Life Insurance Reform – Changes for Insured and Insurers
One week after passing through the Bundestag, the Life Insurance Reform Act also received the approval of the German Upper House, the Bundesrat. Some amendments are effective immediately; others will become effective on 1 January 2015. The German Insurance Association (GDV) explains the most significant changes.
New arrangements in respect of participation in valuation reserves
In 2008, life insurance companies had been legally obligated to pay out half of their valuation reserves to policyholders whose contracts expired or had been terminated. The companies had to take into account not only valuation reserves on equities and real estate but also those on fixed-income securities. Meanwhile, due to extremely low interest rates, the value of fixed-income securities has ballooned. As a result, life insurance companies were forced to pay more and more money to the small group of leaving policyholders instead of keeping it for the remaining ones – representing 95 per cent of policyholders.
Under the Life Insurance Reform Act, participation in valuation reserves on fixed-income securities will be limited. In future, insurance companies will only be obligated to pay leaving policyholders the reserve amount that is not needed to ensure that guarantee obligations can be met in the future. Important: leaving policyholders will continue to participate without restriction in half the valuation reserve amount held in equities and real estate.
The changes will come into effect immediately when they are published in the Federal Law Gazette and will affect approximately 62 million of the approximately 88 million life and pension policies in Germany. Insurance policies unaffected by these changes include unit-linked and term assurance policies.
Reduction of maximum guaranteed interest rate
The maximum guaranteed interest rate, German life insurers are allowed to offer, will reduce as from 1 January 2015 from its current level of 1.75 per cent to 1.25 per cent. This level of interest must be applied to capital accumulated within classic life and pension policies and remains constant throughout the entire term. The reduction therefore will only apply to policies taken out from 2015 onwards. All existing policies will continue to benefit from the guarantee commitments that already apply to them.
In fact, the guaranteed interest rate is just one of the elements that make up a life insurance policy’s overall return. Policyholders also benefit from participation in investment, risk and cost surpluses that increase the contractually guaranteed sum assured. However, these surpluses are not predictable right from the start of a policy. The overall rate of return on life policies currently works out at an average of approximately 4 per cent.
Higher surplus participation
As from 2015 policyholders’ minimum participation in the so-called risk surpluses will rise from the current level of 75 per cent to 90 per cent. This will apply to both existing and new customers. Risk surpluses are one of the three sources of surplus participation that is characteristic for life insurance in Germany; the others being cost surpluses and investment income. Risk surpluses are generated when lower levels of risk are held than had been calculated – for example, if term assurance policyholders live longer than had been assumed.
Distribution block on dividends for companies
In order to ensure that life insurance companies remain able to meet their guarantee obligations even during long periods of low interest rates, legislators have decided that there should be a distribution block on dividends. The block means that it should not be possible in the short term for resources generated by companies to be diverted to shareholders where such resources are required to secure guarantees in the future. The new arrangements are intended to come into effect immediately when they are published in the Federal Law Gazette.
They do not apply to companies which belong to a parent company with which they have concluded a profit/loss transfer agreement. Such companies are permitted to continue to distribute their profits; the parent company, on the other hand, is obliged to cover its subsidiary’s losses. Thus, resources would remain available to policyholders exactly as before, should this become necessary. This will also be ensured by the Federal Financial Supervisory Authority (BaFin).
Introduction of a yield indicator
With effect from 1 January 2015 all life insurance policies must contain key indicators regarding the impact of management costs; this is already due to become the norm in respect of state-subsidised Riester policies in future (anticipated to apply from 2016). The reduction in yield rate will indicate what effect costs do have on a policy’s return. The indicator will include all built-in costs, taking into account acquisition costs as well as on-going costs. In the case of unit-linked products, fund costs will also be included. This will create full transparency in the interest of consumers.
Reduction of maximum zillmerisation rate
With effect from 1 January 2015 the maximum zillmerisation rate for life insurance policies will reduce from 4.0 per cent to 2.5 per cent. This means that, during the first five years of a policy, companies will only be able to financially account for acquisition costs equivalent to 2.5 per cent or less of the life policy’s premium amount. The Federal Government believes this will produce higher surrender values and will create a downward pressure on acquisition costs.
|Alexander Erdland, President of the GDV:
„We welcome the new arrangements on valuation reserves. The Act is responsible and equitable, focusing on customers’ interests. At times of extremely low interest rates, life insurance remains an important and secure part of our retirement provision that will offer attractive returns in the future. The vast majority of life insurance policyholders will benefit from the new rules – so today is a good day for consumers.
We also support the moves to make life insurance costs more transparent. A simple indicator will allow our customers to tell what effect costs will have on their policy return. And they will now be able to compare actual costs in a realistic manner.
Admittedly, the legislators have given insurance companies a few bitter pills to swallow. Our members now face a massive technical and financial challenge to implement the changes required by the legislators. Not only do we have to adjust the guaranteed interest rate for new policies and introduce a yield indicator by 1 January 2015, we also have to adjust the maximum zillmerisation rate. And we have less than six months to do that.”
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