then. In light of the quantitative easing (QE) of monetary policy in the euro area, life insurers may nd it dicult to continue this positive trend.

Portfolio Optimization With Illiquid Life Insurance Investments

Endowment life insurance products contain a collective component resulting in smoothed returns. By unsmoothing the data of German life insurers we are able to extract the risk/return pattern of the underlying financial assets. Thus, we can analyze mean-variance optimal portfolios including a smoothed with-profit contract compared to an unsmoothed unit-linked contract. We find that life insurance is attractive for conservative investors and cannot be easily replicated. Furthermore the investor cannot regain his expected utility when being allocated to an undesirable amount of the illiquid with-profit contract -- neither through reallocation of his liquid investments nor through collateral lending. Overall, the with-profit contract shows similar characteristics than other illiquid assets. The main difference is that the regulation by law allows the investor to participate in the smoothed returns -- contrarily to all other financial market products where the investor shall participate in his holding period returns.

The pricing of hedging longevity risk with the help of annuity securitizations

Purpose– The purpose of this paper is to develop a model to hedge annuity portfolios against increases in life expectancy. Across the globe, and in the industrial nations in particular, people have seen an unprecedented increase in their life expectancy over the past decades. The benefits of this apply to the individual, but the dangers apply to annuity providers. Insurance companies often possess no effective tools to address the longevity risk inherent in their annuity portfolio. Securitization can serve as a substitute for classic reinsurance, as it also transfers risk to third parties.Design/methodology/approach– This paper extends on methods insurer's can use to hedge their annuity portfolio against longevity risk with the help of annuity securitization. Future mortality rates with the Lee-Carter-model and use the Wang-transformation to incorporate insurance risk are forecasted. Based on the percentile tranching method, where individual tranches are aligned to Standard & Poor's ratings, we price an inverse survivor bond. This bond offers fix coupon payments to investors, while the principal payments are at risk and depend on the survival rate within the underlying portfolio.Findings– The contribution to the academic literature is threefold. On the theoretical side, building on the work of Kim and Choi (2011), we adapt their pricing model to the current market situation. Putting the principal at risk instead of the coupon payments, the insurer is supplied with sufficient capital to cover additional costs due to longevity. On the empirical side, the method for the German market is specified. Inserting specific country data into the model, price sensitivities of the presented securitization model are analyzed. Finally, in a case study, the procedure to the annuity portfolio of a large German life insurer is applied and the price of hedging longevity risk is calculated.Practical implications– To illustrate the implication of this bond structure, several sensitivity tests were conducted before applying the pricing model to the retail sample annuity portfolio from a leading German life insurer. The securitization structure was applied to calculate the securitization prices for a sample portfolio from a large life insurance company.Social implications– The findings contribute to the current discussion about how insurers can face longevity risk within their annuity portfolios. The fact that the rating structure has such a severe impact on the overall hedging costs for the insurer implies that companies that are willing to undergo an annuity securitization should consider their deal structure very carefully. In addition, we have pointed out that in imperfect markets, the retention of the equity tranche by the originator might be advantageous. Nevertheless, one has to bear in mind that by this behavior, the insurer is able to reduce the overall default risk in his balance sheet by securitizing a life insurance portfolio; however, the fraction of first loss pieces from defaults increases more than proportionally. The insurer has to take care to not be left with large, unwanted remaining risk positions in his books.Originality/value– In this paper, we extend on methods insurer's can use to hedge their annuity portfolio against longevity risk with the help of annuity securitization. To do so, we take the perspective of the issuing insurance company and calculate the costs of hedging in a four-step process. On the theoretical side, building on the work of Kim and Choi (2011), we adapt their pricing model to the current market situation. On the empirical side, we specify the method for the German market. Inserting specific country data into the model, price sensitivities of the presented securitization model are analyzed.

Sales Efficiency in Life Insurance: The Drivers for Growth in the German Market

German life insurers are facing consolidation tendencies as the major players increase their market share. As a result, insurance companies are being forced to grow to ensure future prosperity. In the past, the industry has shown that growth can be achieved while maintaining profitability. The central question of our research is to detect factors for the generation of new business. In order to determine what drives sales—and thus growth—in the German life insurance industry, we apply different multi-linear regression models. We use panel data from 1998 to 2011 with characteristics of German life insurers and mostly full market coverage. In our modelling, we distinguish between sales success on the business unit level of life insurance and on the level of specific life products. The sales success drivers for pension insurance as well as term life insurance are analysed. By doing so, we determine different significant drivers for sales success, which include the total return granted to policyholders, commissions paid to sales partners, the solvency of the insurer, company (financial) rating and firm size.

