On the Effect of Intensified Regulation on the Product Strategy of Nordic Life Insurance Companies

Article author: Olli-Pekka Ruuskanen
Position: Professor
E-mail: olli-pekka.ruuskanen@uta.fi
Organization: Insurance Science at University of Tampere
1, 2015
Language: English



Seven big Nordic life insurance companies were interviewed to find out how intensified regulation and especially Solvency II has affected their product strategy.  Almost all companies have given up writing new traditional business, and each company uses risk based steering which is a positive side effect of Solvency II.   Variable annuities could be a compromise between traditional and unit liked businesses, but the companies do not write variable annuities very intensely.  The companies’ activity in fixed annuities is gradually growing, but they do not transfer the longevity risk to a third party.  This will prove necessary when the annuity market grows. The companies are growing their risk life business, but few of them have implemented new risk factors instead of gender which is no more allowed in life insurance.  All companies use bancassurance as sales channel solution.  Almost all of them are a part of a captive structure, and they do not foresee any changes in this.  In this respect the companies differ from a current trend in Southern and Central Europe according to which banks are lightening their holdings in insurance companies.

1                Introduction

The insurance regulation in the EU has intensified during the past few years and it will be intensified greatly in the near future.  In the old Solvency I regulation the inherent risks of insurance obligations and investments have not been taken into account at all or have been taken into account only superficially.  The forthcoming Solvency II framework changes this fundamentally.  It introduces a new way to calculate the solvency capital requirement for an insurance company in the EU.

To what extent will the tightening regulation affect product strategy and product development of insurance companies?  One reaction could be to move the product offering towards capital-light products, i.e. products whose capital requirement is relatively low.  This might have negative effects on customers who perhaps cannot have his/her most preferred life product in the market. In this study the aim is to find out what the effects of changing regulation have been and will be in Nordic life insurance companies. This will be determined by asking the companies themselves about their reactions.

This study concentrates on the effects of regulation on life insurance companies, and deals mostly with EU’s Solvency II framework.  Solvency II is a reform project on the solvency regulation and supervision of life and nonlife insurance undertakings within the EU.  The purpose of the reform is a harmonized, comprehensive and risk based solvency framework which promotes internal competition within the EU, effective use of capital, and own risk management of the enterprises, and consequently intensifies the security of the benefits of insured parties. The Solvency II regulation has been under preparation and unfinished for over a decade. The Solvency II directive will be finally applied from 1. January 2016.  Because of the long preparation period insurance companies have had time to adapt themselves to the new legislation and it is possible to foresee the forthcoming requirements already now. To get a closer look at Solvency II, the reader is advised to read e.g. Doff (2014).

The risks of an insurance company are calculated in much greater detail according to Solvency II than in the earlier legislation, and according to several implemented impact studies the solvency capital requirement of most life insurance companies will rise substantially.  On product level this varies a lot, which we expect to see in this study. For example, market risk in with-profits (also called traditional) life products and interest risk and longevity risk in annuities typically increase capital requirement of these products essentially.  The guarantee obligation in variable annuities brings high solvency requirement unless transferred away. Risk life insurance is capital-light compared to savings insurance.

As Lorent (2008) notes, the risks inherent in life-insurance products have shifted from technical risks to market risk. The hypothesis is that these facts are shown in product design, product development, risk management and marketing in the interviewed companies.  In particular, it is assumed that there has been a clear transition from traditional life business to unit linked business. 

The aim of this research is to find out how increased regulation affects the product strategy, product development, marketing, customer service and other functions of life insurance companies.  The impact of regulation on the business and product development areas and the withdrawal of established products and introduction of new kinds of products is especially the target of interest.

Most of the previous studies on the impact of insurance regulation have been conducted in actuarial frameworks. [For example Ballotta, Haberman and Wang (2006), Tanskanen and Lukkarinen (2003), Gatzert and Schmeiser (2008).] However, recently management surveys have been used to study industry effects in scientific literature. For example, Kreutzer and Wagner (2013) studied the perceived impact, effects and uncertainty accompanying current reforms of solvency regulation in European insurance companies. They adopted a high level (CEO) viewpoint and did not touch product issues any more than concluding that product diversification will grow and product pricing will get higher.

