Increase in life insurance run-off portfolios expected in Germany

Low investment returns and higher capital requirements on some business could drive a two-thirds increase in the volume of German life insurance portfolios in run-off over the next five years, Fitch Ratings says.

Firms are likely to initially continue managing these portfolios internally, but in the medium term Fitch expects transfers to specialist run-off platforms to accelerate, accounting for around half the overall increase.

Around 9 percent (€90 billion of assets) of the German life insurance sector is already in run-off and Fitch believes this could grow to around €150 billion by 2022 as low investment yields continue to put pressure on the profitability of traditional products with minimum guaranteed returns. These products also have higher capital requirements under the new risk-based Solvency II framework, making them less profitable. A growing regulatory burden and increasingly costly IT systems will also make smaller non-guaranteed portfolios unprofitable, making them candidates for run-off.

Putting portfolios into run-off can be attractive because of the potential cost reductions. Acquisition costs can fall substantially because no new business is being written. If the insurer uses third-party distribution channels the impact will be immediate and the only remaining acquisition costs will be those related to after-sales service.

Insurers with a run-off portfolio will also usually be able to strengthen profitability by making lower bonus payments to policyholders. This is because most firms make bonus payments above the legal or contractual minimum to help attract new business, which will no longer be necessary in run-off.

Administrative costs will probably fall in the short term when a portfolio goes into run-off, but may become a burden in the longer term as the underlying insurance portfolio shrinks. The rising burden of fixed costs in a run-off portfolio could make insurers more likely to consider a transfer to a run-off specialist in the longer term, as these companies can benefit from economies of scale as more portfolios are transferred. If these benefits are shared with the seller a transfer may prove more profitable for the seller than keeping the portfolio.

The transfer market in Germany is fairly undeveloped and it will take time for pricing to evolve and the necessary expertise to develop, but Fitch expects assets under management among external run-off specialists will more than double to €60 billion from €25 billion over the next five years.

Bermuda-based Athene Holding, for example, has raised €2.2 billion common equity investment to support capital and reinsurance transactions in the German and European guaranteed life insurance run-off market.

Athene sees an ‘unprecedented need in the German and broader European market for equity capital and reinsurance solutions to support run-off portfolios and closed block reinsurance transactions, particularly those with high guarantees’, according to a statement.