Stock investments for German life insurers in the current low interest environment: more homework to do

Currently a stock market rally and at the same time extremely low interest rates can be observed. This coincides with more volatile risk premiums for interest baring assets like government bonds. The mixture makes life harder for investment managers of (especially life) insurances. They have to continuously find profitable investments with good returns for the customers’ money, in case of the life insurers, in order to be able to pay at least the promised returns of the contracts. After the stock market burst around the turn of the century the levels of stock investments by German insurers have declined significantly, therefore also missing out on the rises leading up to the Lehman crash and also not participating in recent developments. With insurance asset managers avoiding stocks in the past years the questions can be raised, if they are forfeiting a good opportunity for their portfolio and if there is still time to participate in possible future gains. On the other hand the upcoming regulatory environment, namely Solvency II, will play an important role in the future and likely already has an impact on the investment decisions of the companies. Higher capital requirements for stock investments make it even harder to earn the so-called “Garantiezins”. Without ignoring the risks related to stock investments, effectively banning equities from asset managers’ buy lists might lead to missing out on desperately needed returns for the life insurance industry. So policy makers probably should reconsider their directives. This paper evaluates the attractiveness of stock investments from a long term as well as a risk adjusted perspective using e.g. different indicators and commonly used measurements for stocks with a rather conservative focus, in order to possibly get some insight into the future performance of stocks. Looking back to a decade of boom and bust cycles in the equity markets does not necessary rule out stocks as an important source for returns. The results are discussed comprehensively also in face of the regulatory changes to come. In the end timing plays a major role and due to that the current valuation of stocks as well as the look ahead are of vital importance. Assessing the reliability of professional forecasts for financial market time series—in this context especially for stocks as well as interest rates—plays an important role for asset managers.

Are interest rates too low? Empirical evidence and implications for German life insurers

The current financial crisis has reduced government bond yields in Germany, the U.S., the UK and other countries. Low interest rates do create some problems for the European insurance industry. Especially life insurers seem to face some difficulties. The empirical results reported in this paper give support to the point of view that the relationship among German long-term interest rates, consumer price inflation and industrial production has changed significantly in the year 2009. Turning to the important question under which circumstances an increase to interest rates is likely to occur the empirical evidence reported in this paper does indicate that higher inflation rates should be a cause for rising bond yields.

The Effects of a Low Interest Rate Environment on Life Insurers

Low interest rates are becoming a threat to the stability of the life insurance industry, especially in countries such as Germany, where products with relatively high guaranteed returns sold in the past still represent a prominent share of the total portfolio. This contribution aims to assess and quantify the effects of the current low interest rate phase on the balance sheet of a representative German life insurer, given the current asset allocation and the outstanding liabilities. To do so, we generate a stochastic term structure of interest rates as well as stock market returns to simulate investment returns of a stylized life insurance business portfolio in a multi-period setting. Based on empirically calibrated parameters, we can observe the evolution of the life insurers' balance sheet over time with a special focus on their solvency situation. To account for different scenarios and in order to check the robustness of our findings, we calibrate different capital market settings and different initial situations of capital endowment. Our results suggest that a prolonged period of low interest rates would markedly affect the solvency situation of life insurers, leading to a relatively high cumulative probability of default, especially for less capitalized companies. In addition, the new reform of the German life insurance regulation has a beneficial effect on the cumulative probability of default, as a direct consequence of the reduction of the payouts to policyholders.

The Effects of a Low Interest Rate Environment on Life Insurers

Low interest rates are becoming a threat to the stability of the life insurance industry, especially in countries such as Germany, where products with relatively high guaranteed returns sold in the past still represent a prominent share of the total portfolio. This contribution aims to assess and quantify the effects of the current low interest rate phase on the balance sheet of a representative German life insurer, given the current asset allocation and the outstanding liabilities. To do so, we generate a stochastic term structure of interest rates as well as stock market returns to simulate investment returns of a stylized life insurance business portfolio in a multi-period setting. Based on empirically calibrated parameters, we can observe the evolution of the life insurers' balance sheet over time with a special focus on their solvency situation. To account for different scenarios and in order to check the robustness of our findings, we calibrate different capital market settings and different initial situations of capital endowment. Our results suggest that a prolonged period of low interest rates would markedly affect the solvency situation of life insurers, leading to a relatively high cumulative probability of default, especially for less capitalized companies. In addition, the new reform of the German life insurance regulation has a beneficial effect on the cumulative probability of default, as a direct consequence of the reduction of the payouts to policyholders.

How is the Low-Interest-Rate Environment Affecting the Solvency of German Life Insurers?

