Revamping of insurance contract act has to be reconsidered

by Finanzplatz München Initiative

The draft of the insurance contract act (ICA) does have several productive provisions, believe the insurers and several other members of the Munich Financial Center Initiative (fpmi). Its implementation in its current form would, however, harm insurers – and thus consumers – in several key ways. This criticism particularly applies to the regulation proposed on the participation by holders of life insurance policies in the insurers’ undisclosed reserves. Another criticism is the draft’s failure to faithfully observe the rulings issued by the high courts of the land. The draft goes way past these rulings. The country’s banking industry disapproves of the draft’s doing away with the key provisions of mortgage creditor protection.

The in-depth positions taken by the participants in the Munich Financial Center Initiative on the insurance contract act are contained below:

The positions taken by the insurers

Allianz: campaign for greater accountability should be set forth

In mid-March, Germany’s Ministry of Justice submitted the draft act compiled by its experts. The draft contains most of the thrusts detailed in the paper formulated by Brigitte Zypries, Germany’s minister of justice. Several of these thrusts pertain to life insurance. Its accountability is to be increased. Minimum and guaranteed repurchase amounts are to be introduced, as is the customers’ participation in the companies’ undisclosed reserves.

Achieving greater accountability and comprehensibility primarily entails the provision of more information prior to the signing of contract. Allianz supports the position taken by GDV (the association of German insurers), whose campaign for greater accountability is comprised of a range of proposed measures. One of them is the provision of a sheet providing an at-a-glance overview of all key information on the contract for a product which a customer is considering buying – with this including premiums and costs – during the briefing given to the customer by the consultant. This paper should detail which of the product’s costs stem from acquisition and which from administration. The paper should also contain a detailing of the ratio and relationship between administrative costs and funds deployed. Containing such would ensure the comparability between our products and those of providers of funds and other services.

The Federal Supreme Court has decreed the establishment of a minimum repayment amount for those contracts called in during the first few years of the policy. To satisfy this decree, the costs of acquisition for capital-constituting life and pension insurance are to be allocated over the first five years of contract. This approach is being employed in the Riester contracts. GDV has proposed paying to customers their requisite shares of undisclosed reserves at contractual term. The pay-out would apply to the reserves accrued in real estate and shares, and would not include the reserves constituted to shield the company against changes in quotes. Also not be taken into account are those reserves accrued in fixed-interest products, as these reserves are retransferred on an automatic basis during the papers’ term. GDV’s proposals are also steps in the right direction.

Munich Re: planned reform undermines life insurance model
Several of the provisions forming part of the reform of the Insurance Contact Act undermine the key features of life insurance, which has established itself as one of the main pillars of Germany’s system of private old age care. These features distinguish life insurance from other forms of providential care. Life insurance is the only form of care which doesn’t impose time limits, and which covers biometric risks. These features would be de facto strongly impaired by the proposed reform. The reform’s provisions can not be justified upon the basis of the latest rulings issued by the high courts of the land, as several of these provisions impose changes which go far beyond those demanded by the courts.

The draft formulated by the Ministry’s experts stipulates that policy-holders’ accounts are to be credited with all net income and with half of the valuation reserves within two years and on an irrevocable basis. This 50% applies to the undisclosed reserves accrued in shares, real estate, and fixed-interest securities. This crediting is to be carried out without having to take into account the securities’ subsequent swings. This provision would largely eliminate the use of the reserves as a buffer against changes on capital markets. The consequence: life insurers would have to sell virtually all their investments in shares, participations and real estate. The stipulation that the values of valuation reserves credited to the policy-holders would no longer be allowed to rise and fall would require insurers to invest only in those products bearing no risks at all. These do not have reasonable rates of return. This change would have a corresponding effect on the pay-outs guaranteed, which would no longer attain their customary amounts. The only way of providing life insurance products offering adequately-sized guaranteed amounts would be to secure additional shareholders’ funds, and to use it as a buffer against risks. This practice would make the insurance products much more expensive, and thus unattractive to customers.

