Fitch Ratings' Outlook for the German life insurance sector remains Negative, according to a special report, despite the relative resilience of the sector when compared with other life insurance markets. The negative outlook reflects Fitch's expectation that the number of rating downgrades will exceed the number of upgrades over the next 12-18 months.

German life insurers' 2008 earnings were significantly impacted by the financial crisis, however their balance sheets remain relatively robust. As the largest institutional investors in the German capital markets, life insurers are significantly affected by the financial market crisis. Fitch believes that the crisis will have a significant impact on 2008 financial statements and result in a net interest return significantly below 4% (2007: 4.6%). As the average profit participation for 2009 remained almost stable at 4.3% (4.4% in the previous year), the agency estimates that the lower interest return will have resulted in a significantly decreased level of the funds for future appropriation (known in German as free RfB) of EUR42bn (-15%) at year-end 2008.

"Fitch believes that, while German insurers are experiencing unrealised investment losses, these are smaller than those experienced by many life insurers in other markets," says Tim Ockenga, Senior Director in Fitch's Insurance rating group, based in Frankfurt.

Including participation rights, Fitch estimates the proportion of equity shares held at year-end 2008 to be in the range of 5%-6% of total investments, a relatively low figure globally. In addition, life insurers typically invest in bonds and loans of high creditworthiness. For the majority of insurers the proportion of corporate bonds (excluding financial institutions) as well as exotic or structured securities is very low with an estimated 1.8% and 3.1% of total investments respectively. With about 46% of fixed-interest securities, the industry has a relatively larger exposure to the financial institutions sector compared to other life insurers globally. However, Fitch does not view this as an immediate concern, despite significant pressures in the financial sector, since most of this debt benefits from protection arrangements in the German market.

A particular feature of the German market is the emergence of material unrealised gains on fixed-interest securities driven by declines in interest rates. Fitch does not view interest rate-induced gains as really offsetting the credit losses. Fitch views a low interest rate environment as negative, particularly given current low risk free interest rates for German government bonds compared to existing guaranteed return rates on life policies.

As the agency expected, the 2008 new business figures were relatively weak if the one-off effect of state-sponsored annuity products is excluded. Fitch expects some insurers will post a significant decline in 2008 new business. However, as long as no individual entity fails, Fitch believes life insurers could benefit from the current crisis as they may be perceived as reliable asset managers and attract business previously held by banks.

In October 2007, Fitch Ratings changed the Rating Outlook for German life insurers to Negative from Stable with reference to the structural challenges and the prospect of increasingly volatile capital markets.