Die Lebensversicherer sind von den Auswirkungen des Niedrigzinsumfelds unmittelbar betroffen. Damit sie die zugesicherten Garantien erfullen konnen, mussen sie unter Umstanden Eigenmittel aufwenden. Dies ist dann der Fall, wenn die von den Unternehmen festgelegte Uberschussbeteiligung oder sogar die garantierten Leistungen nicht mehr aus den laufenden Ertragen erwirtschaftet werden konnen. Dadurch kann ihre Solvabilitat gefahrdet sein. Mit Hilfe einer Szenarioanalyse wird untersucht, zu welchem Zeitpunkt die deutschen Lebensversicherer aufgrund des Niedrigzinsumfelds die derzeit gultigen Eigenmittelanforderungen nach Solvency I nicht mehr erfullen konnen. Im Gegensatz zur ubrigen Literatur in diesem Bereich kann fur die Analyse auf regulatorische Einzeldaten von 85 deutschen Lebensversicherern zuruckgegriffen werden. Die Untersuchung zeigt, dass bereits in einem milden Stressszenario zwolf Lebensversicherer mit einen Marktanteil von rund 14% bis zum Jahr 2023 die Eigenmittelanforderungen nicht mehr erfullen konnten. Unter verscharften Stressbedingungen, insbesondere wenn auch die Renditen auf andere Anlagenverstarkt unter Druck gerieten, wurden 32 Unternehmen die Eigenmittelanforderungen nach Solvency I nicht mehr erfullen. Dies weist auf ein Gefahrdungspotenzial fur die Solvabilitat der Lebensversicherungsbranche hin.

PARTICIPATING PAYOUT LIFE ANNUITIES: LESSONS FROM GERMANY

AbstractThis paper analyzes the framework of German participating payout life annuities (PLAs), which offer guaranteed minimum benefits as well as participation in insurers' surpluses. We show that the process of sharing surpluses between shareholders and policyholders follows transparent and consistent rules. Subsequently, we develop an asset-liability model for a stylized German life insurer that offers PLAs to evaluate benefit variability and insurer stability given stochastic mortality and capital market developments. Our results suggest that guaranteed benefits can be provided with high credibility via PLAs, while, at the same time, annuitants receive attractive money's worth ratios. Moreover, we show that it might be difficult to offer a fixed benefit annuity providing the same lifetime utility as a PLA for the same premium and a comparably low insolvency risk. Overall, PLA schemes may be an efficient way to deal with risk factors that are highly unpredictable and difficult to hedge over the long run, such as systematic longevity and investment risks.

What Policy Features Determine Life Insurance Lapse? An Analysis of the German Market

AbstractWith the largest data set ever used for this purpose (covering more than 1 million contracts), we analyze the impact of product and policyholder characteristics on lapse in the life insurance market. The data are provided by a German life insurer and cover two periods of market turmoil that we incorporate into our proportional hazards and generalized linear models. The results show that product characteristics such as product type or contract age and policyholder characteristics such as age or gender are important drivers for lapse rates. Our findings improve the understanding of lapse drivers and might be used by insurance managers and regulators for value‐ and risk‐based management.

Gauging the Impact of a Low Interest Rate Environment on German Life Insurers

A low interest rate environment can pose a key risk to the life insurance sector. A deteriorating return on investment holdings jeopardizes the guaranteed return on life insurance contracts. In this paper, we examine the effect of low interest rates on German life insurers by applying various adverse scenarios to a simple model of life insurers' balance sheets. A low return on investment can lead to a depletion of the bonus and rebate provisions (BRPs). As a result, life insurers' resilience may deteriorate. By way of this analysis, we can model approximately when the bonus and rebate provisions will be depleted. JEL Classification: G14, G21, G28

Participating Payout Life Annuities: Lessons from Germany

This paper analyzes the regulatory framework of German immediate participating payout life annuities (PLAs), which offer guaranteed minimum benefits as well as participation in insurers’ surpluses. Our particular focus lies on the mechanics of sharing surpluses between shareholders and policyholders. We show that the process of surplus determination, allocation, and distribution mostly follows transparent and clear rules, and that an insurance company’s management has limited leeway with respect to discretionary decision making. Subsequently, we develop an Asset Liability Model for a German life insurer that offers PLAs. Based on this model, we run Monte Carlo simulations to evaluate benefit variability and insurer stability under stochastic mortality and capital market developments. Our results suggest that through PLAs guaranteed benefits can be provided with high credibility, while, at the same time, annuitants receive attractive Money’s Worth Ratios. Moreover, we show that it might be difficult to offer a fixed benefit annuity providing the same lifetime utility as a PLA for the same premium and a comparably low insolvency risk. Overall, participating life annuity schemes may be an efficient way to deal with risk factors that are highly unpredictable and difficult to hedge over the long run, such as systematic mortality and investment risks.