The experts’ draft revamps the regulations governing the claims accruing to policy-holders calling in their policies prior to term. The draft foresees the policy-holders’ being guaranteed that the associated repurchase values will be paid out whenever demanded by the customers, and at amounts equivalent to the premium reserves constituted for paying out at contractual term. These reserves are not calculated in ways taking into account swings on capital markets. This stipulation would cause a rise in the interest rates-caused fall in the value of the capital investments to not impact upon the repurchase value paid out to the policy-holders calling in their contracts. This would be advantageous for those policy-holders who are opting out from their life insurance policies prior to term. It would be to the serious detriment of the community of solidarity-minded policy-holders maintaining the policies’ ability to fully pay out by adhering to their contractual obligations. The proposed arrangement of paying repurchasing values not adjusted to the returns prevailing on markets would be financed by the capital guaranteed to be dispensed at the term originally foreseen by the life insurance contracts.

The Association of Germany’s Insurers has submitted proprietary proposals. These accord to the rulings issued by the high courts of the land, and would ensure that there would be no impairment of life insurance’s provision of benefits to all of its policy-holders. The proposals foresee the assigning of at least 90% of the valuation reserves not needed as a buffer against risk to the policy-holders on a revocable basis. This amount would be paid out upon the calling in of the contract. The Association has developed an approach which establishes objective criteria and ensures accountability for and in the calculation of repurchasing amounts according to capital market development. Munich Re supports these proposals, as they serve the interests of both insurers and policy-holders.

NÜRNBERGER VERSICHERUNGSGRUPPE: excessive consumer protection serves no one’s interests
NÜRNBERGER VERSICHERUNGSGRUPPE is critical of the ICA’s one-sided bias towards – excessive – consumer protection. This bias damages the interests of policy-holders, who are also consumers. The reform’s key thrust, with this affecting both insurers and policy-holders, is the latter’s participation in the undisclosed reserves accrued in capital investments. The draft submitted would impair the insurers’ ability to bear risk to the point that their suffering losses would be preordained. These, in turn, would require large-scale equity-securing measures, and would lead to the complete elimination of customers’ participation in net income. All this would give rise to the financing of these losses, which will arise by the premature and inexpert allocation of income which wasn’t really earned, by customers adhering to their contracts and by shareholders.

Another criticism is the draft’s replacing the “all or nothing principle” with regulations setting up complex breach of responsibility clauses. This provision would be conducive to policy abuse, and would foster the lodging of lawsuits – resulting in further burdens for the community of policy-holders and thus consumers as a whole.

A further criticism is the doing away with the “policy model”, which has functioned so effectively since 1994. Its replacement by an “application model” would decrease policy comprehensibility by adding a large number of passages, in small-print, to the listings of contractual terms contained in the policies and provided to holders upon conclusion of contracts. Customers taking out policies actually require cogent, easy-to-understand briefings on the essential conditions of the insurance protection being sought. Germany’s insurance industry has already formulated a proposal for such.

The ICA’s foresees a range of legal consequence for violations of reporting requirements. These would disrupt processes of risk assessment. This holds especially true of the requirement to lodge violations of reporting requirements within five years. This would greatly curtail the insurers’ means of imposing penalties upon policy-holder contractual abuse. The experts’ draft places the interests of individual consumers far above those of the communities of policy-holders and of consumers.

Versicherungskammer Bayern: a threat to the existence of guaranteed products
Versicherungskammer Bayern supports many of the reforms contained in the ICA, with these including the increasing of the information provided prior to conclusions of contracts and the detailing of cost calculations. We also regard the allocation of acquisition costs among the first five years of policy term, a practice known from the Riester rents, as being highly efficacious, as it will impart flexibility, in a reasonable way, to our system of old age care. The introduction of this practice is, however, dependent upon the instituting of the requisite accounting procedures.

The draft contains reforms which we regard as not being justified or justifiable. This especially applies to the doing away with the “policy model”, and to the proposal to enable customers to participate in undisclosed reserves.

