German Life Insurance Research Articles

Evaluation of German Life Insurers Based on Published Solvency and Financial Condition Reports An Alternative Model

German life insurance companies were selected for a complete survey. Quantitative data relevant to the analysis was extracted from the individual Solvency and Financial Condition Reports reports and transferred to a systematic overview. To make the collected observations usable, they were transformed into various growth, profitability, and security ratios cited in the literature, thus enhancing comparability. The data transformed into ratios were presented in histograms with ten intervals each, and a score between one and ten was assigned depending on the ratio value. In addition, four qualitative risk categories were initially identified, based on which the model would be operationalized. These were underwriting risk, market risk, credit risk and operational risk. Artificial intelligence was used to design seven questions on the requirements of Article 295 of Delegated Regulation 2015/35. Specifically, there were questions on the methodology of risk assessment, the description of specific measures, the comprehensibility of the measures, information on risk concentrations and the impact on the risk profile of the company as a whole, and risk mitigation measures and their effectiveness. Points were awarded from one to four, depending on the quality of the text used to answer the questions, based on the Appelfeller and Feldmann maturity model. This was followed by a weighting with individual factors to reflect the importance of each metric. While consumers can, for example, simply use the indexed total score for further consideration, the model equation can also be filled with fictitious values. This makes it possible to predict the risk class of a fictitious life insurer in the German market in 2022.The analyses show that it is in principle possible to extract both quantitative and qualitative assessment elements from the respective solvency reports, transform them into meaningful ratios, and finally combine them in a weighted model to generate a decision-making basis for the model user. It is precisely the dovetailing of the two strands of quantitative and qualitative analysis that makes it possible to make meaningful use of information that was previously not taken into account.

Interaction effects between dynamic hybrid products and traditional deferred annuities in the German life insurance market

Dynamic hybrid products emerged in 2007 and are now well established in the German life insurance market. In this article, we study interaction effects between dynamic hybrid products and traditional deferred annuity contracts, that are sold by the same insurance company. The key question we investigate is whether the presence of dynamic hybrid products has a negative effect on the payout of traditional insurance products. We do so by using data drawn from a Monte Carlo simulation that is based on a model presented in this article. These data reveal that dynamic hybrid products reduce the payment to policyholders of traditional deferred annuities via the channel of surplus participation.

Estimating extreme cancellation rates in life insurance

AbstractThis paper assesses the risk of a mass lapse event in life insurance. The rarity of the event and the complexity of policyholder behavior make the risk assessment of such a scenario difficult. Using a simulation study, we evaluate how different estimation methods can assess the risk of this scenario, using panel data at the company level. We then use the best‐performing method to estimate the probability distribution function of a mass cancellation event in the United States and Germany. We identify dependencies of the event on company and country characteristics, which have not been taken into account by regulating agencies. We also find that the current mass lapse scenario in Solvency II has no empirical foundation for the German market. We show that an empirically valid scenario leads to a significantly lower solvency capital requirement for the average German life insurer.

Least-Squares Monte Carlo for Proxy Modeling in Life Insurance: Neural Networks

The least-squares Monte Carlo method has proved to be a suitable approximation technique for the calculation of a life insurer’s solvency capital requirements. We suggest to enhance it by the use of a neural network based approach to construct the proxy function that models the insurer’s loss with respect to the risk factors the insurance business is exposed to. After giving a mathematical introduction to feed forward neural networks and describing the involved hyperparameters, we apply this popular form of neural networks to a slightly disguised data set from a German life insurer. Thereby, we demonstrate all practical aspects, such as the hyperparameter choice, to obtain our candidate neural networks by bruteforce, the calibration (“training”) and validation (“testing”) of the neural networks and judging their approximation performance. Compared to adaptive OLS, GLM, GAM and FGLS regression approaches, an ensemble built of the 10 best derived neural networks shows an excellent performance. Through a comparison with the results obtained by every single neural network, we point out the significance of the ensemble-based approach. Lastly, we comment on the interpretability of neural networks compared to polynomials for sensitivity analyses.

