Rules for calculating the Zinszusatzreserve amended
The Federal Ministry of Finance (BMF) has amended the requirements for the calculation of the Zinszusatzreserve (ZZR). The Third Regulation amending regulations under the Insurance Supervision Act - only available in German (Versicherungsaufsichtsgesetz – VAG - only available in German) of 10 October 2018 applies directly to the 2018 financial year.
The amendment comes in response to the developments of the capital market environment since 2011, when the ZZR was implemented. The persistently low level of interest rates has made it necessary to readjust the interaction between covering existing guarantee obligations adequately and using future investment income in advance.
At a glance:Zinszusatzreserve (ZRR)
The ZZR was introduced in 2011 to set life insurers up for times of consistently low interest rates. Background: since life insurers assume long-term guarantees, especially in endowment and annuity insurance, they are required to set up provisions under commercial law to ensure that these guarantees can be met at all times. This is the premium reserve, which is to be established in accordance with section 341 f of the German Commercial Code (Handelsgesetzbuch – HGB - only available in German) and the provisions of the Premium Reserve Regulation (Deckungsrückstellungsverordnung - DeckRV - only available in German .The ZZR is part of the premium reserve. Its purpose is to provide for periods in which the investment income alone is no longer sufficient to finance the interest guarantees of life insurance contracts concluded in periods with significantly higher interest rates. When these contracts gradually expire, the ZZR is released accordingly.
The legal situation and its effects on insurance undertakings and customers were described in detail in the August 2017 edition of the BaFinJournal (only available in German). This description largely still applies even after the amendment. It should be noted that the primary legal requirement of section 341 f of the Commercial Code remains unchanged: the calculation of the provision for interest guarantees must take into account the current and expected return on the undertaking’s investments. The Premium Reserve Regulation merely specifies the manner in which undertakings are to determine the future amount of investment income.
Contents of the amendment
The amendment that has now entered into force only relates to one, albeit important, element of the regulation: the determination of the reference interest rate used to calculate the ZZR. In the past, determining the reference interest rate was a mechanical process: it was the average rate of long-term capital market interest rates over the last ten years, and it could therefore vary significantly from year to year. In future, the annual change will be limited in that the new value will only be able to change within a given corridor around the previous value. The width of that corridor depends on how far the current capital market interest rates deviate from the previous reference interest rate.
The amendment also means that the possibility of the reference interest rate continuing to fall even if the current market interest rates have already risen no longer arises.
Impact on the amount of the premium reserve
The amendment will have its first effects on the amount of the premium reserve on 31 December 2018. The reference interest rate will decrease from 2.21% to 2.09%. The buffer of around 60 billion euros previously in the ZZR will be retained in full, and a further five billion euros is expected to be added for the 2018 financial year. This will mitigate the now overly dynamic effects of the previous regulation, under which the insurers would have had to provide 20 billion euros for the current financial year (see interview with BaFin Executive Director Dr Frank Grund).
At a glance:The Zinszusatzreserve in 2017 and 2018
In the 2017 financial year, the 84 life insurance undertakings subject to BaFin's supervision set aside around 15 billion euros for the ZZR. In the aggregate, the ZZR thus grew to roughly 60 billion euros by the end of 2017. It will amount to around 65 billion euros by the end of 2018. With the modified calculation method, the undertakings will only have to provide roughly five billion euros, about 15 billion euros less than under the old regulation.
Assuming a constant level of interest rates over the next few years, the amendment to the regulation will initially lead to a further increase in the ZZR. However, this will be much more moderate compared with the previous regulation. Similarly, the release of the ZZR expected in a few years' time will start somewhat later and progress in smaller steps.
According to the forecast calculations regularly made by BaFin, the financing of the interest guarantees is adequately ensured even during this slower progression.
Impact on customers
Many insurance undertakings have so far had to release significant parts of their valuation reserves and use their risk profits to finance the ZZR. Under the new regulation, this is less necessary, which means that the undertakings will have more flexibility in their investments and the allocation of profits to policyholders. The risk that undertakings will have to make withdrawals from the provision for premium refunds solely for accounting reasons has also decreased significantly.
At the current interest rate level, the previous regulation would have led to excessive balance sheet provisions, which would have been to the detriment of customers, in particular of policyholders with low interest rate guarantees. The new regulation thus also contributes to intergenerational fairness.
At a glance:Three questions for Dr Frank Grund about the new formula for calculating the Zinszusatzreserve (the additional provision to the premium reserve introduced in response to the lower interest rate environment)
Dr Grund, what is your assessment of the decision made by the German Federal Government to amend the rules for calculating the Zinszusatzreserve?
It is just as necessary now to change the calculation method for the Zinszusatzreserve as it was appropriate in 2011 to introduce it. This recalibration prevents the Zinszusatzreserve from being built up too quickly, which would potentially have placed too much strain on the undertakings; this, in turn, would have been bad for their customers as well.
So the decision does not have any negative consequences for the customers of life insurance undertakings?
No. Nothing changes for the guarantee commitments to the customers. And the existing Zinszusatzreserve, the cushion that makes sure that insurers are able to meet the higher guarantees from the past even in the low interest rate environment, remains unchanged. All that has happened is that a decision has been taken to allow it to accrue more slowly.
Does this solve the industry's problems with the low interest rate environment?
For as long as the low interest rate environment continues, it will remain a challenge for insurance undertakings. There are a number of options, such as new forms of guarantee and internal run-offs. For us, as supervisors, the important thing with all solutions is the protection of policyholders and beneficiaries.
Dr Kay-Uwe Schaumlöffel
Director-General for life insurance and investments
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