The policy model in current use foresees the delivery of an insurance policy’s being accompanied by those of the contractual stipulations and generally-applicable contractual conditions. The proposal made by the federal ministry of justice foresees this occurring at the time of consultation with potential policy-holders. This would greatly increase administrative expenditures and thus costs. Another reason speaking against it is the fact many consultations do not lead to the taking out of policies.

We are especially critical of the proposal giving life insurance policy-holders a 50% stake in the valuation reserves, and entitling them to all income some two years subsequent to its determination. This proposal does not satisfy the brief given by the Federal Constitutional Court to Germany’s legislators. We firmly reject this proposal, as it would lead to a large portion of our reserves no longer being available as a buffer against the swings experienced on capital markets. This proposal also contravenes insurance’s key principle of equitable and collective sharing of risk and opportunity, as it favors a group of policy-holders – those whose accounts would be credited with the reserves. This practice would disadvantage those customers subsequently joining the community of policy-holders. This proposal thus means the end of such products whose guarantees satisfy social and political concerns as the Riester annuity. Also and equally affected would be corporate providential plans. Such moves benefit neither the public sector nor the country’s citizens.

We are equally critical of the proposals made on repurchasing value and pre-contractual reporting requirements.

Statements made by banks

Association of Bavaria’s banks, Association of Bavaria’s cooperative banks and credit unions, Association of Bavaria’s savings banks: protection of mortgage creditors has to be retained

The associations welcome the reforms being undertaken of Germany’s Insurance Contract Act (ICA), which is now nearly 100 years old. It is time to incorporate the changes which have taken place during the last few decades into it.

The draft submitted by ministry experts incorporates most of the recommendations made by the independent commission. Germany’s banks see the draft as containing substantial improvements on the proposals contained in the final report submitted on April 19, 2004, by the commission convened to reform the insurance contract act. The draft does foresee the incorporation of some of the rules applying to fire insurance §§ 81- 107c of the Insurance Contract Act, and especially §§ 143 ff of the Insurance Contract Act-E.

The banking industry regrets the draft’s doing away with provisions providing essential protection to mortgage creditors, with these including §§ 102 para. 1 (insurers’ obligations to pay mortgage creditors, notwithstanding the freedom of choice applying to payment execution and existing in the relationship to policy-holders as a result of breach of responsibilities by the latter, or due to calling in/dispute of the insurance contract), 105 (legal obligations to accept contracts on behalf of creditors holding liens on property) and 106 of ICA (need to secure approval on behalf of creditors holding liens on property upon policy-holders’ callings in of insurance contracts).

The oft-repeated justification for the elimination of these rules is that they unduly privilege holders of real estate-based collateral. These rules do in fact also apply to mobile assets, provided that these are covered by fire insurance for buildings. This therefore obviates any privileges. The especially important position accorded to mortgage creditors by §§ 102, 105, 106 of ICA is also entirely justified. The peril of a building being completed destroyed by fire – and with it, the rights of recompense held by the mortgage creditor – is substantially greater than the dangers of such emanating from such damaging-causing events as hail, storms, water pipelines’ bursting and others. The contention that the privileging of the creditors holding liens on property solely benefits the country’s banks and is therefore not worthy of retention is incorrect, as the experts’ draft cogently points out.

An elimination of the regulation protecting such creditors would have far-reaching ramifications for those providing collateral, as this change would inevitably affect the valuations of real estate serving as securities for credits. In conjunction with the EU’s new regulations on equity, which implement Basel II, these changes would increase interest rates.

Also speaking for the retention of the special level of protection accorded to creditors holding liens on property – and this argument is not solely being made by Germany’s banks – is that the risk of fire-caused damage can not be determined by a creditor holding a lien on a property, as this risk can not be bundled into an aggregate comprised of similar risks. Each creditor holding a lien on a property is completely exposed to the risk of destruction of his building by fire, and thus of his collateral, without his being able to spread the risk.

