Contract
Documento di consultazione n. 3/2022 SCHEMA DI REGOLAMENTO IVASS RECANTE DISPOSIZIONI IN MATERIA DI CONTRATTI DI ASSICURAZIONE DI CUI ALL’ARTICOLO 41, COMMI 1 E 2 DEL DECRETO LEGISLATIVO 7 SETTEMBRE 2005, N. 209 – RECANTE IL CODICE DELLE ASSICURAZIONI PRIVATE – E SUCCESSIVE MODIFICAZIONI E INTEGRAZIONI | |
Legenda Nella riga “Commentatore” i singoli soggetti dovranno inserire la loro denominazione (anche in forma abbreviata). Nella riga “Osservazioni generali” i singoli soggetti potranno inserire commenti di carattere generale. Nelle colonne “Articolo”, “Comma” e “Lettera” andranno inseriti, rispettivamente, l’articolo, il comma e la lettera cui si riferisce l’osservazione e la proposta di modifica. Nella colonna “Osservazioni e proposte” andranno inserite le osservazioni specifiche e le proposte di modifica. | |
Commentatore | MUNICH RE (Münchener Rückversicherungs-Gesellschaft A.G.) |
Osservazioni generali | 1 Introduction Munich Re currently understands that IVASS’ objectives at a high level, as implied by its consultation, are: 2. Ensure policyholder value-for-money and appropriate transparency |
3. Xxxxxx relevant product innovation 4. Benefit from experiences gained in other large European insurance markets in shaping the new business framework 5. Enable investment from insurance companies into the economy, benefitting from the long-term nature of insurance business 6. Avoid structures that may lead to subsidies between different products types (either by illegitimate transfer of investment returns or by an implicit share of risk other than through diversification) 1.1 Agenda Within this document, Munich Re will share its views and experiences: - Section 2 describes fund-linked product experiences in Germany and France, the local frameworks, product “families” and suggestions to IVASS - Section 3 describes index-linked product experiences in Germany, the local framework, product “families” and suggestions to IVASS Furthermore, Appendix A provides costs indications for Death Benefits, as requested in the Consultation paper. |
1.2 Definition
For the purpose of definition this document follows Article 132 (“Prudent Person Principle”), Paragraph 3 of the Solvency II Delegated Acts (Directive 2009/138/EC of the European Parliament and of the Counsel).
With respect to “fund-linked products” it states:
“…with respect to assets held in respect of life insurance contracts where the investment risk is borne by the policy holders… [and]… the benefits provided by a contract are directly linked to the value of units in an UCITS as defined in Directive 85/611/EEC, or to the value of assets contained in an internal fund held by the insurance undertakings, usually divided into units, the technical provisions in respect of those benefits must be represented as closely as possible by those units or, in the case where units are not established, by those assets.
With respect to “index-linked products” it states:
“Where the benefits provided by a contract are directly linked to a share index or some other reference value other than those referred to in the second subparagraph, the technical provisions in respect of those benefits must be represented as closely as possible either by the units deemed to represent the reference value or, in the case where units are not established, by assets of appropriate security and marketability which correspond as closely as possible with those on which the particular reference value is based.”
Furthermore, Article 132 makes explicit reference to guarantees in fund-liked and index linked products:
“Where the benefits referred to in the second and third subparagraphs include a guarantee of investment performance or some other guaranteed benefit, the assets held to cover the corresponding additional technical provisions shall be subject to paragraph 4.”
Implicit in this rule is the need to calculate the “additional technical provisions” based on Article 76-86 of the Directive. Most relevant in this context is the requirement to determine the respective value based on a market-consistent best estimate approach (Article 76/77) with current assumptions, and the admissibility to establish reinsurance recoverable held against such technical provisions (Article 81).
For the purpose of this document a relatively strict interpretation of Article 132 Paragraph 3 is applied. As a result, the traditional products called “Gestioni Separate” sold on the Italian market are excluded from the definition of fund-linked products, as the policyholder benefit is not contractually linked to the value of units in a UCITS or the value of assets held in an internal fund. Therefore Munich Re considers “Gestione Separata” products to not form part of the consultation and hence does not cover such products within this document.