Fundamental features and regulatory implications of traditional business were studied by Briys and Varenne (1993). As Grosen and Jörgensen (2001) point out, one of the reasons for the defaults of life insurance companies has been the mismanagement of the interest rate guarantees. It is not surprising that the Solvency II project has taken this into account rather seriously, which is shown in high market risk charges.  As a result it seems that there has been a transition from traditional life insurance to unit linked life insurance.

The aim is to produce questions from the actuarial framework directed to the management of life insurance companies. These questions were presented in a survey questionnaire that was directed to those directors of significant Nordic life insurance companies who are responsible for the product strategy and/or product and business development of their companies. This paper will in effect mix two literatures and provide new insights on the workings of life insurance industry. The aim is to move from theoretical results to policy implications.

2                Research questions and data

We received answers from seven Nordic life insurance companies, all of which belong to the four biggest life insurers of their country. We structured the questionnaire into a six general areas: General implications of Solvency II, introduction and use of variable annuities, longevity risk and annuities market, pure life risk products, effect of other recent regulation and the impact of regulation to bancassurance. The research questions are attached as an appendix. 

To give the reader some idea about the life insurance industry in each Nordic country, we give some details from the year 2013.  In Sweden the total gross written premiums were 21,8 billion euros, and the biggest life insurance companies in terms of market share were Skandia (14%), Folksam (14%), Alecta (12%), and AMF Pension (10%).  In Denmark the total premiums were 18,5 billion euros, and the biggest companies were PFA Pension (15%), Danica Pension (12%), Nordea Liv & Pension (10%), and PensionDanmark (8 %).  In Norway the total premiums were 11,2 billion euros, and the biggest companies were KLP (31%), DNB Liv (24%), Storebrand Liv (19%), and Nordea Liv (9%).  In Finland the total premiums were 5,4 billion euros, and the biggest companies were Nordea Life (41%), OP Pohjola Life (21%), Mandatum Life (19%), and LokalTapiola Life (8%). 

Bank-owned life insurance companies are quite common in the Nordics – in Denmark, Norway and Finland two of the above mentioned four companies are subsidiaries of a bank.  In Sweden bank-owned life companies do not fit in the top four.  We sent a research questionnaire to the four biggest life companies in each country, and we received answers from seven companies. 

3                Analysis of results

3.1.               General implications of Solvency II on the product strategy

The companies were asked to give a self-assessment on the scale 1-10 how much Solvency II has affected their product strategy and product development separately. The average score of seven for both questions indicated that the companies felt that the Solvency II has had a profound effect on their product strategy and development.

The companies indicated that the biggest impact in the product strategy will be the result from the high solvency capital requirements which Solvency II is likely to impose on traditional (with-profits) life assurance. The estimated average effect was eight out of maximum ten. As many as six out of seven companies answered that they have stopped selling traditional life business. Moreover, some of the companies reported that they are trying to modify or convert traditional old policies to unit linked policies. 

The effect of Solvency II is visible in all product categories: the companies have both modified their original products and some have also launched new products: unit linked both with and without guarantees. Also pure risk products have been both modified and new products launched.

When asked about the development of traditional products as a share of total life insurance premium most of the companies had seen a decrease in that share. On average the share has decreased by 30 percent. However, there was one respondent who indicated that the share of traditional products had increased by 40 percentage points. This company is the same that indicates that it has launched new traditional business. This is an indication that companies position themselves differently in a new competitive landscape.

General closing of traditional business is a problem for customers because they evaluate high the capital guarantee and guaranteed interest in a traditional policy.  In a unit linked policy the investment risk is totally delegated to the customer.  One possible compromise could be the variable annuity (unit linked policy with some guarantee element).

Solvency II can be found beneficial from company strategic management point of view as it makes possible for companies to build better management information systems that reflect the risk.  The companies were asked to define if they had started or intended to utilize risk based management. All the companies that answered gave a positive answer. Most of the companies had started to use it just recently or alongside the development of Solvency II. One company indicated a longer history of risk based management.  

3.2.               Variable annuities

Bragt et al. (2010) investigates risk/return tradeoff for life insurance companies in the light of Solvency II framework.  They note that one of the ways to mitigate market risk is by increasing unit linked liabilities and decreasing traditional liabilities. Ordinary unit linked insurance products delegate all investment risk to the customer.  A compromise between traditional and unit linked insurance is unit linked with some kind of guarantees, better known as a variable annuity.

