It's incredibly bad timing for the insurance industry.
Holders of life insurance policies in Germany can expect extra cash back from their providers at the end of this year – and the country’s struggling insurance industry will have to survive with one less cushion in the tough times ahead.
After years of wrangling, the German Finance Ministry and representatives of German states have agreed a new law that will effectively force insurers to hand over many billions of euros in windfall profits to their customers.
The money comes from a surplus pot totaling anywhere from €15 billion, or $17.1 billion to €30 billion that insurers have been withholding from policyholders for many years – and using to shore up their own shaky capital situation instead.
"The modifications coordinated with the Finance Ministry are an important component of a suitable balancing of interests between insurance companies and policyholders," Monika Heinold, the finance minister of the northern state of Schleswig-Holstein, told Handelsblatt.
In an era of low ultra-low interest rates in Europe, money is tight among Europe’s insurance firms, many of which have struggled to earn a decent return. At the end of last year, Europe's insurance regulator Eiopa warned that if interest rates stay low for a prolonged period, almost a quarter of all insurers could be threatened with bankruptcy.
Such desperate times have called for desperate measures.
Common sense means that, in the current environment of negative yields, the principle of caution must be placed in the foreground. Hermann Weinmann, Insurance expert University of Ludwigshafen
"The consequence is that companies are not handing out more than is absolutely necessary given the competitive situation," Hermann Weinmann, an insurance expert who heads a financial institute at the University of Ludwigshafen, told Handelsblatt.
This is about to change – at least partially. The government now plans to close a loophole that had allowed many insurance companies to keep a portion of their proceeds in a separate account, even though their customers were in fact entitled to the funds.
The German Insurance Association, or GDV, has grudgingly backed the compromise deal, but warned that the capital buffers of many insurance companies would be "compromised" as a result.
The long-running dispute has revolved around the extent to which customers should be allowed to participate in a company's windfall profits.
But while the pot may seem large, Mr. Weinmann played down just how much of this money will flow out of insurance company's coffers. With interest rates at a record low, the windfall profits of many insurance companies have shrunk dramatically in the last couple of years. Much of the surplus is a legacy from better days and is now being used to shore up shaky finances.
"Common sense means that, in the current environment of negative yields, the principle of caution must be placed in the foreground," Mr. Weinmann said. "Insurance customers are already feeling this too – through lower yields in their policies."
The details may be complicated but are critical to the industry. Each of the roughly 100 life insurance companies in Germany is required to return most of its surpluses – such as those generated by investment profits or administrative surpluses – to customers within the same year. The so-called "Policy Reimbursement Reserve," or RfB, is identified on the policyholder's annual statement as a "share of surplus."
However, insurers have not been disbursing every euro of their surpluses directly to their customers. Instead, they have parked a portion of the money in a fund known as "collective RfB," which is in fact an offset between the old and the new customer base. The cutoff date is 1994, the year the insurance market was deregulated in Europe.
The current regulation is highly advantageous to insurers but disadvantageous to their customers. The money deposited into the "collective RfB" fund doesn’t have to be distributed in the same year. In fact, life insurance companies can keep the money in this account for as long as they please. At the same time, they have been able to declare the money in this account as equity with the European Central Bank – a good reserve base in today's financially-challenging times.
Experts say that insurers many have generated additional profits of at least €15 billion in this manner, an estimate that seems plausible, given that Germans hold a total of 80 million life insurance policies. Some even say that the additional profits could amount to as much as €30 billion.
Berlin insurance expert Hans-Peter Schwintowski once explained the crazy logic of collective RfB funds to the finance committee as follows: "There is a big, fat pile of money that can no longer be allocated. We can only stand there and gape at it."
Instead, the money was not dished out was simply held in reserve. "There is no legal basis for this. In this area, regulators have refused to comply with lawmakers," Mr. Schwintowski.
The German Finance Ministry and representatives of the German states are now hoping to put a stop to this practice by setting an upper limit for how much of this money can be counted as reserves. Instead of the previous 80 percent, only 60 percent of an insurer's equity can come from this fund. For instance, if an insurer needs €1 billion in equity capital to cover its investments with the central bank, only €600 million can come from the collective RfB in the future.
This all but eliminates the appeal to life insurers to keep their money in these funds for longer periods of time. As a result, the fund is expected to shrink and the money to flow back into the classic premium reimbursement system, in which customers must be reimbursed at the end of each year.
It's the government's second try, after an earlier bill was deemed too lenient to insurance firms and failed to meet with approval in the Bundesrat, the body that represents the German states at the federal level, in December 2012.
The opposition Green Party, in particular, had insisted on changing the current practice.
"This makes it possible to give all the insured their proper share of the companies' reserves and revenues," Green Party politicians Karoline Linnert and Tarek Al-Wazir said in a joint statement on Tuesday. "The federal government's previous plans would probably have led insurance companies to strengthen their equity... But policyholders are the ones who are mainly entitled to the money."
Ozan Demircan is an editor with Handelsblatt in Düsseldorf, focusing on the insurance industry and its troubles. Frank Drost is a Handelsblatt reporter in Berlin, covering the divide between politics and finance. Christopher Cermak of the Handelsblatt Global Edition contributed to this story. To contact the authors: [email protected] and [email protected]