1.3 Summary
Munich Re believes that index-linked products form a valuable complement to fund-linked products within the linked product framework. As described in this document, index-linked products can provide substantial policyholder value, reduce costs, enable transfer of risks (biometric and/or investment) from policyholder to insurance company and have shown to appeal to policyholders in other major European countries, such as Germany.
As Munich Re believes that policyholders do not and cannot differentiate between fund-linked and index- linked products, the new set of rules should be created for the purpose of enabling innovation and allowing insurance companies to choose the implementation route most suitable for its strategy, marketing positioning and internal infrastructure with the final aim of optimising the benefits for both policyholders and the Italian insurance industry. As a consequence the new set of rules should create a level playing field between fund-linked and index-linked form, focussing on substance over form.
Beyond providing an additional framework to launch appealing products, the index-linked framework can be applied to transfer operational processes/risks associated with e.g. rebalancing from the insurance company to a third party.
Furthermore, as banks and reinsurance companies are positioned differently, Munich Re believes a level playing field between derivatives and reinsurance treaties would benefit the innovation.
Within this document, Munich Re aims to describe the benefits that index-linked products can provide and how reinsurance solutions have been applied in other Solvency II-regulated countries.
Munich Re has substantial experience with the reinsurance of market, biometric and behavioural risks associated with insurance products across all relevant product types and gained over the last decades with transactions in Europe, Asia and the United States of America.
1.4 The Italian market
After the disappearance of the previously generation of Index-linked business, the Italian market has been characterised in the last ten years by the dominance of traditional products. The high level of capital requirements introduced by Solvency II, alongside with the increasing level of the embedded risks that the achievement of appealing yield for policyholders introduced, pushed the Italian insurance companies to switch some of their production into pure fund-linked products or the so called “multi-ramo” (multi-branch or static hybrid) products, a combination of general accounts and fund-linked.
In this context, product innovation has proven to be difficult and effectively came to a halt in the middle of the last decade. The current consultation is providing the market with a unique moment of confrontation that could lead to some significant regulatory changes with the aim to set a new product offering by:
1. Rethinking the index-linked segment;
2. Innovating the multi-branch products;
3. Differentiating the insurance product offering from similar financial products offered by banks and asset manager by introducing some biometric components
2 Fund-linked products
2.1 Experience in other countries
2.1.1 Germany
Insurance regulation framework
The German Insurance Act (“Versicherungsaufsichtsgesetz”) transposes the relevant paragraphs for fund-linked products, as mentioned in Section 1.2 approximately verbatim1.
With respect to guarantees provided under such products, the German regulation requires to establish additional technical provisions following two rule-sets:
1 „… Verträgen für die betroffenen Vermögenswerte, wenn die Leistungen aus einem Vertrag direkt an den Wert von Anteilen an Organismen für gemeinschaftliche Anlagen in Wertpapieren im Sinne der Richtlinie 2009/65/EG oder an den Wert von Vermögenswerten gebunden sind, die xx xxxxx xxx xxx Xxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxx xxx xx xxx Xxxxx xx Xxxxxxx aufgeteilten internen Fonds enthalten sind, die versicherungstechnischen Rückstellungen für diese Leistungen so genau wie möglich durch die betreffenden Anteile oder, sofern keine Anteile gebildet wurden, durch die betreffenden Vermögenswerte abzubilden“ - German Insurance Code § 124
1. A technical provision based on Solvency II Article 76-77 has to be established.
2. For historical reasons in certain cases it may be required to have an additional so-called “Herde- Rückstellung”, which reflects the reserve that would be required, if the provision would be calculated based on traditional (German GAAP) rules.
Available products
In Germany, (Part-)fund-linked products that are currently offered in the market can be grouped into:
1. Entirely fund-linked products, which in turn can be broken down into:
a. Fund-linked products without investment guarantees
b. Fund-linked products with investment guarantees, in turn comprised of:
i. Products with an embedded rebalancing mechanism in order to enable the investment guarantee (e.g. based on an iCPPI mechanism, individualised constant proportion portfolio insurance);
ii. Products without rebalancing mechanism;
Here, the guarantee is provided by the insurer on top of the fund investment in return for receipt of a guarantee fee. Such products are typically so-called “Variable Annuity” or “unit-linked guaranteed” products.
