Customers must have confidence that insurers are able to honour contractually agreed payments at all times and over a very long period of time. In supervising and monitoring insurance undertakings, BaFin helps insurers to justify the confidence that customers place in them.
Insurance Supervision in Germany
Insurance supervision is based on the Insurance Supervision Act (Versicherungsaufsichtsgesetz - VAG). In Germany, the Federal Government and the Federal States have combined responsibility for insurance supervision.
Functions and objectives of insurance supervision
Insurance is based on trust: customers expect insurers to be able to honour contractually agreed payments at all times and often over a very long period of time. In its supervision of insurance undertakings, BaFin therefore performs important social and economic functions and contributes to the long-term stability of the financial sector as a whole. The legal basis for insurance supervision is the Insurance Supervision Act (Versicherungsaufsichtsgesetz - VAG). Pursuant to section 294 of the Act, the primary objective of insurance supervision is the protection of policyholders and beneficiaries. To this end, BaFin ensures that:
• the interests of the insured are adequately safeguarded;
• the obligations under insurance contracts can be fulfilled at all times;
• the business operations are properly conducted and statutory provisions are met.
In this respect, particular importance is attached to solvency supervision. In particular, insurers must establish adequate technical provisions, invest their assets in accordance with the ‘prudent person principle’ and observe the principles of good business practice.
Division of responsibilities between the Federal Government and the Federal State
Insurance supervision is divided between the Federal Government and the Federal States - in accordance with the federalist system of the Federal Republic of Germany.
BaFin supervises on behalf of the Federal Government private insurance undertakings operating in Germany which are of material economic significance and public insurance undertakings engaging in open competition which operate across the borders of any Federal State. The supervisory authorities of the Federal States are mainly responsible for supervising public insurers whose activities are limited to the Federal State in question and those private insurance undertakings which are of lesser economic significance.
Scope of insurance supervision
All private and public insurance undertakings which carry on private insurance business within the scope of the Insurance Supervision Act and have their registered office in Germany are therefore subject to supervision either by BaFin or by the supervisory authorities of the Federal States. Pensionsfonds have also been subject to unlimited insurance supervision by BaFin under the Act since the beginning of 2002, as have domestic reinsurance undertakings since December 2004. Insurance undertakings having their registered office in another EU member state or in a state party to the Agreement on the European Economic Area (EEA) which conduct business in Germany under the freedom to provide services are primarily subject to supervision by their home country. BaFin does, however, consult the foreign supervisory authority if it identifies breaches of general German legal principles.
Social insurance institutions - i.e. statutory health insurance funds, the statutory pension insurance fund, statutory accident insurance institutions and unemployment insurance - are not subject to supervision under the Insurance Supervision Act. They are regulated by other government agencies, such as the German Federal Insurance Authority (Bundesversicherungsamt).
Authorisation and ongoing supervision
Before an insurance undertaking can actually be supervised on an ongoing basis, it must first be granted an authorisation.
Authorisation and the conditions that have to be met
As a matter of principle, insurance business may not be transacted unless or until the undertaking has authorisation from BaFin. If an insurer having its registered office in Germany wishes to be allowed to engage in insurance business, it must meet various conditions. Here are some examples:
•The undertaking must have a particular legal form - that of a public limited company (Aktiengesellschaft), which includes SEs, a mutual society or a public-law institution.
•The insurer may engage only in insurance business and directly related business; it may not engage in non-insurance business. The principle of business segregation also applies: a life insurance company, for example, may not at the same time provide health or property insurance.
• The undertaking must submit a business plan describing what risks it intends to cover.
• The insurer must set out the broad outlines of its reinsurance policy.
• The undertaking has to prove that it has sufficient own funds. The absolute floor of the Minimum Capital Requirement depends on the class of insurance which is to be offered. Furthermore, the undertaking has to prove that it has sufficient resources to develop the business and sales organisation (organisation fund).
• In addition, the insurer has to prove that it has at least two members of the management board – or other persons appointed to represent the undertaking - (principle of dual control) who are "fit and proper" persons. They must be able to demonstrate that they have sufficient knowledge of the insurance business in question and sufficient management experience.
• The insurer must nominate the persons who have key functions and ensure that they are at all times fit and proper to perform their duties.