Dealing with Low Interest Rates in Life Insurance: An Analysis of Additional Reserves in the German Life Insurance Industry

Interest rates have been very low for several years, which is particularly challenging for life insurers. Since 2001, German life insurers have had to set an additional reserve due to low interest rates to ensure the protection of policyholders. However, the method introduced at that time to calculate these reserves was criticized, therefore, the German Federal Ministry of Finance replaced it with a new approach. In this article, we investigated the effects of the different methods on a typical German life insurer in various future interest rate scenarios and from various perspectives. For this purpose, we modelled such a life insurer holistically, considered its asset liability management and projected its future development in different interest rate scenarios using simulation techniques. Taking into account dependencies between assets, liabilities and interest rates, we analyzed and discussed our results from the life insurer’s, equity holders’, policyholders’ and regulators’ perspectives. The results show that the new method eliminated the weaknesses of the previous one and seems to be a suitable alternative to determine the additional reserve.

Estimating Extreme Cancellation Rates in Life Insurance

This paper assesses the risk of a mass lapse event in life insurance. The rarity of the event and the complexity of policyholder behavior, make the risk assessment of such a scenario difficult. Using a simulation study, we evaluate how different estimation methods can assess the scenario when using panel data at the company level. We then use the best performing method to estimate the probability distribution function of a mass cancellation event in the U.S. and Germany. We identify dependencies of the event on company and country characteristics, which so far are not taken into account by regulating agencies. We also find that the current mass lapse scenario in Solvency II has no empirical foundation for the German market. We show that an empirically valid scenario leads to a significantly lower solvency capital requirement for the average German life insurer.

The impact of hedging on life insurance companies

This paper examines the effects of hedging in the asymmetric profit and loss distribution mechanisms caused by the complex regulatory framework of the German life insurance business. It studies the effects of applying a hedging strategy to the equity positions in the firm’s asset portfolio from two perspectives: the shareholder perspective and the perspective of the insured. It also addresses the possible trade-off between these interests of the two. The analysis is conducted through a stochastic simulation with 10,000 capital market scenarios. The used asset-liability-management-software is widely used in the insurance sector. This approach allows for a realistic representation of a model company with its performance and management key figures in accordance with the German GAAP. In addition, it creates the possibility of a detailed analysis of the tails of result distributions, which are of particular interest when assessing the effects of hedging.

Interest Rate Risk of Life Insurers: Evidence from Accounting Data

Life insurers are exposed to interest rate risk, and their liability side is typically more sensitive to interest rate changes than their asset side. This paper develops an accounting-based measure of interest rate sensitivity. My approach uses the coexistence of historical cost and market value accounting, which permits the observation of valuations for different discount rates. Using microdata, I show that German life insurers have a significant exposure to interest rate risk. However, there is a wide dispersion across the sector. I find that insurers' size, growth and solvency are negatively correlated with interest rate risk. The heterogeneity suggests that insurers would behave differently during times of stress, which has important implications for understanding the macroprudential risks to which the sector is exposed.

Return on Risk-Adjusted Capital Under Solvency II: Implications for the Asset Management of Insurance Companies

We derive a European life insurer’s return on risk-adjusted capital (RORAC) under the Solvency II capital requirements. To do so, we draw on historical time series data and construct a large number of asset allocations, taking into account current portfolio shares of the German life insurance industry. Subsequently, we determine expected profits and market risk capital charges by means of the standard formula. Our results indicate that the RORAC is mainly driven by the capital requirements, while the expected profits are almost irrelevant. Moreover, we show that less-diversified portfolios with high asset risk need to be backed by low capital buffers and therefore result in high RORAC values. Well-diversified portfolios with balanced risk–return profiles, on the other hand, involve higher capital charges and thus achieve low RORAC figures. Hence, under Solvency II, a RORAC-based performance measurement may have detrimental effects for a life insurer’s stakeholders.

Applications of the central limit theorem for pricing Cliquet-style options

Cliquet-style options in different variants are basic building blocks in select products which are offered by German life insurance companies. We present both an analytical pricing approximation via the central limit theorem and a corresponding control variate Monte Carlo approach for their valuation. The control variate approach turns out to be a good alternative to the integral representation of Bernard and Li (SIAM J Financ Math, 4:353–371, 2013). Further, it can be modified to increase the efficiency of pricing cliquet-style options in the Heston price setting.