2. Hybrid products, i.e. products combining traditional components (i.e. saving product with investments at the risk and reward of the insurance company) with fund-linked components. These can be broken down into:
a. Static hybrid products, i.e. applying a deterministic (typically fixed) allocation between the traditional and fund-linked components;
b. Dynamic hybrid products, applying a rebalancing mechanism in order to allocate dynamically between the traditional and fund-linked components;
Most products that benefit from an investment guarantee are offered with guarantee levels up to between 80% and 100% of gross premium, depending on the product, premium payment (single or regular) and term.
It is worth noting that the German market is characterized by a high proportion of regular premium payments when compared to other European countries.
New business production
Although increasing slightly, fund-linked products without investment guarantees continue to play a minor role in the German life savings insurance industry at 11.2% of annual premium equivalent over the last 5 years (2017-2021)2. Together with index-linked products, hybrid products and fund-linked guaranteed products form part of the product group “non-traditional guaranteed products”, which in total constituted 55.7% of annual premium equivalent on average over the last 5 years. Dynamic hybrid products, offered by 11 of the top 20 life insurance company by annual premium, form a substantial part of this product group by estimates of Munich Re.
Dynamic Hybrid products
Dynamic Hybrid products, i.e. products that rebalance between traditional components and fund components in order to achieve an investment guarantee, are popular with policyholders as they combine:
2 Source: German Insurance Association
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1. Typically, a high degree of investment flexibility (broad choice of funds), including the possibility for switching funds during policy life; and
2. Investment guarantee levels of typically ≥ 80%; and
3. Substantially higher capital markets exposure when compared to static hybrid products (i.e. products without rebalancing) for the same guarantee level; and
4. Investment expertise of the insurance company reflected in the traditional component.
A number of recent product developments in this product category has been made in recent years to address a number of implicit challenges in this product. See Section 3.2.3.
Death benefits
Typically, death benefits typically offered up to the age of 85 years and are typically either:
1. The higher of a) paid premium, and b) prevailing account value; or
2. The prevailing account value only.
2.1.2 France
Insurance regulation framework
Under the French insurance code, unit-linked products are expressed as contracts with a performance obligation expressed as a number of units. The insurance code details a list of eligible assets, but does not foresee internal funds. The unit-linked classification allows for more assets than solely funds, but does not include index-linked structures.
Available products
Life insurance contracts in France are invested in so-called “supports”. The main supports being general account (“fonds-euros”) and unit-linked (“unités de compte”). A recently introduced new support (“euro- croissance”) allows for more risky investments than the traditional general account support by offering term guarantees, instead of guarantees at any time (as per fonds-euro). Products that are invested in multiple supports are referred to as “multi-support” products.
(Part-)unit linked products that are currently offered in the market can be :
1. Entirely unit-linked products, which in turn can be broken down into:
a. Products without investment guarantees
b. Products with investment guarantees embedded in the reference unit(s) (e.g. a guaranteed fund)
2. Multi-support products, comprised of:
a. Products with an investment guarantee delivered solely from the general account or the euro-croissance components
b. Products with an investment guarantee delivered by all components, in turn comprised of
i. Products where the investment guarantee of the unit-linked component is embedded into the reference unit(s) (e.g. a guaranteed fund)
ii. Products with a guarantee at insurance contract level (in excess of that provided by the general account or the euro-croissance supports). Such guarantees are typically referred to as “garantie plancher”, i.e. floor guarantee, trigger by e.g. death.
New business production
Net production of unit-linked contracts has generally risen over the last years due to the cost of general- account based products. However, it should be noted that the net new production is highly correlated with equity market performance (i.e. more unit-linked production when equity markets go up, less when markets go down).
2.2 Munich Re suggestion
This section briefly summarizes how in our view reinsurance can be used to xxxxxx innovation in unitised linked products (as mentioned above) by decreasing complexity and increasing efficiency by means of so-called unit-liability reinsurance.
