German insurers turn to CPPI and volatility control to back new guaranteed policies

Ergo dynamic hybrid product leads new wave

German life insurers are turning to innovative constant proportion portfolio insurance (CPPI) and volatility control mechanisms to underpin a new range of long-term guaranteed products.

Ergo, the life insurance subsidiary of Munich Re, will launch a product on July 1, which promises both a guaranteed return of gross premium and a guaranteed pension for life, in addition to potential investment participation.

Allianz Germany is also set to launch a new pension product, ‘Perspektive', on July 5 offering a return of premium guarantee, a minimum guaranteed annuity and a yearly increase in the maturity benefit.

In the case of Ergo's Rente Garantie [guaranteed pension] product, the premium will be split into a secured component to finance the guarantee and a growth component invested in stocks and bonds.

A major portion of the gurantee will be hedged through reinurance contracts with Munich Re.

The exposure to stocks and bonds is managed by what Ergo calls "a dynamic concept", understood to be a variation on a CPPI structure that employs a mechanism using volatility measures to trigger shifts in allocation.

Christoph Schmitt, insurance director at Fitch Ratings in Frankfurt, says the product structure is a novel addition to the German life market. "Most hybrid products calculate the investment share, which is not guaranteed according to the market value of the investment. This Ergo product takes more into account the volatility of capital markets," he says.

It is not yet clear what mechanisms Allianz Germany will use to hedge the guarantees in its new product.

German life insurers are no strangers to CPPI structures, which shift allocations between risky and risk-free assets according to an algorhythm defined by a fund's net asset value and guaranteed level of return. The Ergo Rente Garantie builds on this concept by using asset volatility to define allocations.

Henning Maaß, senior consultant at Towers Watson in Cologne, says the launch of dynamic hybrid products underline a growing trend in the German market. "CPPI seems to have been identified by many insurers as the favourite hedging or risk management technique."

He adds: "Some companies are also trying individualised or micro-CPPI, which is fully unit-linked, meaning the policyholder can look up their account value every day."

While such innovations offer policyholders upside potential alongside a guaranteed return on their investment, they do not solve the underlying problem of low interest rates that is plaguing the German market.

The maximum guaranteed rate German insurers are allowed to offer customers, as set by the German regulator BaFin, stands at 1.75% for new products. But low yields on fixed-income assets used to match liabilities, coupled with high policy management charges, makes this difficult for insurers to fulfil.

"Companies guarantee the gross premium," says Towers Watson's Maaß. "You can imagine it will be difficult to guarantee the gross premium if the charges are too high."

He adds that the need to make up the guarantee diminishes the value offered by the growth portion of hybrid products. "High charges mean there is not much buffer for insurers to provide the guarantee. This means the equity [growth] content of the investment is fairly low," he says.

This problem may undermine the attractiveness of Ergo's new product to some investors, says Fitch's Schmitt. "I would expect that this product is too conventional for those who are investment-risk types, because they recognise the high volatility of capital markets and will assume this product has only a minor portion in the risky part of the investments on average and everything else on the premiums guarantee."