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The Actuary The magazine of the Institute & Faculty of Actuaries

Winds of change in Germany

Since the time of Bismarck the social security system (Sozialversicherung) in Germany has
been on a pay-as-you-go basis. For the major-
ity of people in retirement the annuities paid by the Sozialversicherung have been the major source of income. But, as in all of western Europe, demographic development has put a heavy strain on the system, with contributions rising to approximately 20% of one’s salary but with the expectation of future annuity payments being cut back. For years reforms of the public pension system were discussed and debated but with no result, and then a year ago a proposal was made by secretary of state for labour Walter Riester to supplement the pay-as-you-go system by a funded pension scheme.
Market development since deregulation in 1995
Even after deregulation, not much changed in the German life insurance market. The opportunity to create new products or to change the basis of the fundamental calculations has been used to a minimum. Virtually the whole industry uses the same interest rate and the same mortality table. There have been a few mergers and acquisitions and some new market entrants, but the picture has remained relatively unchanged.
The only remarkable development has been the rise of unit-linked business, being only 4% of new business sales in 1994, rising last year to approximately 27%, and expected to reach more than 35% this year, particularly since Allianz has announced its intent to market unit-linked products in the very near future.
The market share of annuities has also risen considerably. The market share of the traditional endowment fell from over 50% in 1995 to less than 25% last year. The development of annuities has been stimulated by the discussion about longevity, and the rise of unit-linked products is partly a result of the recent popularity of the stockmarket. In 1999 banks, together with investment management companies, tried, with great resolve but eventually to no avail, to inhibit the ability of insurance companies to offer savings products. They argued for a level playing field in that German life insurance enjoys a tax privilege envied by the other investment alternatives, the death and/or disability risk covered by insurance policies playing only a minor role in some market segments.

Riester products
Commentators discussing the new pensions reform have coined the term ‘Riester plan’, named after its architect. A Riester plan is a financial services product complying with certain rules set by the new law and bearing a Riester certificate which, at the moment, can only be issued by the Bundesaufsichtsamt fur das Versicherungswesen (BAV), the regulatory authority of the insurance industry. The certification process is expected to start at the end of this year.
With the so-called Riester Rente (Riester annuities), a new era has been declared in the German financial industry and it remains to be seen which companies will prosper in the long term. At least two professions will be major beneficiaries, namely revenue officers and actuaries. It is estimated that between 1,000 and 2,000 new revenue officers will be needed to supervise the Riester plans.
Contributing into a Riester contract is, at least for the moment, a voluntary option. But contributing a percentage (to a defined maximum) of your salary will entitle you to a government supplement and, where appropriate, also a child allowance. The percentage of earnings permitted will grow from 1% in 2002 to 4% in 2008. Contributions will normally be based on and deducted from gross salary, prior to calculating income tax. Since all employees (about 20m) in the private sector are entitled to participate, the annual premium for Riester plans is estimated to be around e10bn in 2008. And of course the premiums will rise as the average income in Germany rises, so the current forecasts are relatively conservative.

Administrative headaches
While Riester is, on the face of it, very attractive for providers, there are many administrative headaches to overcome, for example the irregularity and source of contributions. Normally there will be monthly employee contributions, but there is also the opportunity for an individual to make additional single contributions. Each employee has to complete an annual tax return, and this will be checked and will form the basis for the government’s contribution which will subsequently be sent to the provider and paid into the individual’s contract.
All contributions and profits have to be accumulated within the contract. Only in the case of disability is there a chance of getting an annuity before retirement. An individual can change the provider of the contract at any time during the savings phase. At retirement the maturity value has to be transferred into an annuity with pension payments until death. The annuity does not have to be with the same provider as for the savings phase.
There is a guarantee requirement that the maturity value must be at least equal to the sum of the total contributions paid. The conventional products of the traditional German life insurance company invest in gilts and fixed-interest bonds and only a small portion is invested in equities. The endowment or annuity policy will normally have a performance of between 5% and 7% compared to that of 10% for investment funds. In the last few years the industry has come under pressure because the demand was perceived to be for performance rather than insurance cover and guarantees, hence unit-linked business boomed because it offered a profit opportunity similar to investment funds. But investment funds usually carry no guarantee, and solely investment fund-based Riester products are unlikely, although banks can offer simple deposit-based saving plans. So in the race for retirement provision run on the basis of product performance the insurance industry is in pole position.

Sales commission
However, it might just be a mixed blessing for the insurance companies. The success of German life insurance is mainly due to the high front-end commission which, through Zillmerisation, places no financial strain on the companies. This will not be possible for Riester products because the law states explicitly that the contribution costs to finance the sales commission have to be evenly distributed over at least the first ten years of the contract. But since the intermediaries depend on high front-end commission, they are demanding it even for Riester products, and companies are trying to find ways of providing it. For example, reinsurance companies offer contracts financing at least part of the commission. Additionally, that which consumer organisations have demanded for a long time the disclosure of premium components, split into administration expenses, sales expenses, and risk premium parts is obligatory for Riester products, and this transparency is likely to set a precedent for all future life insurance products.

Most insurance companies will have great difficulty in administrating the products. In recent years there has been a considerable strain on IT departments and administration systems. Apart from the normal daily work there was Y2K, and the conversion to the euro starting in 2002.
Then there has been the widespread introduction of unit-linked products and some significant actuarial changes, for example a reduction of the interest rate used in the traditional contract calculations, which led to a new product generation in July of last year for the whole industry. More than ever before, companies are looking to buy application software packages or components and, for the first time in Germany, may use third-party administration (TPA) as a means of introducing new products.
Stuttgart-based software company COR has recently been successful in offering TPA for unit-linked products to smaller insurance companies, and the leading system supplier to the German life insurance industry FJA has announced that two medium-sized companies have signed up for their newly established TPA service. This development would have been inconceivable a few years ago.
Riester reforms will transform the industry but will prove difficult to implement. This is not the end of the story, merely the beginning of a long saga.