2.2.1 Reinsurance of fund performance
Munich Re believes that policyholders can benefit from life insurance products that provide:
• A degree of investment choice that is appropriate for the target market, e.g. investment themes or individual fund portfolios chosen by the policyholder or its advisor
• A material degree of risk transfer covering biometric and/or investment risk
• A cost-effective solution
Through capital market hedging transactions, guarantees can be offered at cost-effective levels by reinsurance companies and investment banks only on a sub-set of the funds that available in most fund- linked contracts. Typically these are funds that closely track a benchmark index.
In order to provide guarantees (investment and/or biometric) on a substantially wider set of funds, as well as more cost-effectively, reinsurance of fund performance can be foreseen.
Under such reinsurance transaction, typically combined with the reinsurance of guarantees, the fund assets held by the insurance company is reduced by a certain (variable) amount and replaced by a reinsurance recoverable. Effectively part of the insurance company’s liability to “pay” the fund performance to the policyholder is reinsured. This structure can also be utilised for fund-linked products that require frequent rebalancing (as are present currently in the Italian market).
See Appendix B for technical details of the structure.
Reinsurance case study: reinsurance of fund performance (2017) Context
From its Irish carrier, a continental European insurance company had offered life insurance products in four European countries. These products provided policyholders with lifelong income guarantees, where the annual income is linked to the performance of a fund basket as selected by the policyholder.
The insurance company wished to hedge the market and biometric risk arising from the lifelong income guarantee.
Problem
The market risk for the guarantee could not be effectively hedged with capital market instruments, leading to a prohibitively expensive price.
Reinsurance solution
A reinsurance solution was put into place, that both:
- Reinsured the embedded guarantee (i.e. transfer of market and biometric risk from insurance company to reinsurance company)
- Reinsured part of the fund performance. Thereby the number of funds held directly by the insurance company was reduced by to the amount for which the reinsurance company pays the fund performance (€ 10 in the example in Appendix B). As the transaction is collateralised, the reinsurance company held cash for this amount.
Policyholder benefits
Continued offering of the lifetime income product.
Insurance company benefits
A cost-effective risk transfer solution relieving the company from the risks.
3 Index-linked products
3.1 Experience in other countries
3.1.1 Germany
Insurance regulation framework
The German Insurance Act (Versicherungsaufsichtsgesetz) transposes the relevant paragraphs for index-linked products approximately verbatim3.
3 „Wenn die Leistungen aus einem Vertrag direkt an einen Aktienindex oder an einen anderen als den in Nummer 1 genannten Referenzwert gebunden sind, die versicherungstechnischen Rückstellungen für diese Leistungen so genau wie möglich durch die Anteile, die den Referenzwert darstellen, abzubilden; sofern keine Anteile gebildet werden, sind die Rückstellungen durch Vermögenswerte mit angemessener Sicherheit und
Practically, and applied in common practice, when for example issuing a contract linked to the EuroSTOXX 50 Index (an index comprised of equities of the 50 largest European companies by market capitalisation), an insurance company can:
1. Hedge this through purchasing the 50 constituent shares; and/or
2. Hedge this through purchasing an ETF tracking EuroSTOXX 50 Index; and/or
3. Hedge this through purchasing a futures contract, or entering into another derivative, linked to EuroSTOXX 50 Index; and/or
4. Reinsure its obligation to provide policyholders with the index performance.
Available products
Insurance products
Index-linked products currently offered in the German market typically include a general account investment. These products can be classified into:
1. Products with index-participations financed by (expected) annual bonus declaration
- These products often allow the policyholder to select one or multiple indices and/or a fixed crediting rate (i.e. no index participation) on an annual basis for the subsequent year
Realisierbarkeit abzubilden, die so genau wie möglich denjenigen Werten entsprechen, auf denen der jeweilige Referenzwert beruht ..“ – German Insurance Code § 124
- Typically, these products are constructed such, that the policy value cannot fall year-on- year (i.e. annual ratchet) unless the policyholder elects a feature whereby also parts of the policy value are additionally at risk for the subsequent year.