Interest Rate Risk of Life Insurers: Evidence from Accounting Data

Life insurers are exposed to interest rate risk, and their liability side is typically more sensitive to interest rate changes than their asset side. This paper develops an accounting-based measure of interest rate sensitivity. My approach uses the coexistence of historical cost and market value accounting, which permits the observation of valuations for different discount rates. Using microdata, I show that German life insurers have a significant exposure to interest rate risk. However, there is a wide dispersion across the sector. I find that insurers' size, growth and solvency are negatively correlated with interest rate risk. The heterogeneity suggests that insurers would behave differently during times of stress, which has important implications for understanding the macroprudential risks to which the sector is exposed.

Local and Terminal Volatility of Equity in a Hybrid Model with Hull White Interest Rates

We consider a hybrid model for stocks and interest rates as it is proposed by GDV (Gesamtverband der Deutschen Versicherungswirtschaft) to assign market consistent values to the technical provisions of german life insurance companies. In this model, stock prices are modeled with a Black Scholes model with time-varying parameters, and interest rates are modeled with a Hull White short rate model.We find that local and terminal volatility of equity differ in this model and that the terminal volatility of equity is considerable higher than the local volatility. This raises the question, which of both volatilities is the right reference to calibrate the model. We argue that calibration should be done with respect to local volatility rather than terminal volatility, at least for the application we have in mind.

Liquidity and Interest Rate Risk of Life Insurers: Sources and Mitigation

U.S. and German life insurers offer similar products, except for different penalties to withdraw funds. We identify market value reductions (MVR), which are common in the U.S. and prevented by law in Germany, as a main instrument to manage liquidity risk in the industry. It turns out that German life insurers may ultimately be at risk of experiencing a policyholder run if interest rates hike strongly. Based on a unique set of regulatory panel data from 2005 to 2014, we show that this risk has increased over the course of the financial and sovereign debt crisis.

Participating life insurance contracts under Solvency II: inheritance effects and allowance for a Going Concern Reserve

Some details of the Solvency II framework are still under discussion. A crucial aspect in the debate is the appropriate reflection of surplus participation mechanisms that apply to traditional participating life insurance contracts. In particular, the inheritance of profits between existing business and new business resulting from the surplus participation process has to be incorporated in the Solvency II valuation framework which requires a run off valuation of the existing portfolio under going concern assumptions. This paper analyzes the inheritance effects caused by the pre-financing of acquisition cost of new business via cost surplus of existing business which is inherent in traditional German life insurance. We show that in the context of Solvency II an allowance for the inherited funds—denoted as Going Concern Reserve (GCR)—is justified and in line with the Solvency II valuation principles. Based on a stochastic balance sheet and cash flow projection model, we present a methodology to quantify the GCR and provide a profound analysis of the GCR and its components. Our results show that the GCR has significant impact on the overall solvency situation of life insurance companies offering participating contracts.

Enhanced Annuities: Drivers of and Barriers to Supply and Demand

Enhanced annuities pay higher pensions than standard annuities in case of a reduced life expectancy and are very prominent in the U.K. insurance market but not in other markets. The aim of this paper is to study drivers of and barriers to supply and demand of enhanced annuities as well as potential market implications of their introduction, including implications for the standard immediate and deferred annuity markets, annuitisation rates and the so-called cannibalisation effect, which may arise within the portfolio of standard annuities because of the enhanced annuity offering. The analysis is based on a comprehensive literature review and an empirical survey in the German life insurance market, which is also intended to offer insight for other industrialised countries with a similar situation in regard to the demographic development and an increasing need for private pensions.