The financial innovation has produced a number of hybrid products in the variable annuity space that encompass features of security and high yields. The financial landscape is populated with a continuum of life-insurance products that carry various amount of expected investment gain and various guarantees for minimum gains.

At the moment the products with guarantees can be categorized into four major categories depending on the nature of these guarantees. They are:

  • Guaranteed Minimum Death Benefit (GMDB)

  • Guaranteed Minimum Accumulation Benefit (GMAB)

  • Guaranteed Minimum Withdrawal Benefit (GMWB)

  • Guaranteed Minimum Income Benefit (GMIB)

Solvency II will force companies to evaluate how expensive current and future products are in terms of the capital. Introducing new products is a time consuming and error-prone process. One outcome for Solvency II has been that companies have been forced to build internal models to estimate the capital requirements. There has been increased research activity in trying to model the solvency capital requirements for hybrid products in order to assess their viability (Kochanski and Karnarski, 2011).

Lorent (2008) assumes that as a result of risk-based capital requirements insurers will promote contracts with fewer risks for the insurer like unit-linked and more products with more flexible readjustment terms. This should lead to a mix of products that have various features in terms of various guarantees and return profiles. We asked whether this has indeed been the outcome for life insurance companies in our sample.

Four companies disclosed to have launched variable annuities.  Three companies have launched minimum death benefit type of variable annuities, two companies’ minimum accumulation benefit and one company minimum withdrawal benefit type of variable annuities.  No company had launched guaranteed minimum income benefit type of products. 

Out of the four companies having launched variable annuities, none had introduced an internal model to assess the solvency capital requirement of the product. Two companies disclosed how they planned to transfer the risks involved in these products. The other company said they will transfer at least a part of the guarantee obligation to an investment bank. Another company said they will be using dynamic hedging process in transferring the guarantee obligation.

The companies were asked in which customer segments the penetration of variable annuities is highest.  One company answers “upper (preferred) retail customers”, and two companies answer “middle retail customers and corporate customers”.  The companies were asked the premium share of the variable annuities compared to traditional premiums/unit linked premiums.  Three companies gave information indicating a heavy dependence on the traditional products in the share of premiums.

Only four companies have launched variable annuities, and only two companies tell anything about hedging the inherent guarantee obligation.  There seems to be potential in variable annuity business, which is much more developed in certain parts of Europe, USA, and Japan than in the Nordic countries.  Guaranteeing the death benefit and/or the savings at some point of time is better than no guarantee.  When the variable annuity market matures, it is important for a life insurer to hedge the guarantee risk effectively to avoid severe solvency requirements.  From customer point of view there are of course alternatives for variable annuities which reduce investment risk, like unit linked with regular advice for reallocating the assets or even automatic reallocation – they are, however, no guarantee vehicles.

3.3.               Annuities and longevity

Along with ageing populations, annuities are growing in importance.  Their solvency capital requirement is related to longevity risk, whose accurate estimation is extremely challenging.  (See e.g. Doff (2014).)  In this situation the transfer of the longevity risk to a third party might be a feasible option.  If the annuity is a traditional policy, it carries also interest-rate risk.

Annuities are quite commonly offered.  One company does not offer annuities, three companies offer annuities only for selected customers and three companies offer annuities for all customers.  The reason why one company does not offer the product is that it is not tax wise feasible in that country.

The companies were asked if the high solvency capital requirement which Solvency II is likely to impose on annuities carrying longevity risk/credit risk has affected each company’s product development.  The scale is 0-10.  The answers differ significantly, and the average score for longevity risk is 3,5 and for credit risk 3,1.  These are quite low figures.  All six companies in annuity business report that they have not transferred longevity risk to a third party.  In the longer run and along with the aging populations the annuity markets will inevitably grow, and longevity risk transfer becomes necessary.

The high solvency capital requirement which Solvency II is likely to impose on annuities is not considered a big problem by our respondents.  All companies in annuity business report that they have not transferred longevity risk away even if the transfer would bring lighter solvency capital requirements according to Solvency II.  Facing the aging populations it becomes all the more important to offer solutions with which customers can individually complement the public benefit systems.  Annuity is a useful vehicle to transform assets to life-long cash flow. In this respect, the global annuity markets will inevitably grow.  When savings volumes in annuities grow, and the longevity risk is not offset by a company’s own mortality book, the inherent longevity risk must be transferred to a third party efficiently.  For this purpose a life insurer can use the services of a reinsurance company, an investment bank, or a mortality underwriter.

