For many people in Germany, endowment and annuity insurance policies are an essential part of their retirement provision. The dominant life insurance products are those that offer a guaranteed interest rate and thus provide for a predetermined minimum amount of the maturity benefit or the permanent annuity. Predetermined benefits are not only guaranteed by life insurance undertakings but also by institutions for occupational retirement provision (IORPs), i.e. Pensionskassen and Pensionsfonds. The guaranteed interest rate, however, should not be confused with the maximum technical interest rate (see info box “Guaranteed interest rate versus maximum technical interest rate”).
Definition:Guaranteed interest rate versus maximum technical interest rate
The public often treat the two terms as meaning the same, which is a mistake. Life insurance providers use guaranteed interest rates for the calculation of premiums and the benefits of their endowment and annuity products. In order for them to be able to meet their benefit obligations at all times, they must establish a sufficiently high premium reserve. This must be calculated based on an interest rate that is no higher than the statutory maximum technical interest rate applicable at the time the contract was concluded. Although this does not apply to regulated Pensionskassen, these too must calculate their premium reserve in such a way that their obligations are met at all times.
It is permissible – and may be necessary during periods of extremely low capital market interest rates – to establish a guaranteed interest rate that is below the maximum technical interest rate, which is determined by the Federal Ministry of Finance (BMF). Currently, this is 0.9%.
In the past, providers often based their calculations of premiums and benefits on the exact amount of the maximum technical interest rate. This was mainly due to competition for customers and market shares. However, in the current low interest rate environment, risk-free market interest rates are partially significantly lower than the current maximum technical interest rate of 0.9%. In BaFin’s view, it is therefore quite doubtful that all providers will be able, with sufficient certainty and in the long term, to generate returns for their new investments and reinvestments that are above the current maximum technical interest rate. This is particularly true where the main focus of the new business is on long-term savings products.
Appropriate risk management requires that providers pay close attention to the level of the guaranteed interest rate that they can afford for new business in terms of their risk-bearing capacity and earnings power. However, BaFin’s current prognostic survey shows that more than a quarter of all life insurers whose new business includes long-term savings products still calculate their benefits based on an average guaranteed interest rate equal to the maximum technical interest rate. A further quarter of undertakings apply interest rates that are only slightly lower. The situation is similar for IORPs. A significant number of Pensionskassen even use a guaranteed interest rate for new business that is above the maximum technical interest rate.
Therefore, BaFin cannot consider at this stage that all providers are aware of the problems their promised interest rates can create. Since they are able to exert influence on the management board, the staff of the actuarial function and the appointed actuary play a particularly important role in this context.
One of the tasks of the actuarial function is to adopt a position with regard to the provider’s underwriting policy. It must address the management board regarding issues such as the adequacy of premiums for new business and whether the premiums are sufficient to meet the guarantees included in the insurance contracts.
With regard to long-term savings products with guaranteed interest rates, BaFin therefore expects the actuarial function to analyse whether the expected returns from the undertaking’s new investments and reinvestments can, with sufficient certainty, generate the guaranteed interest rates promised for new business in the long term. In its analysis, it must take into account the individual situation of the undertaking, such as the investment strategy. The specific design of the products is also important. A general indication that the guaranteed interest rate is not higher than the currently applicable maximum technical interest rate is therefore in no way adequate.
In order to be able to assess the adequacy of premiums, the actuarial function must analyse the profitability and risks of the products offered. This includes the question of how the undertaking’s own funds and the solvency capital requirement are expected to develop if new business is written based on the guaranteed interest rate envisaged. The actuarial function should therefore be able to understand how the guaranteed interest rate affects the coverage ratio of the solvency capital requirement.
The appointed actuary plays an important role too. He or she is obliged to safeguard the rights and interests of the policyholders. The appointed actuary should help ensure that the obligations under the insurance contracts can be met at all times and therefore has an important consumer protection role in the undertaking.
The tasks of the appointed actuary are primarily based on commercial law. Under section 141 of the German Insurance Supervision Act (Versicherungsaufsichtsgesetz – VAG), the appointed actuary must ensure that the calculation of the premium reserve is in line with the principles of the German Commercial Code. In addition, he or she must ensure that the premiums are sufficient for the undertaking to be able to meet its obligations and to establish adequate premium reserves.
When assessing the guaranteed interest rate for new business, the appointed actuary and the actuarial function should take into account the expected future returns from new investments and reinvestments, instead of merely referring to the applicable maximum technical interest rate. BaFin expects the appointed actuary to incorporate the results of the assessment in the report to the board of management (explanatory report).
Since the tasks of the actuarial function and the appointed actuary overlap, an intensive exchange of information is important. Instead of duplicating work, synergies should be exploited. For example, each function should be able to use the other’s analyses.
Only with a high degree of responsible and forward-looking activities can both functions ensure that providers establish an appropriate guaranteed interest rate for new business that is sufficiently secure in the long term. Endowment and annuity products have long maturities, often stretching into several decades. This gives rise to substantial uncertainties, which the actuarial function and the appointed actuary must take into account. The current interest rate environment clearly shows the extent to which framework conditions can change during such long contractual terms and how high interest rates promised in the past can burden undertakings. The actuarial function and the appointed actuary should draw the right lessons from this for the future and critically question the practices of the past.
The tasks of the actuarial function and the appointed actuary are closely interrelated. An intensive exchange of information is therefore a prerequisite for effective action. Together, they ensure that life insurers and the IORPs agree on guaranteed interest rates which they can meet at all times over the entire duration of the policies, irrespective of the applicable maximum technical interest rate.
Dr Guido Werner
BaFin Division for Basic Issues relating to Life Insurance
This article reflects the situation at the time of publication and will not be updated subsequently. Please take note of the Standard Terms and Conditions of Use.