• The insurer must also specify any natural or legal persons who have a qualifying holding in the undertaking - by which is meant at least 10 per cent of the nominal capital or initial fund. Any holders of qualifying holdings must also meet certain requirements in order to guarantee sound and prudent management of the undertaking.
Insurance supervision monitors all undertakings which have been granted an authorisation on an ongoing basis. It collects information, evaluates it and observes the way in which the insurance undertaking conducts its business, in order to avoid undesirable developments or to identify any such developments in good time. If any such undesirable developments do occur, the supervisory authority intervenes in order to put things back onto a proper footing as rapidly as possible.
In its ongoing supervision BaFin pays particular attention to the following points:
• The insurance undertaking must conduct its business in a fit and proper manner and comply with all statutory and regulatory provisions. The main statutory requirements are set out in the Insurance Supervision Act (Versicherungsaufsichtsgesetz – VAG), the Insurance Contract Act (Versicherungsvertragsgesetz – VVG) and the Civil Code (Bürgerliches Gesetzbuch – BGB).
• In the case of life insurance undertakings, for example, insurance supervision staff have to watch carefully in order to ensure that the bonuses distributed to policyholders are appropriate and that benefits are being paid correctly.
• The insurance undertaking must charge appropriate premiums for the benefits it expects to have to pay and must establish adequate technical provisions.
• Investment must take due account of the prudent person principle. For example, the required guarantee assets must be covered by suitable investments. Furthermore, the undertaking has to have sufficient free financial resources to be able to cope with unexpected losses.
• The insurance undertaking must observe the principles of good business practice, such as, for instance, keeping proper accounting records and rendering proper accounts. Balance sheets and statements of income and expenditure must reflect the undertaking's true financial position and financial performance. In addition, the insurance undertaking must implement an appropriate internal control system for planning, management and control purposes.
• In accordance with section 24 of the Insurance Supervision Act, the undertaking must ensure that all persons who effectively run the undertaking or have other key functions are fit and proper to perform their duties.
• The undertaking's level of own funds (solvency) must be adequate. If it is not, i.e. if the Solvency Capital Requirement or the Minimum Capital Requirement is not met, the insurer must submit a recovery plan or a finance scheme, respectively, to the supervisory authority.
• In addition, insurance undertakings must take out appropriate reinsurance.
BaFin obtains key information from undertakings' financial reporting. Not only do insurers have to render accounts for the public, but in particular they have to render accounts for supervisory authority consumption and provide whatever information is needed to ascertain their economic and financial situations. The sources of this information include the audit reports on the annual financial statements, the annual reports and any information provided under the narrative and quantitative reporting obligations of insurance undertakings.
At certain intervals or as required, BaFin also gains deeper insights into an undertaking's situation by way of on-site inspections at the undertaking's registered office. But if need be, BaFin staff also visit offices or branches in other EU or EEA countries. They have to be presented with all the documents and provided with all the information they require on demand.
BaFin has various means of taking action against insurance undertakings. Under the Insurance Supervision Act it may issue any instructions that are "appropriate and necessary" in order to prevent or eliminate undesirable developments that threaten to harm the interests of policyholders. One kind of "undesirable development" in particular would be if an undertaking failed to comply with the statutory and regulatory requirements applying to the carrying-on of insurance business.
In addition to this general clause, the Insurance Supervision Act gives BaFin a number of special powers in order to avert certain typical threats. These special powers are wide ranging. The supervisory authority may appoint a special commissioner to replace the board of management, the supervisory board or other governing bodies of the company. It can even revoke an undertaking's authorisation to operate. BaFin can also conduct ad-hoc surveys into, for example, the effects of falling equity prices on the guarantee assets (for example by way of projection calculations).
History of Insurance Supervision
Unified state supervision of Germany's insurance industry stretches back over more than a hundred years. It dates back to the Reich Act relating to Private Insurance Undertakings (Reichsgesetz über die privaten Versicherungsunternehmungen), which was passed on 12 May 1901 and came into force on 1 January 1902. This Act created the Imperial Private Insurance Supervisory Office (Kaiserliches Aufsichtsamt für Privatversicherung) in Berlin, which commenced operations on 1 July 1902. The first thing that the Imperial Supervisory Office set about doing was to devise principles of supervision and to compile the first-ever list of all insurance undertakings subject to supervision. 30 May 1908 then saw the adoption of the Insurance Contract Act (Gesetz über den Versicherungsvertrag – VVG), which came into force on 1 January 1910.
