ALM for life insurers, pension funds and pension schemes

The aim of the ALM model is to optimize the management of investments in accordance with the specific business characteristics and the accounting and regulatory requirements.

In contrast to life insurance, the actuarial interest rate of pension plans and some pension funds is not a hard guarantee. In the case of pension funds, the actuarial interest rate can be reduced for existing contracts.

In the event of long-term low interest rates, the liabilities must be subsequently reserved. Even in the case of rapidly rising interest rates, the so-called additional interest reserve increases, e.g. for life insurers and competitor pension funds, due to a moving average method.

Pension funds can finance the additional reserves by increasing contributions and reducing benefits.

In the case of life insurers, the Minimum Allocation Ordinance regulates the distribution of surpluses between shareholder and policyholder as required by supervisory law.

ALM optimization should essentially pursue two HGB objectives:

1. the avoidance of a loss and thus an additional contribution by the shareholders or the parent company

2. the achievement of a certain target surplus participation (for life insurers).

ALM analyses can be performed either deterministically in specific capital market scenarios or by means of stochastic analyses.

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Risk Management

Investment risks are among the most important in the overall risk management of a pension fund or insurance company. The investment risks must be duly integrated in a holistic company-wide risk management approach, known as Enterprise Risk Management (ERM).

The supporting pillars of an ERM are the risk management culture, risk calculation, risk control and risk management.

Solvency I

On 12.12.17, the capital investment circular R 11/2017 replaced the capital investment circulars R 4/2011, R 1/2002 (ABS/CLN) and R 7/2004 (hedge funds). The new circular is a concretization of the Investment Regulation (AnlV), which was last updated on 21.4.16. Compared to the old AnlV (status prior to 2015), there are relaxations with regard to loans to infrastructure projects, companies with a sub-investment grade rating and real estate companies with sufficient real security (new No. 4c with 5% limit). In addition, the implementation of the AIFM introduced an AIF quota of 7.5%. Here, for example, 100% loan funds are possible.

In addition, BaFin published the circular R 8/2017 “Hinweise zur Nutzung von derivativen Finanzinstrumenten und zur Anlage in strukturierten Produkten” on 30.8.17. The new circular replaces the BaFin circulars R 3/2000 (for derivatives) and R 3/99 (for structured products) as well as other statements in this context. In the new circular, BaFin extends the possibility to use derivatives.

The obligation to apply the Investment Regulation (AnlV) and the associated circulars has been removed with Solvency II for non-small insurers. Many Solvency II insurers are still basing their internal investment guidelines on the AnlV and the associated circulars, as they have proven their worth as “crash barriers”.

I expect that most insurers will need some time before they adapt their internal guidelines to the Solvency II world. In the past, these guidelines were closely based on the Investment Ordinance and the circulars for capital investments.

Solvency II

Since 1.1.16, insurance companies have been subject to the new Solvency II supervisory regime. This consists of three pillars, which I would like to call the following.

1st pillar: “Calculation
2nd pillar: “Understanding
3rd pillar: “Reporting

Insurers should see Solvency II as an opportunity. It will help life insurers in particular to better “manage” their risks. Insurers should also use ORSA to deviate from the standard formulas when justified. This requires analyses that go beyond the standard model.

Insurers should dare to develop partial models. In one place or another, capital can possibly be saved if the model results are justified.

In addition, a rethinking of capital investment is necessary. In the case of bonds, for example, the decisive factor is no longer the return in relation to, say, the rating, but the return in relation to the cost of capital. The regular comparison of different possible asset allocations and management rules must be part of every investment manager’s obligatory program.

Furthermore, investments must not be managed solely with a view to minimizing capital requirements. Recommendations regarding a particular strategy depend on the current capital and market situation.


The accounting standards are decisive in determining whether a financial instrument is suitable for an investor’s business. The effects of the investment in the balance sheet and the income statement determine the success or failure of the investment decision. However, the accounting regulations are often only formulated in general terms, so that they must be interpreted correctly for the individual investment.

The following special regulations are of particular interest:


IDW RS HFA 22: structured products
IDW RS HFA 35: Derivatives
German Actuarial Reserve Ordinance: Insurance contracts (incl. additional interest reserve)

IAS 39, IFRS 9: Derivatives and structured products
IFRS 10: Consolidation
IFRS 17: Insurance contracts
IAS 19: Pension provisions


In December 2016 the revised Directive on the activities and supervision of institutions for occupational retirement provision (EbAV-RL II) was published. EbAV II focuses on “improving the governance, transparency and reporting of EbAV”. In Germany, pension funds and pension funds are covered by the EbAV-II-RL.

The new directive does not contain any tightening of the capital requirements for EbAV. However, EbAV-QIS (Quantitative Impact Study) has already been carried out, using so-called Holistic Balance Sheet approaches (HBS) and examining the effects on the capital situation.

I think that the most important pillar is governance: The bodies of EbAV will continue to be required to maintain documented rules in the areas of risk management, internal controls, internal audit and outsourcing, and to regularly conduct their own “Risk Evaluation for Pensions” (REP).

The pension funds supervised by BaFin have already been allowed to implement the Minimum Requirements for Risk Management (MaRisk). EIOPA will go a little further.

Depending on how these standards are further developed by EIOPA, considerable additional requirements and costs may result from EbAV. However, the EIAs should see this as an opportunity and expand their risk management and governance.

Derivatives and structured products

Life insurance companies, for example, use financial derivatives to hedge the risks arising from the contract options sold to policyholders. The market environment and procedural requirements always present major hurdles.

Structured products are still a proven means for investors to enter into derivatives embedded in a balance sheet and process-friendly package. These structures are used for hedging as well as for yield enhancement purposes. The issuer risk and the term of the interest carrier play a significant role in addition to the derivative. Furthermore, special funds are often used for the management of derivatives.

Financial derivatives also offer the investor a risk and return profile that is not possible with other financial instruments. In the case of options, for example, the distinguishing feature can be the downwardly limited possibility of loss, liquidity or participation in index and quantitative trading strategies.

If you want to compare all the different possibilities of investing in financial derivatives, you have to take into account accounting, regulatory and procedural aspects.

Alternative Investments

Institutional investors who have offered their customers a high return on their assets are suffering enormously from the low interest rates. Low-risk securities that fall due and still have higher fixed coupons are expiring and must be replaced by investments with lower returns at the same risk. Alternatively, a higher reinvestment return can be achieved by taking a higher credit, liquidity or other risk.

However, no investor would buy new risks without first understanding them. Investors must therefore examine in particular the market risks, valuation, accounting, taxes, contracts, and regulatory requirements and implications. Every new investment product requires a “new product process” in which all these points must be worked through and answered positively until an investment can be made.

However, the above requirements alone are not enough. In the case of alternative investments, investors usually have to cooperate with external institutions that already hold the investments or have the necessary market expertise for the origination and/or ongoing management. This results in a further chain of review. Is it the right cooperation partner? Where does he get his assets from? Do I continuously get the assets that I have already found positive? Do I get all information I need for my internal processes? Are there new risks through the cooperation?

Furthermore, the cooperation partner of alternative investments usually offers you one or more investment vehicles, which again involve several verification steps. You may need a vehicle other than the one offered by the partner. Embedding in your own existing vehicles, such as special funds, may also be an option.

If you too would like to introduce new asset classes or expand existing ones and need an independent partner who can use its expertise to close existing temporary gaps for the above-mentioned audit steps, please contact me.