3.4                Risk life insurance

One effect of Solvency II tighter capital requirements can be the move from products that have investment characteristics to pure life insurance, where the only risks are mortality and morbidity. These types of risks have a light solvency capital requirement in comparison with the products that carry investment risk.

Furthermore, recent surveys (e.g. Swiss Re (2010)), indicate that households have underinsured their mortality risks. One of the reasons for lack of insurance cover might also been that under Solvency I the companies did not find this market as lucrative. The actual need of customers for a better life insurance cover and the new regulation might push companies to target these products.

All the companies surveyed indicated that the amount of risk premiums had increased in last five years in their portfolio. However, they indicated that the premium increase rate had been more modest in recent years. It could be the case that risk insurance may already before recent solvency requirement developments have had big weight in some companies’ business portfolio.

In order to determine which of these two effects had contributed more to the increase in premiums we asked if there had been a move in the companies’ business portfolio towards risk insurance due to the relatively light solvency treatment of risk insurance lines. Four companies out of seven answered positively and the rest said that it had not.  We then asked whether the move to market these products was motivated by the low average life insurance cover of people in the country/countries the companies operated in. Also four companies answered negatively and the rest answered positively.

The relatively light solvency treatment of risk life insurance has not moved the weight of risk insurance lines in the companies’ business portfolio very much on the average.  This indicates that the weight of risk business is rather high in many companies already now.  The risk premiums have typically grown steadily during the last five years.  The possibly low average life insurance cover of people in the country/countries where the companies operate has not promoted life risk business significantly.  This calls for the question if this topic could be used in risk life insurance marketing more effectively, see also Swiss Re (2010). 

3.5                Gender neutral tariffs and new disclosure rules

At the same time that Solvency II is in preparation there has been and are currently in preparation a number of other regulatory reforms and other rulings that impact life insurance companies. One of the major pieces of legislation affecting life insurance industry in the European Union has been the Court of Justice’s decision that gender cannot be used as a rating factor in life insurance from December 2012. (EU MEMO 11/123). Because the gender is not available companies might introduce additional rating factors to supplement the unavailable ones and to make their predictions more accurate. We asked if the companies have introduced new tariff factors. Five companies reported that they had not introduced new ones. Two indicated they had.

There has also been regulation on the consumer protection that require companies to disclose more information to the customers on yields and administration expenses. This regulation is local and differs from country to country, for Finland see FSA Finland (2012). We were interested in the effect of this additional regulation on the product and business development. These kinds of new disclosure requirements usually call for adjustments in the product characteristics even at the actuarial level.

Half of the companies indicated that the regulatory obligation to present the customer all expenses and yields of a policy had not affected their business and product development.  Indeed, one of them explained that the obligation had been implemented many years ago. The other half agreed that it had affected them either slightly or strongly. One of them had to modify the actuarial rules of their products because of these requirements. The regulatory obligation to present the customer all expenses and yields of a policy has affected only slightly or not at all five out of six companies’ business.

3.6                Solvency regulation impact on bancassurance

We asked if the companies use bancassurance as sales channel solution.  Each company answered “Yes”.  Six out of seven companies are involved in captive model, i.e. a bank owns the life insurance company or the life company and the bank which sells their products belong to the same group of companies.  The seventh company is a part of a non-exclusive alliance i.e the company and their sales channel bank are independent and there is a non-exclusive sales agreement between them.  The status of all the seven companies was exactly the same three years ago.  Six years ago the companies that are now involved in captive model had already the same status, and the seventh company had no sales relation with banks.  The companies were asked what their status will be in three years, and all of them answered that the status will be the same as now.  The companies seem to be in a rather static position regarding bancassurance, and with one exception their bancassurance model is being a captive of a bank. 

