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German Insurers Brace For More Resiliency Tests In 2022-2023

German insurers have faced significant challenges over the past two years: a recession in Germany in 2020 (see table 1), COVID-19-related claims last year, and record natural catastrophes in 2021 and the first quarter of 2022. More obstacles are ahead: geopolitical uncertainties arising from the Russia-Ukraine conflict, rising inflation, increasing loss frequency in property and casualty (P/C) associated with climate change, and potential capital market volatility. Nevertheless, the German insurance industry has withstood this adverse environment well up to now. The vast majority of our ratings have remained stable, the average rating is in the upper 'A' category (see chart 1a), and we took positive rating actions on about 6% of companies last year. As of May 1, 2022, 98% of the 53 German insurers we rate had a stable outlook and only 2% carried a negative outlook (see chart 1b). Ratings on German insurers continue to benefit from the insurance groups' diversity: most groups write multiple lines of business, including life, health, and P/C.

Chart 1a


Chart 1b


Sound Operating Performance

Overall, German insurers' operating performance was sound in 2021 and 2020 despite record natural catastrophe losses in P/C, COVID-19 losses--mainly through business interruption, event cancellation, and health insurance--and an even further decreasing interest rate environment in that period. The sector has benefitted from strict underwriting with solid pricing in P/C over the past few years, robust reinsurance protection in the natural catastrophe losses, and lower claims frequency in motor and household insurance as a result of the pandemic. We believe the P/C sector is well placed to post a gross combined ratio of 95%-98%, including about 6% of natural catastrophe losses (compared to 16% in 2021) and a return on equity (ROE) of 8%-11% in 2022-2023. We also expect that life insurers will post sufficient returns to exceed their guarantee commitments in 2022-2023, with an increasing contribution from risk results. Health insurers should post stable underwriting profitability ratios of 10%-12%, which would lead to an ROE of about 9%-11% in 2022-2023. Across all segments, German insurers gradually further diversified their investment mix to mitigate the trend of declining investment returns.

We estimate German insurers have an asset and insurance liability exposure to the Russia-Ukraine of less than 2% of total adjusted capital, or below 1% of total assets and liabilities, and that it is nonexistent for many domestic players. Specialty insurance business affected by the conflict, such as aviation or marine, are not significant lines of business for most German primary insurers, and about 50% of losses from these lines will be carried by the top 21 global reinsurers (see "Russia-Ukraine Conflict Adds To A Bumpy Start To 2022 For Global Reinsurers," published March 31, 2022, on RatingsDirect).

A more relevant area of focus for German insurers is rising inflation. While claims and medical inflation was already high in previous years, general inflation is now picking up too. We assume about 5% consumer price inflation for Germany in 2022 (see table 1). We expect health and P/C lines to be most affected, and long tail lines of business in particular could experience reserve-strengthening measures. However, we also believe that the effects of inflation will be somewhat mitigated by the option for annual premium adjustments in health and because the majority of German P/C business is renewable annually, with relatively short repricing timeframes and solid historic reserving.

Table 1

Germany Key Macroeconomic Indicators
% 2020 2021 2022 2023 2024 2025
Real GDP growth -4.6 2.8 2.9 2.8 2.2 1.7
Unemployment rate 3.7 3.5 3.1 3.0 2.9 2.9
CPI growth 0.3 3.2 5.0 2.4 2.1 2.0
Source: S&P Global Ratings.

Solid Capital Adequacy

German insurers continue to benefit from solid capital adequacy. Rated Germany-based primary insurance groups entered 2022 with a strong capital buffer of about 11%-13% above the 'A' level, according to our capital model, which equates to above €20 billion. Regulatory capital is also sound and improved for life insurers in 2021. According to the German insurance association GDV, life insurers' solvency ratios in 2021 (excluding transitional measures) improved to about 245%-255% from 199% in 2020. For P/C insurers they remained robust at 265%-270%, after 285% in 2020. We believe German insurers' capital adequacy will remain a rating strength in 2022-2023 based on our assumption of continued strong underwriting performance in P/C, while asset-liability mismatch risks could remain flat or slightly improve, in view of rising interest rates.

Asset Risk Appetite Is Broadening, But Still Conservative

Insurers' asset risk appetite has evolved in response to low-for-longer interest rates. Companies have shifted further toward illiquid assets, such as property or participations (see chart 2). However, the largest block of investments remains fixed-income securities. Here, we have seen a shift from sovereign bonds into corporate bonds in recent years, while the average rating is still high, in the 'AA' to 'A' range. We have also observed a material shift out of German Bunds into other European economic area sovereign debt, which now outweighs domestic sovereign debt exposure. We assume asset risk appetite will remain balanced and will not increase materially, although we will monitor closely insurers' strategies to turn toward more illiquid or risky assets such as infrastructure, property, listed equity, and private equity, and the potential reaction to rising interest rates. We believe running investment performance for German insurers on average will continue to decrease by about 10-20 basis points per year in 2022, while new investment yields could expand in 2022 after years of declines.

Chart 2


Property And Casualty: Resilient To Record Nat Cat

Insured natural catastrophe (nat cat) claims were more than 6x higher in 2021 than in 2020, at €12.5 billion from €2 billion the previous year. Around €9 billion of the 2021 losses are attributable to damage to residential buildings, household goods, and businesses caused by flooding and heavy rain, while €2 billion was due to storm and hail damage. The remaining €1.5 billion arose from natural hazard damage to motor vehicles. For 2021, the gross combined ratio deteriorated by about 11 percentage points to 102%, and we expect the net combined ratio to be in the range of 98%-100% based on average reinsurance protection of about 2%-4% percentage points in years with significant natural catastrophes. At the same time, we believe that reinsurers are likely to assume much of the gross loss for German P/C insurers. The nat cat losses even accounted for around 16% of gross premiums written (GPW) compared to the 10-year average (2012-2021) of about 5.8% (see chart 3).