Further progress on standardised insurance supervision was interrupted by the First World War. Against the backdrop of the subsequent economic collapse – and in particular Germany's rampant inflation – the legislature extended the supervisory authority's powers of action. In the early years of the Weimar Republic the supervisory authority, which had been re-named the Reich Private Insurance Supervisory Office (Reichsaufsichtsamt für Privatversicherung) in 1918, strove to return to an orderly system of supervision. In the summer of 1929 the Frankfurter Allgemeine Versicherungsaktiengesellschaft insurance undertaking (FAVAG) collapsed, prompting calls for supervision to be tightened up. The Reich Act relating to Private Insurance Undertakings was restructured by the Act amending the Insurance Supervision Law of 30 March 1931. "Substantive state supervision" was expanded and strengthened, and supervision of building and loan associations (Bausparkassen) was introduced. From then on, the supervisory authority was known as the Reich Insurance and Building and Loan Association Supervisory Office (Reichsaufsichtsamt für das Versicherungs- und Bausparwesen), while the restructured supervision act was named the Insurance Supervision Act (Versicherungsaufsichtsgesetz – VAG).
The accession to power of the National Socialist Party in 1933 also brought radical changes for insurance supervision. In 1939, the Supervisory Office fell under complete National Socialist control. In 1943 the Office was assigned responsibility for the supervision of all private insurance undertakings and the technical supervision of public insurance institutions. From then on the authority bore the name of Reich Insurance Supervisory Office (Reichsaufsichtsamt für das Versicherungswesen).
With the end of the Second World War, unified insurance supervision collapsed altogether. The Reich Insurance Supervisory Office had ceased to exist, and the Occupying Powers assumed responsibility for insurance supervision. However, by the end of 1945 attempts were beginning to be made to re-establish insurance supervision. Even though the Occupying Powers were pursuing different aims and objectives, the Supervisory Offices of the Western Occupation Zones were keen to help the insurance industry to overcome the biggest crises. Insurance supervision in the immediate post-war era was based on the by now outdated Insurance Supervision Act. Life insurers were the most heavily affected by the effects of war and the associated destruction of assets. Non-life insurers had to contend with war damage. The supervisory authorities made a particularly significant contribution to stabilising the situation, among other things by sending special representatives out to insurance undertakings that were no longer functioning properly due to their headquarters having to be relocated and their loss of staff.
The next major turning point for the whole economy was the Currency Reform of 20 June 1948. The hyperinflation of 1922/23 had already destroyed the financial resources of a large proportion of the population. Now members of the same generation once again lost almost their entire savings. All Reichsmark-denominated claims on insurance undertakings were devalued in the ratio of 1:10. Even so, the remaining assets held by insurers were nowhere near sufficient to cover all obligations arising under the newly-converted insurance contracts. The military governments therefore by law granted insurers what were known as equalisation claims against the Federal States – to a total amount of DM 3.1 bn. Without these claims virtually all insurers would have been doomed to fail.
The fragmentation of insurance supervision in post-war Germany was felt to be counterproductive. In the debate surrounding the overhaul, nobody disputed that the Insurance Supervision Act of 1901 should continue to apply; there were, however, differing views as to whether public insurers should also be subject to supervision. Eventually, on 4 August 1951 the Act on the Establishment of a Federal Insurance and Building and Loan Association Supervisory Office (Gesetz über die Errichtung eines Bundesaufsichtsamtes für das Versicherungs- und Bausparwesen) came into force. The Supervisory Office commenced work on 1 April 1952 in Berlin – the first Federal authority to be based in this Federal State, incidentally. It was responsible for the supervision of both private insurance undertakings and public insurance undertakings competing on the open market that operate beyond the borders of their own Federal States.
Compared to the early post-war years, the first two decades following the establishment of the Supervisory Office were relatively quiet. The basic concept of insurance supervision remained unchanged: its primary objective remained the protection of policyholders. In addition, the smooth functioning of the industry and, consequently, the establishment of an adequate capital base became increasingly important from a supervisory perspective.