All the companies practice the bancassurance sales channel solution, and one of them has a loose sales agreement with their partner bank (without exclusivity). The status of all the banks seems to be static i.e. the current sales channel solution was the same already three years ago and it is assumed to remain the same during the next three years.  This is again an interesting result.  It has been reported recently (see e.g. van der Poel (2013) and Navarro (2014)) that banks tend to give up the captive bancassurance model and transfer to joint ventures or different kinds of sales agreements.  The rationale for a bank is the optimization of its capital management.  This trend is particularly visible in Southern and Middle Europe.  Our study confirms that the captive model will be the dominant bancassurance solution during the next three years in those of our sample life companies which are members of that kind of alliance now.  It is important to notice, however, that their bank partners may have other plans for the future.

In bancassurance, the Nordic companies of this study have not followed and do not expect to follow the Central and Southern European trend of loosening ownership ties between the bank and the insurance company, but this is something where the bank takes initiative if and when necessary.  In other parts of Europe banks have acted this way when they have come to the conclusion that the capital charge of owning insurance in the solvency assessment of the bank exceeds the returns from insurance business.  Considering that the captive model is the dominant bancassurance model in the Nordics, this has not been the result of the evaluation there so far.

3.7                Capital acquisition

Al-Darwish et al. (2011) note that one of the possible consequences for tightening regulation is that it will become more difficult for financial industry to raise capital as investors will demand higher return for the additional capital that the companies will require. We asked if the life insurance companies in our sample have encountered or anticipate encountering problems in acquiring more capital because of the tightening solvency regulation. 

Four companies indicated that they would not face additional problems. Two companies agreed on minor problems. The company that had indicated in earlier answers a strong emphasis on traditional life insurance products and told that Solvency II has had a minimal effect on their product strategy and product development, saw serious problems arising from their ability to access capital in the future.

4                Diverging strategic space

Based on the answers received, is it possible to find different strategic outcomes that the companies are pursuing? Among the seven life insurance companies there was one company which can be denoted by EC (“Exceptional Company”). The answers differ very much from the other companies.  EC is by far the biggest company of our sample and its ratio of traditional business to all business is much higher than the other companies both in terms of technical reserves and premiums. 

EC states that Solvency II has had very small effect on their product strategy and product development, and that new higher solvency capital requirements on traditional business have had only modest effect on their product development and offerings. 

All the other companies report quite high or very high effects that tightening regulation will have on their product offerings. All the other companies except EC have stopped new traditional business while EC has launched new traditional business recently.  EC reports significant increase of the share of traditional / all premiums during the last five years while the answers of the other companies vary between sharp decrease and remaining the same.

The fact that almost all companies report high influence of Solvency II on their product strategy and product development, and Solvency II has sharply reduced their traditional business is expected.  The existence of EC is interesting.  Their answers to the general implications of Solvency II for that company are almost opposite to the other answers.  What is even more interesting is that they have encountered and anticipate major problems in acquiring more capital because of the tightening solvency regulation.

From a customer’s point of view it is important that traditional life insurance is still available in EC, because hardly any other company sells traditional policies.  We can assume that EC has grown so big by selling traditional life while other companies have finished new sales.  Because of increasing solvency capital requirements EC has to consider its product offering again in the light of Solvency II.

5                Concluding remarks

In this study we have examined several trends in life insurance industry that could be the result of Solvency II:  downtrend of traditional business, uptrends of variable annuities, fixed annuities, and risk life insurance and a kind of downtrend of banks’ ownership in insurance companies. 

To find out which of these were currently on the agenda of major Nordic life insurance companies, the companies were approached directly via questionnaires. Answers to survey questions confirm that the life insurance companies of this study follow the downtrend of traditional business and the uptrend of risk insurance. However, the response is not uniform. Among the companies there are different strategic positions taken. In variable annuities and annuities the companies do not move against the trend, but there seems to be much potential in these areas.

In their IMF-report on the possible unintended consequences of Basel III and Solvency II Al-Darwish et al (2011, 49) mention disintermediation. They imply that this will be determined by the elasticity of demand and supply between different products.  They also argue that customers may face non-socially optimal risk sharing products, where consumers will be exposed to excessive risk, especially in long term products like pension products. Therefore, the possible consequences of product portfolio readjustment on consumer welfare should be assessed in future work.

It would be interesting to renew this study in the Nordic countries after a couple of years and in other parts of Europe whenever to verify if the above mentioned trends are followed and with what intensity.



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