Sustainable pensions under changing conditions – products and concepts
While interest rates have been on a steady downward trend for some time – let us recall the development of the reference interest rates since the introduction of the additional interest reserves in 2011 – and the term ‘low-interest period’ has become a standard phrase, in spring 2022 there were first signs of an interest rate recovery, which continues to this day with a sharp rise in interest rates.
The development was driven by increased inflation, which is attributable to supply chain problems and changes in consumer behaviour in the wake of the Covid-19 pandemic, on the one hand, and the Russian war of aggression in Ukraine and subsequent sanctions on the other. To combat rising inflation, the ECB has increased the main refinancing rate from 0 per cent to 3.5 per cent in several stages – 3.5 per cent since 22 March 2023. Although inflation is still a long way from the 2 per cent target, further interest rate decisions must also take into account the turmoil that has now arisen in the banking sector – problems for several banks in the US and an arranged takeover of Credit Suisse by UBS in Switzerland.
Against the backdrop of the low interest rate phase, classic products and concepts in the field of life insurance were repeatedly reviewed. With the gradual lowering of the maximum technical interest rate, it was necessary to adjust traditional products with an annual interest guarantee and customary premium guarantees. Products with guaranteed maturity values and reduced guarantees were introduced; they are often referred to as the ‘new classic’. Over time, however, at a maximum technical interest rate of almost 0 per cent, traditional products have lost their dominant position in the market.
At the same time, unit-linked and hybrid products have become more important. The classic unit-linked product combines individually selectable funds with rather low risk protection in the event of death. Hybrid products can take advantage of investment opportunities in the fund sector and provide guarantees through partial investment in the cover fund or so-called guarantee funds. But premium guarantees have also been reduced for hybrid products – for example, 80 per cent of the premium amount is guaranteed as a survival benefit at the end of the contract.
As recommended by the DAV, the maximum technical interest rate of 0.25 per cent – since 1 January 2022 – is to remain unchanged as of 1 January 2024. With generally higher interest rates and a maximum technical interest rate of 0.25 per cent, traditional products are difficult to offer as a competitive investment – although in retrospect, of course, the surpluses make a decisive contribution to the development of the assets. However, no rosy times can be expected for surpluses in the case of products with investments in the classic cover fund, given the sharp rise in interest rates. Investments in the classic cover fund in long-term fixed-interest securities will continue the earnings situation from the low-interest phase for years to come and have a major impact on earnings and the surpluses financed with them for some time.
What products and concepts can be derived from this in the area of old-age pensions? Developments in recent years have shown that long-term stability and sufficiently high interest rates are not to be taken for granted. The required duration of stable interest rates is determined by the typical duration of traditional insurance products – often several decades in the case of old-age pension products. With regard to the amount required, positive returns are expected after taking inflation into account. Information on this can be found in the draft leaflet on the prudential aspects of capital-forming life insurance products from BaFin. Even if the information sheet refers to unit-linked and hybrid products, the requirement for positive real returns must also be applied to traditional insurance products.
For this reason, preference is given to pension products with a partial or predominant investment in tangible assets, i.e. investments with higher expected returns, but also with higher volatility.
To this end, unit-linked products must first be mentioned in which the policyholder bears the investment risk and can decide which fund to invest in. The combination of investment in funds with guarantees is a characteristic of hybrid products. Typically, a portion of the premiums for these products is invested in the classic cover fund in order, for example, to secure the promised guaranteed maturity value. The remaining contributions are invested in the funds selected by the policyholder. In the case of dynamic hybrid products, the investment is adjusted to the current situation over time, for example on a monthly basis. In the case of a three-pot hybrid model, a guarantee fund, where a potential drop in value within one month is limited, for example, is used to hedge the guarantee in addition to the classic cover fund. The basic approach is to invest as much as possible in funds, with the additional condition that the promised guarantee is secured.
The key feature is investment in assets with higher returns – combined with certain collateral that mitigate the volatility risk for the individual policyholder.
For an interesting version of this approach, please refer to the long-term savings insurance of the Swiss company La Mobiliére. The higher-yielding investment is combined with collective buffers to build up collateral. The ideas can also be found in the social partner model for workplace pensions, whereby the non-classic investment is not only limited to the deferment period but also applied to the pension payout phase.