2. Products with index-participation financed through a premium split
- E.g. for a € 100 premium, € 95 is invested in the general account, the remaining € 5 is utilised to “purchase” participation in the positive development of a reference index
- Upon surrender or death, the market value of the index-participation typically is included in the relevant benefit
Indices
The referenced indices can broadly be classified into:
1. Broad-based indices such as S&P 500, DAX or EuroSTOXX 50
2. Indices constructed by banks or reinsurance companies
a. Such indices often reallocate within a set of components (e.g. multi-asset) based on quantitative signals. Typical components are other indices, stocks, bonds, futures, ETFs and mutual funds.
b. Such indices often include an embedded risk-management mechanism designed to stabilise the cost of the index-participation.
c. Some indices have been developed together with an asset manager associated with the insurance company. In this case, the asset manager can take discretionary investment allocations within the predetermined index guidelines and typically receives an index advisory fee.
3. Indices constructed by policyholder choices (e.g. selection of referenced assets)
In all cases, the referenced indices are calculated by independent external calculation agents.
Differentiation versus fund-linked
From a German policyholder perspective, fund-linked and index-linked products are considered to be substantially similar. Choice of structure is driven by desired outcome and marketing preferences.
When an insurance company opts for an index-linked structure rather than a fund-linked structure, this is typically for one or both of the below reasons, each explained in more detail below::
1. Index-linkage allows for a more flexible and cost-effective product for the policyholder; and/or
2. Index-linkage transfers operational complexity associated with e.g. rebalancing to the party that provides the index return (if externalised)
Reason 1: A more flexible and cost-effective policyholder solution
Index-linked can provide more policyholder efficiency, through one or multiple of the below reasons:
1. Costs
2. Lower minimum amounts, thereby e.g. allowing to make e.g. more investment themes available for policyholders
3. Time-to-market
4. Tailoring flexibility, e.g. to tailor the index to the risk profile and preferences of the policyholder
Please note that funds can be utilised in indices, for instance to access markets that are not accessible via other means. In such cases, the index value reflects (inter alia) the fund net asset value development after fees.
Reason 2: Reduce operational complexity for insurance company
As described above, a number of products in the German market benefit from a guarantee that is constructed through active rebalancing, either between high-risk and low-risk unitised asset or between high-risk assets and the general account. When delivering such a product in a fund-linked, this requires a high degree of operational complexity and associated infrastructure, as rebalancing typically is performed daily. Through opting for an index-linked structure, such complexity is effectively outsourced to a third party that provides the index return. From a policyholder perspective, the fund-linked and index-linked experience is very similar and typically provides a broad choice of funds (mutual funds and ETFs) as “performance engine”. In such cases the effective cost in the reference asset is substantially similar, but efficiency and risk gains can create a more appealing product for policyholders (for instance through a faster response time). An example is provided in Section 3.2.
In Germany, the relevant index governance is based on the context it is applied to. As such, certain indices are considered “benchmark indices” for the purpose of the ESMA Benchmark Regulation framework and certain indices are not (see example in Section 3.2.3). In both cases an independent calculation agent is utilised to ensure appropriate governance.
New business production
As described in Section 2.1.1., index-linked products are not explicitly split out within the product group “non-traditional guaranteed products”. This group in total constitutes 55.7% of annual premium equivalent on average over the last 5 years. Index-linked products form a material part of this by estimates of Munich Re.
Death benefits
Typically, death benefits offered are the higher of a) paid premium, and b) prevailing account value. Death benefits offered are typically 100% of gross premium options offered up to the age of 85
3.1.2 France
Index-linked products are not possible in France. Unit-linked products however can be linked to e.g. structured certificates / notes issued by x.x. xxxxx. In contrast to index-linked products, these typically transfer credit risk of the issuing bank to the policyholder.
3.2 Munich Re suggestions
3.2.1 General positioning
For the purpose of achieving the objectives as set out in Section 1.1, Munich Re believes that index- linked products can provide a meaningful and material complimentary framework within the linked- products world. Italy can benefit from the experiences gained in other Solvency II-regulated countries.