Legislation passed in the 1950s and 1960s brought few really significant changes for insurance supervision. The only lasting effect on the work of the Supervisory Office came from the Act against Restraints of Competition (Gesetz gegen Wettbewerbsbeschränkungen – GWB), also known as the Cartel Act, which came into force in January 1958 and transferred jurisdiction for cartel arrangements between insurers to the Cartel Authority.
At the beginning of 1973, when the Bausparkassen Act (Gesetz über Bausparkassen – BauSparkG) came into force, supervision of building and loan associations (Bausparkassen) came under the remit of the then Federal Banking Supervisory Office (Bundesaufsichtsamt für das Kreditwesen – BAKred). As a result, not only were the responsibilities of the Supervisory Office reduced but its name was also shortened – to the Federal Insurance Supervisory Office (Bundesaufsichtsamt für das Versicherungswesen – BAV).
Current supervisory law is based to a large extent on developments at the European level, which have had a major impact on German regulatory standards and thus also the functions and working procedures of the Insurance Supervisory Office since the mid-1970s.
In the 1970s and early 1980s, insurance supervision law underwent two fundamental changes as a result of the European Non-Life and Life Insurance Directives. As part of the partial harmonisation of national supervisory legislation, the conditions for undertakings with a registered office in EU member states to establish branch offices in other member states were significantly relaxed, as were, eventually, those for conducting insurance business on a cross-border basis under what is known as the freedom to provide services. The Insurance Accounts Directive of 1991 and the Third Non-Life and Life Insurance Directives of 1992 virtually completed the harmonisation of supervisory law at the European level, resulting in a single European insurance market in 1994.
The most important change was the introduction of the home country principle. An undertaking that has its registered office in one member state of the EU or in another country party to the Agreement on the European Economic Area (EEA) has all of its business operations throughout the EEA supervised mainly by the competent authority in its home country; the home country authority issues the authorisation and also has sole responsibility for ongoing financial supervision. It does, however, share legal supervision with the competent authorities of the other countries in question.
Other milestones in the re-shaping of the Insurance Supervision Act include the abolition of any prior approval of the general insurance policy conditions and of tariffs (i.e. premium rates) and the introduction of a statutory requirement to monitor shareholders of insurance undertakings.
The Bonn-Berlin Act of 1994 decreed the relocation of the Insurance Supervisory Office from the new capital to Bonn. The first steps towards the relocation to Bonn were taken by the Supervisory Office in August 1999, when it opened its office there. It eventually completed the move to its new headquarters in the former capital in late October 2000.
To consolidate supervisory activities, on 1 May 2002 the Federal Insurance Supervisory Office was merged with the Federal Banking Supervisory Office (Bundesaufsichtsamt für das Kreditwesen – BAKred) and the Federal Securities Supervisory Office (Bundesaufsichtsamt für den Wertpapierhandel – BAWe) to become the Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht – BaFin), Germany’s integrated financial supervisor.
Following more than ten years of intensive preparatory work, on 1 January 2016 Solvency II, a uniform EU-wide regulatory regime, entered into force, concluding a harmonisation process that was initiated after the European Economic Community was established in 1956. The Solvency II Directive (Directive 2009/138/EC) introduced enhanced solvency requirements for insurers based on a holistic risk analysis and established market value-based valuation rules for assets and liabilities. This is intended to reduce the insurers’ insolvency risk.
A core element of the new supervisory regime is the principles-based approach. A principle-based framework means that legislation largely refrains from providing specific rules but instead defines principles, each of which pursues a certain objective. These principles are initially of a general nature. They apply to all undertakings alike and provide leeway with regard to their implementation. The application of the principles requires an individual assessment on a case-by-case basis.
Another essential element of Solvency II is the principle of proportionality. It aims to ensure that the specific characteristics of each insurance undertaking are appropriately taken into consideration so that relief can be granted, in particular, to medium and small insurance undertakings.
The scope of the Solvency II Directive applies to both primary and reinsurers, irrespective of their legal form. It does not apply to institutions for occupational retirement provision and funeral expenses funds. Small insurers with annual gross premiums written of less than EUR 5 million or technical provisions of less than EUR 25 million are generally also exempt from Solvency II.