“We Germans like to be safe,” the moderator says in opening his talk show on prime-time television. “There are more life insurance policies in the country than people alive.” In most countries, the subject of life insurance would hardly be considered a winner in TV ratings. In Germany, it is. That’s because “the business model of life insurance will collapse,” as Sven Enger, one of the panelists says. A former insurance executive and author, he predicts that “savings will be lost, old people will be in poverty. My advice: Get out of your policies.”
These anxieties on the part of policyholders have a mirror image in the troubles of the German insurance industry. They explain why Germans, unlike many other Europeans, are almost uniformly against the low interest-rate policy of the European Central Bank (ECB), which they blame for their insurance crisis. But the German insurance crisis is also an opportunity for many investors in Germany and abroad, as old and loss-making policies become investment opportunities akin to distress sales.
The German-speaking lands, including Switzerland, played a big role in the development of the insurance industry. Germany’s first insurers sprang from the bosom of the merchant guilds of Schleswig-Holstein in the 16th century, when members pooled resources to protect against catastrophic fires. The earliest German commercial insurers appeared in the late 1700s, for marine transport. When Hamburg’s city center went up in flames in 1842, a back-up market was born, to be known as reinsurance. The most famous German insurance innovator was “Iron Chancellor” Otto Bismarck, who introduced the first-ever national schemes for old-age pensions, health care and accident insurance in the 1880s.
Today, Germany is the world’s fourth-largest insurance provider. It has Europe’s largest insurer, Allianz, and the world’s second-largest reinsurer, Munich Re. According to a trade association called GDV, German insurers held assets of nearly €1.5 trillion ($1.84 trillion) in 2016 – about the same size as Italy’s entire GDP.
But for decades German insurers led a coddled existence that led them into trouble, especially in life insurance, which accounts for more than one-third of premiums (see chart). After World War II, German life insurance evolved differently than it did in English-speaking countries. In the US or the UK, plain vanilla term-life policies were the norm, which paid widows and orphans in case of a breadwinner’s death. Then “unit-linked” policies became popular, which resemble investment vehicles such as mutual funds, although the policyholder bears the risk of the investments performing badly.
In Germany, a different type of policy, the Kapitallebensversicherung (capital life insurance) became the standard. These policies are complex and confusing to many savers, because they contain a risk element (as with term life), a guaranteed return, and a discretionary return. In practice, these policies were marketed to savers as promises of a fixed pension, either as a lump sum or an annuity. In this style of retirement planning, Germany is fairly unusual; only Japan comes close.
These policies – in effect savings accounts and private pensions – had long contract periods, with an average lifespan of 20 years. Asset managers invested the premiums in government and corporate bonds, which are about 85 percent of their portfolios. This business model worked as long as the yield, or annual interest rate, of the bonds remained above the rates of return promised to policyholders. In the 1990s, life insurers offered customers annualized returns of up to 4 percent, and still made a profit.
For decades German insurers led a coddled existence that led them into trouble, especially in life insurance.
But then the financial crisis struck in 2008, followed by the euro crisis, and central banks slashed interest rates. They have since stayed puny. After flirting with zero percent last year, German bond yields have risen to only 0.6 percent. As the old bonds held by insurers matured, they were thus replaced by new ones yielding a pittance. The capital-life policies became a millstone as payouts, both current and future, rose above investment returns.
On top of everything else, tighter EU capital requirements for insurers took effect in 2016, leaving some of the firms meant to insure against crises instead teetering on the edge of one. One in three German life insurers now passes stress-test criteria only with the help of temporary bridging funds, according to Bafin, the German financial watchdog. The pressures on earnings and capital have caused the number of life insurers to shrink from 123 firms in 2000 to 84 in 2017.
How can life insurers stop the rot? One answer is to peddle more variable products, such as British-style unit-linked policies. Another is to focus on purely profit-sharing life policies, which also eschew guarantees and shift risk back to the customer. Some nimble insurers such as Gothaer or HanseMerkur have moved into better-paying but riskier investments, such as real estate.
Running into runoff
Many insurers are simply heading for the exits. They are no longer underwriting new life policies and are selling their existing portfolios to administrators, who squeeze out synergies of as much as 30 percent by using turbo-charged IT to process the legacy policies. These so-called runoffs are old hat in the US and UK but still fairly new to Germany.
Runoff specialists include Hamburg’s Darag, Viridium (a German firm owned by UK investment giant Cinven and reinsurer Hannover Re), and Frankfurter Leben (backed by Chinese investor Fosun). They have bought hundreds of thousands of life policies in recent years. In one mega-deal in 2017, Frankfurter Leben snapped up 322,000 life contracts with €2.8 billion in assets under management for an undisclosed sum. Viridium even bought 100,000 policies of defunct life insurer Mannheimer Leben from Protektor, which is ironically the industry’s rescue fund.
Some insurers shy away from quitting out of fear for their reputation. Ergo, a subsidiary of Munich Re, mulled but ultimately rejected a runoff of life policies late last year, saying it preferred to do it in-house. Allianz has ruled it out altogether.
But consumer advocates and politicians are argus-eyed. Ralph Brinkhaus, a conservative leader in parliament, has vowed to protect policyholders from the downside of runoffs and to consider government regulation. The worst of this crisis is yet to come, as policyholders begin to retire en masse, and find themselves poor and angry.
Jeremy Gray is an editor for Handelsblatt Global in Berlin. To contact the author: [email protected]