Munich Re believes that average policyholders can and does meaningfully differentiate between a) linked products; and b) general account products, but does not and cannot differentiate within the various types of linked products. The difference between i) a fund-linked product linked to an EuroSTOXX 50 ETF (tracking EuroSTOXX 50, an index comprised of equities of the 50 largest European companies by market capitalisation); and ii) an index-linked product linked to the EuroSTOXX 50 directly, is not clear to most policyholders in Munich Re’s view.
As index-linked products can provide a number of benefits when compared to fund-linked products (see below), Munich Re suggests to create a level playing field within the linked-products category, being
applicable to both index-linked and fund-linked products, based on a similar set of regulations, applying on substance over form. This would provide insurance companies with more tools and flexibility to innovate and policyholders with a setup that enables efficient risk-transfer (biometric and/or market risk).
Typical benefits of index-linked products when compared with fund-linked products:
1. Reduction of costs at “delivery-mechanism-level”: the cost per index is typically a small fraction of that of a fund; and
2. Isolate policyholders from the effects of fund-level risks (as e.g. occurred with Xxxxxxxx, H2O funds in recent years); and
3. Allows for a higher degree of tailoring to policyholders, as the marginal cost per index is substantially lower than that of a fund. This e.g. permits a broader selection of investment choices available to policyholders, incl. possibilities to tailor these to individual policyholder situations and risk tolerance; and
4. Allows for faster time-to-market; and
5. Typically a higher level of transparency is provided; and
6. Can enable long-term investments by insurance companies. Index-linked products can provide solutions whereby the insurance company can perform a long-term investment, combined index- linked performance delivered through third parties. Economically comparable, but fund-linked structures, often force insurance companies to invest short-term. See below for an example.
When compared to a fund, indices:
1. Include a similar level of governance through the market-standard structure of external calculation agents; and
2. Can also include asset allocation expertise by an asset manager through a role as “index advisor”
This section briefly summarizes how in our view reinsurance can be applied to enable relevant innovation in the linked-product category, in order to enable product innovation, whilst allowing insurance companies to focus on areas of expertise and, e.g. through reinsurance, transfer risks, including operational risks, to reinsurance companies.
Rebalancing interval
From its extensive experience with the design and reinsurance of savings, investment and retirement products, Munich Re believes that high-frequency (e.g. daily) rebalancing can provide a policyholder product benefit, as a faster „response time” leads to less risk for the ultimate risk taker (reinsurance company, bank or insurance company). Such policyholder benefit can manifest itself in a higher guarantee level (biometric and/or investment) and/or lower costs.
As Munich Re understands the operational complexity of daily rebalancing for insurance company, it believes no hard requirements should be set in regulation, but instead each product should be assessed on its merits, taking into account product and capabilities of the risk-management (hedging) infrastructure and choices. Should an insurance company have transferred the risks associated with a daily index rebalancing to a third party with external index calculation, no basis risk, no renewal risk, etc. , Munich Re believes this can be a superior solution in many cases to a product with a slower rebalancing frequency, but without risk transfer. Fund-linked products with daily rebalancing currently exist in Italy.
As in other areas, reinsurance can therefore act as a “playing field leveler”, providing benefits of scale to insurance companies that do not have the financial means to develop an elaborate hedging infrastructure.
Personalisation
In contrast to other industries (asset management, banking), life insurance has a natural proximity to policyholders through being linked to life events. Personalisation in terms of “investment engine” and its path over time (e.g. de-risking when approaching retirement), can be effectively supported in an index- based set-up due to the lower cost per index and faster time-to-market. It can be argued that when policyholders can tailor, at issuance and during life, within a cost-effective setup, the exposure of their policy (to a suitable level for the target market), this leads to a better value proposition for policyholders and hence lower lapse, allowing for a more stable investment by the insurance company. The supporting infrastructure present in e.g. reinsurance companies can provide benefits of scale and permit also smaller and medium-sized insurance companies to launch such products.
3.2.2 Reinsurance of index-linked product liabilities
Munich Re believes that reinsurance of index-linked product liabilities, as is common practice in e.g. Germany, can provide benefits to the policyholder and insurance company, as it:
1. Allows the insurance company to benefit from the risk-management expertise and infrastructure as built up in reinsurance companies.