In contrast to the above situation, the insurance industry has the means of calculating these individual risks, and to cover them by configuring its premiums in a way standardizing it for the insurance industry segment in which it can be bundled.

A further argument speaking for retention of the regulations is the fact that the proposed change in legislation would impair the protection accorded to holders of mortgage bonds. Such mortgage bonds are protected by dedicated laws, and thus represent especially secure forms of investment. Legal regulations ensure that the quality of these forms of investment be maintained even in times of crisis (such as surplus cover). It is impossible to understand why legislators are proposing regulations in the new ICA which would undermine the legally-required security of mortgage bond investments.

Positions taken by institutions

Bavarian Congress of Chambers of Commerce and Industry (BCCCI): buffers protecting insurers against risk have to be retained

BCCCI has criticized the draft reform of the Insurance Contract Act as being unnecessarily bureaucratic. Its consulting requirements are stricter than those required by the EU’s insurance brokering directives. It also creates bureaucratic obstacles.

The BCCCI is highly critical of the proposals revamping the participation in net income. Paragraph 153 of the Insurance Contract Act goes beyond the requirements decreed by Germany’s Federal Constitutional Court by formulating regulations on valuation reserves which favor policy-holders in a one-sided way. The BCCCI maintains that the valuation reserves are constituted to serve as buffers against risks. Should these reserves be credited to the policy-holders, as foreseen in the draft, these buffers would be reduced. This could, in turn, cause the incurring of losses. Insurers would be obliged to credit within two years, on an irrevocable basis, half of the undisclosed reserves accrued from rises in stock quotes. Should the stocks subsequently crash, the insurers would experience losses drying up their liquidity.

The BCCD is therefore calling for the enacting of regulations which enable insurers to retain the buffers for risks. Such regulations could take into account the stipulations of the Federal Constitutional Court’s decrees by crediting only some of the profits irrevocably to the policy-holders’ accounts. The remainder would be transferred to the policy-holders on a provisional basis. This arrangement would serve to secure the insurers’ solvency. Should this not be enacted, insurers could be forced to reduce their holdings in shares, participations and real estate. This would have serious consequences for Germany’s financial community as a whole.

Bavaria’s economics ministry: greater clarity, points of criticism
Bavaria’s economics ministry joins the state-level working circle of the insurance supervisory agency in welcoming the long-overdue and thorough revamping of the antiquated insurance contract act. The draft submitted by the experts staffing the federal ministry of justice has adopted a structure, which is comprised of sections containing generally-applicable and special-purpose rules (for the individual kinds of insurance), which features a greater clarity than that of its predecessor.

Policy-holders will profit from such innovations as the creation of a single term of statutory limitation, as the doing away with the obligation to render claims within six months, and as the establishment of claims arising from the calling in of contracts prior to term.

The ministry is, on the other hand, joining the associations of the insurance industry in criticizing that the draft
  1. foresees requiring insurers to furnish information – in the form of the delivery of all relevant documents – prior to the entering into of an insurance contract. It would make more sense to retain the tried-and-found-true policy model, and to link it with a special right of rescission from the contract.

  2. contains new and highly controversial proposals on the policy-holders’ entitlement to insurers' net income. The proposals incorporate the suggestions made by the Federal Constitutional Court in July 2005 on ways of enabling the policy-holders to participate in the net income on a ‘real-time’ basis. The draft stipulates the policy-holders’ receiving of half the valuation reserves within two years at the most. This arrangement would eliminate the undisclosed reserves’ functioning as a buffer in bear markets.
The suffering of small-sized losses and the employment of current market value assessments would suffice to cause the companies to fail BaFin’s stress test. The draft therefore has far-reaching implications: it would reduce the insurers’ abilities to bear risks and endanger the stability of Bavaria’s financial community. These provisions should be replaced by others, already tabled, on ways of regulating entitlements to net income.

This also applies to the provisions regulating the repurchasing value of life insurance policies. The provisions are too expensive. They also encumber policy-holders fulfilling their contracts on a one-sided basis. These provisions should as well be replaced by ones setting up simple and fair procedures.

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