Reinsurance in life insurance: in the interests of the policyholders? (2024)

Life insurers have been using reinsurance contracts that include financing components for many years. In this way, the expected income is paid out early and losses can be avoided. In times of low interest rates, this way of managing results also would have been possible by releasing valuation reserves.

But now there are times when this is no longer an option: increased interest rates are reducing the valuation reserves that insurance companies have built up in their securities portfolios. In some cases, even the reverse has occurred, and there are now hidden liabilities. This obviously limits insurers' room for manoeuvre. It is for this very reason that they are now using reinsurance contracts.

However, there is a risk with these reinsurance contracts that the interests of the policyholders are not being sufficiently safeguarded. This is because reinsurance commissions must be paid back – and this reduces the profit participation of the customers.

Loss sharing: strict requirements

In profit participation, policyholders are generally entitled participate in the profits of the life insurer in a cause-oriented, timely and appropriate manner. The details are regulated by the corresponding statutory provisions and regulations.

Any losses incurred by a life insurer must generally be covered by equity. Only in exceptional cases, which are narrowly defined, can the insurer utilise funds from the provision for bonuses (Rückstellung für Beitragsrückerstattung – RfB) in order to compensate for losses incurred – and only as long as the interests of the policyholders are safeguarded. A withdrawal from the provision for bonuses is therefore only possible if BaFin expressly grants its consent. The legislation thus deliberately permits loss participation on the part of policyholders only to a very limited extent.

As the financial supervisor, BaFin therefore assesses whether the reduction of the profit participation through the repayment of reinsurance commissions is appropriate. BaFin published the principles on which this assessment is based on 22 October 2020. The decisive factor is that the allocation to the provision for bonuses and the policyholders' profit participations are not unduly reduced (see info box).

Even in the low-interest environment, many life insurers concluded reinsurance contracts with a financing component. They used the reinsurance commissions they received to increase the Zinszusatzreserve (the additional provision to the premium reserve introduced in response to the lower interest rate environment) (ZZR). They could have used their valuation reserves, which they had built up in their securities portfolios due to the low market interest rates, instead, but then they would have had to sell an excessive amount of securities. To avoid having to do so, they concluded reinsurance contracts.

During the low interest rate period, insurers were generally able to demonstrate that they were sufficiently safeguarding the interests of their policyholders by avoiding possible shifts between the sources of earnings, engaging in adequate risk transfer and proving that policyholders also benefited from reinsurance contracts.

Caution where loss is to be avoided through reinsurance

The current interest rate environment is giving rise to the same question – whether life insurers are unduly reducing the policyholders' profit participation by concluding or expanding reinsurance contracts with a financing component.

In the case of reinsurance contracts which include financing components to avoid losses, there is the risk that the profit participation will be unduly reduced. This is because policyholders are usually the ones financing all or the major part of the repayment of the reinsurance commission received by the insurer, which means that through such contracts, losses could be shared with policyholders almost without any limitation. The legislation, however, only permits such loss sharing in exceptional cases via the withdrawal from the provision for bonuses described above.

Ultimately, this means that if the financing component of a reinsurance contract is to be used to avoid a loss that the life insurer cannot compensate for in any other way, it must be assumed that policyholders will be unreasonably disadvantaged by this reinsurance contract. If this is the case, life insurers must refrain from concluding such reinsurance contracts and forego any increase in the reinsurance commissions granted for existing contracts.

If, in principle, the company has other means to prevent impending losses, it must – as before – demonstrate that reinsurance is the more efficient solution. In this context, the interests of the policyholders must be given special consideration.

No increase in risks

The reinsurance commission paid by the reinsurer is generally paid back from the profits expected to be generated by the primary insurer in later years. Life insurers must ensure that these advances on income do not give rise to an undue increase in risks. This would be the case in particular if the reinsurance commission received were to be used for an increase in profit participation that the insurer might not be able to finance in a sound manner.

The risk-reducing effect of the ZZR must also be maintained. To this end, for example, it is necessary to make contractual provisions in order to ensure that the funds released from the reduction of the ZZR are primarily used to fulfil the contractual guarantees. Cases where it is no longer necessary to maintain the ZZR in full because the reinsurer has assumed the initial guaranteed interest rate risk would also not present any problem. However, BaFin takes a critical view of contracts that primarily provide for the released ZZR to be paid directly to the reinsurer.