2. Isolates the insurance company from operational risks associated with hedging activities, as the reinsurance company’s performance is formulaic and linked directly to the index.
3. Avoids the insurance company to focus on inter alia long-term investment, as short-term fluctuations, capital and liquidity needs are passed to the reinsurance company.
4. Provides faster time-to-market and more policyholder choice.
5. Provides guarantees (biometric and investment).
The below case study describes an applied example.
Reinsurance case study: long-term open index-linked products (2022)
Context
A German insurance company wished to launch a product that benefitted from an index-participation at known terms over the policy life, combined with a guarantee in case of death and at policy maturity. In contrast to products with an annual index-participation change (and hence annual “ratchet”), this product should be long-term focussed and avoid the high costs for annual index-participation (n 1-year options are typically substantially more expensive than 1 n-year option).
The insurance company wished to offer this product continually (i.e. not tranche-based) for a range of ages and guarantee levels.
Problem
The insurance company did not have the required infrastructure to risk-manage the indices in-house.
Reinsurance solution
Together with the asset manager of the insurance company, an index was designed that includes the insurance company investment style and expertise. The index benefits from a risk-management mechanism that automatically de-risks the index when certain stress-indicators in capital markets are triggered and applies this on a daily basis. The index is calculated by an independent third party.
At the time of issuance, the policyholder can select a) the guarantee level; and b) the policy maturity and sees the resulting index-participation rate (e.g. 80% participation in the index growth).
The reinsurance solution provides per policyholder the result of the index participation and provides a number of stabilising mechanisms designed to provide the insurance company with stability in the index participation terms (i.e. that the abovementioned 80% does not fluctuate from day to day). Furthermore a surrender value is set including the market value of the index-participation at the time of surrender. This market value also determines the value of the collateral provided to the insurance company.
The product is offered continually since 2017 with investment guarantees ranging from 85% to 100% (dependent on term) and is offered with only one “investment engine”. The guarantee in case of death is 100% of gross premium.
The index is calculated by a third party and its development and constituents are published on the insurance company website, as well as on external services on a daily basis.
Policyholder benefits
Policyholders benefit from:
1. Participation to an index designed reflecting the insurance company’s investment experience
2. Certainty on index participation terms for the policy life
3. The return potential offered by a long-term investment in the general account
Insurance company benefits
The ability to offer, at stable conditions, an appealing multi-year product tailored to each policyholder. The replication, risk-management and hedging of the index-participation is transferred to the reinsurance company, thereby allowing the insurance company on other parts of the product value chain.
3.2.3 Flexibility of index definition
Munich Re believes that an index-linked framework can also provide benefits currently often associated with a fund-linked setup. As is common practice in a number of fund-linked products, policyholders can construct their own investment portfolio (typically comprised of funds) and periodically adjust this in response to e.g. changing life circumstances and/or risk tolerance.
Such products are often based on performance-linked rebalancing mechanisms (e.g. iCPPI) and are offered in fund-linked products (incl. in Italy) as well as hybrid products (e.g. in Germany in the Dynamic Hybrid products explained in Section 2.2).
In delivering such benefits in an index-linked construct, the insurance company can be isolated from the operational complexity and risks associated with risk management of a) unique portfolios per policyholder and b) frequent rebalancing.
In order to facilitate this, Munich Re believes a substance-over-form approach should be taken to the definition of an index with respect to ESMA Benchmark Regulation, which was designed for benchmark- governance of financial instruments and not for the abovementioned context.
Other European countries such as Germany apply a such an approach, as e.g. described in the below case study.
Reinsurance case study: policy-specific indices (2022) Context
A German insurance company wished to launch a product that economically is a “Dynamic Hybrid” Product (see Section 2.2), achieving an investment and biometric guarantee by dynamically adjusting the exposure to a portfolio of funds selected by the policyholder through a rules-based mechanism (a so- called iCPPI mechanism). This mechanism enables a more appealing return potential when compared to so-called “Static Hybrid” products, which split policyholder premium statically.
