The study's main finding was that no major movements are to be expected in the structure of investments, nor are any systemic risks. However, smaller insurance undertakings in particular with little experience in new business areas of this sort are in danger of their risk management not keeping pace with their growing activities.

Incentives for financing real estate

It is increasingly more attractive for insurance undertakings to become more active than they have been as lenders in the field of commercial real estate financing. Until now, German insurance undertakings have not shown much interest in financing real estate for commercial use. At the end of 2011, this type of financing comprised at €5.8 billion just 0.5 percent of primary insurers' total investments. In past years, investment in this area remained very stable at a low level. Despite individual large-volume loans, no significant increase could be seen in the investment statistics.

However, insurance undertakings will use available market potential more intensively in the future. For instance, under the new European Solvency II insurance supervision regime as it stands today, the standard approach in particular contains incentives not to take real estate risks primarily through direct real estate investments, but rather through providing debt financing in commercial real estate transactions. The main reason for this is the considerably lower capital requirement.

This difference in the capital requirement is likely to have a less serious effect on larger insurance undertakings which use internal models. Because of the high market share these large insurance undertakings have, it is therefore likely that shifts in the insurance industry's investment structure in the real estate sector as a whole will be limited.

Even if commercial real estate financing poses no systemic risk to the insurance sector in light of the fact it is still of low significance to the sector, problems could nevertheless occur in individual companies. Most small and medium-sized insurance undertakings which choose the standard approach and as a result tend more towards financing real estate have little experience in this field. They must therefore make particular efforts to ensure that they have sufficient expertise and that their risk management in real estate financing is adequate at all times.

The real estate market benefits

In the current environment, insurance undertakings' increasing activity as lenders comes as a blessing for the real estate markets, which continue to suffer severely from the consequences of the financial crisis. Banks, the traditional providers of debt financing, are increasingly withdrawing from this area, anxious to reduce balance sheet risk. The reason for this is primarily the significantly stricter capital adequacy requirements which credit institutions will soon have to fulfil under the Basel III international regulatory standards and which strengthen the deleveraging process they have begun. Against this background, it is becoming increasingly difficult for real estate investors to get follow-up financing. From their point of view, insurance undertakings are discovering lending at the right time because the gaps left by the banks can be at least partially filled in this way and it somewhat lessens the danger of serious turmoil on the real estate market.

Insurance undertakings have so far been concentrating almost exclusively on financing “core real estate”. This is prime real estate in top locations with a low vacancy rate and good tenant structure and tenant creditworthiness. A lot of real estate investors that want to operate more carefully and reduce their risks in reaction to the financial crisis are currently crowding into this narrow, seemingly low-risk segment of the market. In many places, the increased demand has already led to significant and in some cases excessive price rises in prime real estate so that reversals now have to be factored in even when financing properties of this nature.

Alternative investments' risks and opportunities

German insurance undertakings are also increasingly investing in “real economy” asset classes. These include investments in infrastructure (including renewable energies) and commodities.

As interest rates have remained extremely low for several years, insurance undertakings currently have an investment dilemma. The existing widespread focus on fixed-rate bonds will make it increasingly difficult for life insurers in particular to generate the guaranteed returns on long-term liabilities to their customers. They therefore have an incentive to switch to alternative assets which promise higher yields.

Investments in infrastructure

Infrastructure investments are attractive for insurance undertakings because their lifespans are a good fit for long-term liabilities and they normally generate stable cash flows. Low risk, long-term forms of investment have become rare since the sovereign debt crisis has shown that even bonds from highly developed economies can no longer per se be seen as virtually risk-free.

It is politics in particular which causes uncertainties for long-term infrastructure investments. For example, the discontinuation of state subsidies quickly makes investments in renewable energies unprofitable. However, technological advances also play a role. Existing infrastructure facilities can be swiftly superseded both financially and technologically through innovation.

Diversification with commodities

Insurance undertakings invest in commodities primarily in order to round out and diversify their portfolios. For many years, insurance undertakings were interested in commodities due to their ability to create a balanced risk-return relationship for the entire investment portfolio, because their correlation with other asset classes was low. In the financial crisis, however, commodities performed similarly weakly compared to other types of assets. The correlation has increased substantially, such that their risk mitigating effects for the portfolio have become less strong.

Despite weaker risk-mitigation effects, finite resources suggest commodity prices will rise in the long-term, i.e. aside from the usual cyclical fluctuations, due to the foreseeable shortage of supply. However, the opportunities for potential increases in value are limited, as commodities do not generate any current income.

As with real estate financing, BaFin will keep an eye on the developments of insurance undertakings' investment patterns in other real economy assets in order to identify risks early. In this context, the separate reporting requirement for commodity investments which was introduced as at 31 December 2011 will create greater transparency in this area.