Until recently, insurance companies have escaped the scrutiny of global regulators, while banks carried the burden for the 2008 financial crisis, adapting to a torrent of reforms.
Now compliance is catching up with the insurance industry. The EU Solvency II directive is an early milestone and probably the first of many.In step with global regulatory efforts, German authorities are anxious to implement German market-specific regulations. The latest example here is LVRG (Lebensversicherungsreformgesetz) - the German life insurance reform act, which is set to have a major impact on the country’s life insurance market.
Will you be ready by the start of 2015?
Under the LVRG compliance requirements, insurers’ internal models, IT systems and processes will need to be adjusted or even recreated. Most insurers are not prepared, especially with a deadline of 1st January 2015. From Capco’s experience, the majority of insurance companies’ IT and actuarial departments are already at their limits with compliance demands.
Both, the LVRG and Solvency II have the key objective of maintaining the long-term solvency of a life insurance. Furthermore the LVRG aims to make the collective financially better off at cost of the leaving individual, to supply higher transparency of the products and to improve risk assessment of the company.
In addition to a reduction in the maximum zillmerization rate and maximum technical interest rate, the LVRG requires a higher payout ratio - 90% instead of 75% - of the risk surpluses of a life insurance. The greater payout ratio results in less capital being held by the insurance company and consequently reduced funds are available to fulfil the capital requirements of Solvency II.
Such trade-offs and the tight timeline of the LVRG increase the complexity of the regulatory challenge and can be harmful for the industry and its clients. New clients are also hit by a reduction in the maximum technical interest rate (often called guaranteed interest rate). Traditional German life insurance might become less attractive and insurers will need to counter this by launching innovative products to attract new clients. In addition, a slow response could reduce the numbers of new clients and may even lead to consolidation of the German insurance market.
That said, do we think that German insurers are fit to compete and can handle the current and future regulations on time? Yes, if they act right away. We identified 10 key action points for German life insurers in preparation for life after LVRG:
- Reduction of client participation in valuation reserves of fixed income securities / payout block
- Disclosure of the entire administrative costs to the client
- Reduction of the maximum zillmerization rate of 40 per thousand to 25 per thousand and thus reduction of the acquisition costs
- Reduction of the maximum technical interest rate from 1.75% to 1.25%
- Increase of the minimum stake in risk excess from 75% to 90%
- Long-term evaluation of the risk-bearing capacity
- Adjustment of the method for determining the interest additional reserve
- Creation of comprehensive recovery plans to ensure stability in stress scenarios
- Preparation for reinforcement of the supervisory authorities’ scope of influence
- Offsetting the negative risk result through innovative methods
However, just reacting is not enough. Life insurers need to be proactive. The long-time risk bearing ability requirements of the German legislator go beyond those of Solvency II. Forecasts would be required not only for the next business year, but also the years that follow. This would require changes and enhancements to current operating models. Additionally, a lower interest rate requires a higher percentage of premiums which are dedicated to the actuarial reserve. This will add pressure on life insurers to cut costs, further challenging their business models.
The German life insurance industry is at the beginning of the regulatory race. Those not fit enough will be an easy target for the well-prepared companies. Failing to win against better prepared competition could be the least of their worries - they might get trampled over in the process.