Auswirkungen der anhaltenden Niedrigzinsen auf das Versicherungswesen

Abstract Helmut Gründl discusses in his paper the effects of the present low interest rate environment on the German life insurance industry. By referring to a recent study of the “International Center for Insurance Regulation”, he assesses insolvency probabilities for life insurers with different capital endowments under different interest rate scenarios. Based on that, he discusses measures of insurance regulation that try to cope with the imminent problems of the life insurance industry. Finally, he has a look at product developments and investment strategies of life insurers in the presence of low interest rates. Hereby, he argues, that life insurance products with lower investment guarantees that are granted for a shorter period of time are regarded as the best remedy to avoid low interest rate problems in the future. Such product development also allows for a more risky investment policy of life insurers that can make life and annuity products more attractive. Rolf Ketzler und Peter Schwark explicate that the very accommodative monetary policy of the ECB and the related extremely low interest rates are involved with major challenges for the German insurance sector, in particular for life insurers. As long-term investors, insurers are not only affected in their capital investment strategy, but also by different households’ retirement saving patterns in response to the low interest rate environment. Several significant steps have already been taken in order to ensure the long-term viability of life insurance. These include changes in the product portfolio as well as new approaches in the investment strategy. In addition, new regulatory requirements have been established to strengthen the risk bearing capacity of life insurers. Given the substantial risks of low interest rates, from an economic point of view the question concerning an appropriate exit from the low interest rate environment needs more attention in the public debate. They argue that in this context, further progress regarding the economic reform policies in the euro zone is still necessary as a condition for the ECB to normalize its monetary policy as soon as possible. Focusing the perspective of German life insurance industry, the article of Heinrich Schradin starts with a brief description and discussion of the financial impact of the persistently low interest rate environment. Based on an empirical data set of German life insurers, the author illustrates actual limitations to generate sufficient investment income for to meet the given specific financial guarantees. Moreover, the core problem, caused by the use of volatile timing-related interest rates for to evaluate long-term cash flows, becomes obvious. The currently observed regulatory interventions are trying to overcome the existential consequences of the so-called fair value measurement. In consequence, the author derives four central theses: 1. Life insurance in Germany suffers from insufficient capital adequacy. 2. Persistent low interest rates threaten the fulfillment of financial guaranty commitments of German life insurers. 3. The generally accepted principals of economic evaluation do not satisfy to the traditional business model of German life insurers. 4. Under a business perspective, the development of new life insurance products is inevitable.

Auswirkungen der anhaltenden Niedrigzinsen auf das Versicherungswesen

Abstract This paper discusses the effects of the present low interest rate environment on the German life insurance industry. By referring to a recent study of the “International Center for Insurance Regulation”, we assess insolvency probabilities for life insurers with different capital endowments under different interest rate scenarios. Based on that, we discuss measures of insurance regulation that try to cope with the imminent problems of the life insurance industry. Finally, we have a look at product developments and investment strategies of life insurers in the presence of low interest rates. Hereby, life insurance products with lower investment guarantees that are granted for a shorter period of time are regarded as the best remedy to avoid low interest rate problems in the future. Such product development also allows for a more risky investment policy of life insurers that can make life and annuity products more attractive.

Auswirkungen der anhaltenden Niedrigzinsen auf das Versicherungswesen

Abstract Focusing the perspective of German life insurance industry, this article starts with a brief description and discussion of the financial impact of the persistently low interest rate environment. Based on an empirical data set of German life insurers, the author illustrates actual limitations to generate sufficient investment income for to meet the given specific financial guarantees. Moreover, the core problem, caused by the use of volatile timingrelated interest rates for to evaluate long-term cash flows, becomes obvious. The currently observed regulatory interventions are trying to overcome the existential consequences of the so-called fair value measurement. In consequence, the author derives four central theses: 1. Life insurance in Germany suffers from insufficient capital adequacy. 2. Persistent low interest rates threaten the fulfillment of financial guaranty commitments of German life insurers. 3. The generally accepted principals of economic evaluation do not satisfy to the traditional business model of German life insurers. 4. Under a business perspective, the development of new life insurance products is inevitable.

Enhanced Annuities: Drivers and Barriers of Supply and Demand

Enhanced annuities pay higher pensions than standard annuities in case of a reduced life expectancy and are very prominent in the U.K. insurance market but not in other markets. The aim of thispaperistostudydriversofandbarrierstosupplyanddemandofenhancedannuitiesaswellas potential market implications of their introduction, including implications for the standard immediate and deferred annuity markets, annuitisation rates and the so-called cannibalisation effect, which may arise within the portfolio of standard annuities because of the enhanced annuity offering. The analysis is based on a comprehensive literature review and an empirical survey in the German life insurance market, which is also intended to offer insight for other industrialised countries with a similar situation in regard to the demographic development and an increasing need for private pensions.

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 this, we generate a stochastic term structure of interest rates as well as stock market returns to simulate investment returns of a stylised life insurance business portfolio in a multi-period setting. On the basis of 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 capitalised 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 payouts to policyholders.