This is a topic of great importance for the insurance sector since most German insurers and institutions for occupational retirement provision hold investments in financial instruments from banks, in particular in shares, Pfandbriefe and unsecured debt instruments. In recent years, the level of investment in unsecured debt instruments has amounted to large two-figure billion sums. Therefore, getting to grips with the new regulatory provisions and framework as well as the resulting risks is an unavoidable necessity for insurers. This rings all the more true given that recent events have again demonstrated that the banking sector may well find itself in financial difficulties.

Own credit risk assessments

Pursuant to section 28 (2) of the German Insurance Supervision Act (Versicherungsaufsichtsgesetz – VAG - onyl available in German) in conjunction with Article 5a(1) of the European Regulation on Credit Rating Agencies, insurance undertakings and institutions for occupational retirement provision must conduct their own credit risk assessments and must not rely solely or mechanistically on credit ratings for assessing the creditworthiness of an entity or financial instrument. Against the backdrop of persistently low interest rates and the associated low returns, avoiding defaults and thus maintaining nominal values has become all the more important for insurers. Therefore, regardless of the statutory requirements, own credit risk assessments are now playing a decisive role in how insurers' make investments. Some undertakings have already established complex and comprehensive rating processes.

In addition to quantitative factors, such as data from financial statements, it is also necessary to take qualitative criteria into consideration when assessing the credit risk of bank debt instruments. In this context, insurers should also analyse the extent to which support mechanisms from statutory or voluntary deposit guarantee schemes are also in place. The non-performing loans of a credit institution might also provide insight into the level of credit risk.

Solvency II

At the latest since 1 January 2016, when the European supervisory regime Solvency II came into force, insurers have had to the implement the statutory requirements associated with the prudent person principle. To begin with, this means that, pursuant to section 124 (1) sentence 2 of the VAG, they may only invest in assets whose associated risks they can sufficiently identify, assess, monitor, control and manage. Furthermore, all investments are to be selected in such a way that the security, quality, liquidity and profitability of the portfolio as a whole is ensured.

BaFin therefore expects that undertakings not only take credit risk into account when dealing with bank debt instruments, but also that they consider how they could reduce this risk. Insurers must also consider the possibility of backstops no longer being in place and assess the impact this could have on complying with the investment principles of security and quality.

Furthermore, the VAG stipulates that investments – including unsecured bank debt instruments – must be mixed and diversified appropriately to avoid excessive dependency on a certain asset, issuer, group of undertakings or geographical area and an excessive concentration of risk in the portfolio as a whole. This applies in particular to investments in one and the same issuer or in issuers belonging to the same corporate group. This means that the undertaking must define and subject itself to a set of framework conditions in the form of an internal schedule of investments.

According to the guidelines of the European Insurance and Occupational Pensions Authority (EIOPA) on systems of governance, undertakings must also give consideration to the financial market environment. The financial market environment encompasses all relevant factors outside the undertaking which influence the value, returns and security of its investments.

Solvency I

Insurance undertakings and institutions for occupational retirement provision which do not fall within the scope of the Solvency II Framework Directive face the challenge that they might no longer be able to automatically categorise unsecured bank debt instruments as bonds and debt instruments (Schuldverschreibungen), promissory note loans (Schuldscheindarlehen) or registered securities (Namenspapiere) within the meaning of the German Investment Regulation (Anlageverordnung – AnlV - only available in German). This is because the subordination of unsecured bank debt instruments actually causes them to exhibit characteristics of receivables due from subordinated liabilities.

BaFin is currently examining whether it is necessary to categorise unsecured bank debt instruments in accordance with section 2 (1) no. 9 of the AnlV. Allocating them to guarantee assets (Sicherungsvermögen) pursuant to section 2 (1) no. 9 of the AnlV would entail them being counted towards the risk asset ratio pursuant to section 3 (3) sentence 1 of the AnlV. This amounts to a total of 35 percent of the guarantee assets. If BaFin arrives at the conclusion that such instruments are receivables from subordinated liabilities, it will also have to clarify whether grandfathering will be provided for in the case of unsecured bank debt instruments acquired prior to 1 January 2017. BaFin will provide more information on this matter to undertakings and the public at a later date.