Main Determinants of Lapse in the German Life Insurance Industry

This paper studies the determinants of lapse in the German life insurance industry. Logistic regression models are employed using data on macroeconomic indicators and company characteristics of 133 German life insurers from 1997 to 2009. Five different product categories are considered (endowment, annuity, term life, group, and other). The findings indicate that the main lapse determinants are very similar across all product categories, except that the direction of impact is reversed for the product category “other”, which consists almost exclusively of unit-linked business. In particular, the interest rate and emergency fund hypotheses are supported only for unit-linked business, while these hypotheses do not hold for the remaining product categories. Overall, the analysis provides an understanding of lapse dynamics related to economic indicators and company characteristics. The derived models can be used to predict lapse rates for the different product categories considered. The results are important for insurance company managers, regulators, and life insurance customers.

Technical Note on Profit Sharing and Market-Consistent Embedded Value in German Life Insurance

This technical note highlights the functioning of the profit sharing mechanism of life insurance products using the example of classical German life contracts. The profit sharing and guarantee features of these contracts are potentially very costly from a capital requirements perspective, making an understanding of the technical payout profile and reporting properties vital for a proper discussion of the Solvency II impact on product design.

Does Surplus Participation Reflect Market Discipline? An Analysis of the German Life Insurance Market

The aim of this paper is to analyze whether the level of surplus participation affects customer demand. We use multivariate linear regression models and data on surplus participation, new business, and lapse for the German life insurance market from 1998 to 2008. We find a significant positive dependence between surplus participation and new business growth as well as a significant negative dependence between surplus participation and growth of lapse volume. Overall, these findings indicate that customers do react to changes in product characteristics, which might be seen as indicative of market discipline. Our results are important for insurance company managers, regulators, and boards of insurance associations.

Discontinued German life insurance portfolios: rules‐in‐use, interest rate risk, and Solvency II

PurposeThis paper seeks to provide an overview on potential impacts German primary life insurers are exposed to in relation to upcoming Solvency II regulation and potential strategic choices, especially in the light of halting low‐interest rates. Given a large degree of complexity, the paper aims at giving some guidance to decision makers considering a discontinuation of underwriting.Design/methodology/approachThe paper builds upon current observations made in the German primary life insurance industry, especially, recent strategic decisions of two market participants to discontinue their life insurance carriers. On the background of low‐interest rates but yet guaranteed interest participations and additional capital requirements arising from Solvency II, the paper illustrates the strategic options life insurers have in the German market, given the specific market environment.FindingsRegulatory capital requirements of Solvency II will sanction guarantee products in a way that for some insurers life products will become unattractive. As there is evidence in the market that some participants have started to consider the run‐off option for selected carriers, the paper finds that this option may represent an appropriate consequence not only for foreign insurers ceasing their business in Germany but also for domestic insurance groups. Given the specific rules‐in‐use in the German primary life insurance market, the paper discusses the controlled run‐off approach as a strategic option for selected life insurers, enabling a harvesting strategy through maximizing cash flows from existing liabilities while avoiding further investments.Originality/valueDiscussions in this paper help to bring into focus the strong challenges by both the upcoming regulatory Solvency II and current market conditions. The brief case study included in this paper may illustrate the implications as well as some crucial success factors of discontinued life business.

Gauging the Impact of a Low-Interest Rate Environment on German Life Insurers

A low interest rate environment can pose a key risk to the life insurance sector. A deteriorating return on investment holdings jeopardizes the guaranteed return on life insurance contracts. In this paper, we examine the effect of low interest rates on German life insurers by applying various adverse scenarios to a simple model of life insurers’ balance sheets. A low return on investment can lead to a depletion of the bonus and rebate provisions. As a result, life insurers resilience may deteriorate. By way of this analysis, we can model approximately when the bonus and rebate provisions will be depleted.

Gauging the Impact of a Low-Interest Rate Environment on German Life Insurers

A low interest rate environment can pose a key risk to the life insurance sector. A deteriorating return on investment holdings jeopardizes the guaranteed return on life insurance contracts. In this paper, we examine the effect of low interest rates on German life insurers by applying various adverse scenarios to a simple model of life insurers' balance sheets. A low return on investment can lead to a depletion of the bonus and rebate provisions. As a result, life insurers resilience may deteriorate. By way of this analysis, we can model approximately when the bonus and rebate provisions will be depleted.

Comparing Single- and Multichannel Distribution Strategies in the German Life Insurance Market: An Analysis of Cost and Profit Efficiency

To explain the success of different distribution strategies in the life insurance industry, we analyze the performance of single- and multi-channel distribution firms in the German life insurance industry. We estimate cost and profit efficiency for three groups of life insurers: multi-channel insurers, direct insurers, and independent agent insurers. We use non-parametric Data Envelopment Analysis to calculate efficiencies for German life insurers for the years 1997-2005. We identify the absence of performance advantages of specialized insurers as the most important reason for the coexistence of different distribution systems.