Problem
The insurance company:
1. Wished to perform a long-term investment in the general account, which is not possible in the typical Dynamic Hybrid product, where monies flow in to and out of the general account frequently. Such rebalancings are typically associated with transaction costs, particularly when performing longer-term investments.
2. Did not have the infrastructure to perform daily fund investment increases / decreases. A lower frequency of rebalancing would have resulted in a competitively inferior product, i.a. due to increased costs.
Reinsurance solution
A reinsurance solution was put in place, where each policyholder premium was split into a) a component required to be invested in the general account in order to achieve the guarantees; and b) a “risk budget”. This risk budget is transferred to the reinsurance company, which delivers to the insurance company for each policy the return on the risk budget in accordance with the rules-based iCPPI mechanism applying a daily rebalancing. The policy return is calculated by an external calculation agent, effectively calculating one index per policyholder. This policy-specific index responds to the investment choices, guarantee level and contribution pattern of the individual policyholder and its rules are defined by the insurance company in cooperation with the reinsurance company.
Policyholder benefits
The policyholder benefits from the return potential of a long-term investment in the general account, combined with the ability to select the fund portfolio at an attractive price level.
Insurance company benefits
The policy-specific index performance is fully reinsured, meaning that the insurance company is absolved from the daily fund ordering process and not exposed to any hedging complexities. Any hedging operation and potential losses are assumed by the reinsurance company and do not affect the policy valuation.
The insurance company can invest long-term, including in e.g. infrastructure, in the general account.
Appendix A: Death Benefit
Provision of minimum defined outcome in case of death remains a cornerstone of insurance saving globally. Transfer of meaningful biometric risks can also be done for linked contracts
The table below shows the market-consistent prices for example risk categories and an example 65 year old male and 10 years policy life.
It is worth noting that when combining the death benefit (“DB”) with a guarantee in case of life (i.e. accumulation benefit), the marginal cost of the death benefit can be severely reduced so from a structuring point of view there is value in designing a product that provides policyholders with both guarantee at maturity and death benefit.
Appendix B: Technical details of reinsurance of fund performance Structure without reinsurance of fund performance
When risk-managing guarantees (biometric and/or investment guarantees) without unit-liability reinsurance, cost inefficiencies and risks are often introduced, as described in the example below illustrating a transaction whereby:
• A policyholder makes a contribution of € 100 into a fund-linked policy
• The policy provides benefits of the higher of a) € 100 (100% of the premium); and b) the prevailing account value upon predefined events (e.g. death, invalidity, maturity)
• The market-consistent sensitivity (so-called “delta”) of the embedded guarantee is -10%, meaning that the market-consistent value of the guarantee decreases (increases) by € 1 if the account value increases (decreases) by € 10. For an account value of € 100, this means a delta of - € 10
• The insurance company xxxxxx / reinsures the guarantee risk embedded in the policy through an investment bank or reinsurance company or directly in the capital market
• Fees are ignored for the purpose of illustration
Chart 1: Structure without reinsurance of fund performance
The above results in:
• Costs and inefficiencies created by separate capital market transactions:
o Fund ABC purchasing € 100 of assets; and
o The Investment Bank or Reinsurance Company creating a negative (short) position for € 10 of assets
• Risks, in particular the basis risk between Fund ABC and the underlying of the hedge, that may result in:
o A price increase to cover the risk; and/or
o Limiting the universe of funds for which guarantees / xxxxxx can be provided
Structure with reinsurance of fund performance
Through the reinsurance of (part of) the fund performance, the abovementioned costs inefficiencies and limitations can be mitigated, as illustrated in the below chart, where the elements that are different to Chart 1 are marked in red.
Chart 2: Structure with reinsurance of fund performance
In addition to the abovementioned benefits to the policyholder, reinsurance of fund performance permits insurance companies to:
1. Reduce operational complexities associated with the ordering process for funds. This is particularly relevant when dealing with products that are based on rebalancing mechanisms
2. This mechanism can also be utilised to stabilise the unit-linked value-in-force
The counterparty risk that may arise from such transactions can be mitigated through the provision of collateral.
A number of other countries that also apply the Solvency II regime permit reinsurance of unit-liabilities.
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