Chart 3


In the first months of 2022, the insured nat cat claims from the severe winter storms Lenia, Eynep, and Antonia are estimated at around €1.4 billion. These three storms rank third among the most severe winter storms since 2002, after Kyrill in January 2007, which caused €3.6 billion insured losses, and Jeanette in October 2002, causing €1.44 billion damage. We expect the increased average insured nat cat claims observed over the past 50 years, with the trend toward higher frequency and grater severity of events, will continue (see chart 4).

Chart 4


Insurers have increased their efforts to incorporate higher average nat cat claims arising from climate change in their decision-making processes, particularly regarding exposure management, risk management, reinsurance structure, and repricing. Still, robust scenario calculations will become even more important and companies that do not implement climate change considerations will likely face higher capital and earnings volatility in the future.

We nonetheless consider that the sector was better prepared for the severe natural catastrophes in June and July 2021 than, for example, in 2013, following improvements in underlying performance in recent years. Furthermore, in 2020 and the first quarter of 2021 losses were exceptionally low and performance high because of pandemic-related lockdowns, in particular for motor insurance. The lower claims caused by the pandemic-driven limited economic activity more than offset the COVID-19-related claims from business interruption, event cancellation, and credit insurance.

Underwriting profitability is key in P/C

In the recent past, low investment yields have prompted the industry to focus on restoring and improving underwriting results sustainably, and subsequently implementing rate increases, particularly in cyclical business lines, such as motor and homeowners' insurance. Improved underlying underwriting performance has allowed the market to strengthen its capital adequacy and claims reserves, and it build up a sizable equalization reserve.

In the light of heavy nat cat losses in 2021, we believe the German P/C insurance industry's profitability will recover in 2022, and that the market will be able to achieve ROE of about 8%-11% for 2022-2023, assuming natural catastrophes more in line with the average of the past 10 years. We also assume that the sector will continue its disciplined underwriting approach, continuing the increasing significance of underwriting income versus investment income (see chart 5).

Chart 5


In 2021, the gross combined ratio of 129% in property, the second-largest line of business, stemmed from the high nat cat claims. This was also the main driver for the overall gross combined ratio of 102%. Nevertheless, reinsurers assumed much of the gross loss, and the resulting net loss will vary by insurer.

Claims inflation as a result of core inflation, such as more expensive technology in cars, and social inflation such as higher litigation, may increase prior years' claims provisions and put pressure on profitability. Still, given the pricing discipline and most P/C contracts, with annual repricing mechanisms, we assume the German P/C insurance market will return to relatively solid underwriting profitability in 2022-2023, with gross combined ratios of between 95% and 98%. This assumes a normalized nat cat burden closer to the 10-year-average (adjusted for price changes) of about €4.5 billion and a return to normal economic activity, mainly leading to higher motor insurance claims (see chart 6). We also assume more dynamic growth of 2.5%-3.5% in 2022-2023 compared to 2.2% in 2021, mainly because of the upward inflation trend and the resulting pricing adjustments and coverage extensions.

Chart 6


Life Insurers: Rising Interest Rates Will Not Relax Earnings Pressure

Ongoing low interest rates, although increasing in 2022, are still weighing on life insurers' investment results. Still, market movements in 2020 related to the pandemic relaxed in 2021, while the Russia-Ukraine crisis has so far not caused major market turmoil, although we are monitoring the situation closely. Rising inflation might hold back new business for the life insurance industry. Increasing interest rates could gradually ease the pain of the low yield environment on earnings prospects. However, asset value reserves will decrease, and fewer buffers will be available to handle the additional reserving requirements.

That said, headwinds from a low-yield environment are nothing new to the sector. In light of high Solvency 2 requirements for traditional life products, many life insurers have launched life products featuring alternative guarantee concepts and have additionally built momentum in risk-type products--term life and disability products. Yet, while this shift is visible in the sector's new business split, we believe it will take more time before back books become less sensitive to guarantee rates.

Chart 7


German life insurance business volumes and sales held up relatively well against the significant recession in 2020, and operational challenges stemming from lockdown measures and GPW decreased only slightly by 0.4%, followed by another decrease by 1.4% in 2021. We believe this is due to changes in insurers' product portfolios and customer demands, combined with stable and low surrender rates. Generally, we expect continued growth rates in GPW of about 2% over the period 2022-2024.

German life insurers remain sensitive to low yields and are more dependent on investment results than the health or P/C sectors. Low yields are eroding the spread between investment income and guaranteed rates on life insurance policies. In particular, many insurers are financing the allocation for additional reserving requirements ("Zinszusatzreserve", ZZR, which requires life insurers to put aside extra reserves to ensure their ability to meet their long-term guarantee commitments to policyholders) by realizing fixed-income valuation reserves. This bolsters their reported total investment returns. But, by contrast, it decreases the net investment return measuring the current yield. The average guaranteed rate is still high, having declined only very gradually by 10-20 basis points (bps) annually. For 2021, we estimate it was about 2.5%, calculated on the basis of total invested assets and excluding the ZZR impact (including ZZR the guarantee stood at 1.4% in 2021).

With a further allocation of about €10 billion in 2021 and a total of €97 billion, the ZZR is about 78% financed, in our view. However, we expect further allocations in 2022 and beyond, even as yields rise. In the event of a significant interest rate increase, however, the asset value reserves will diminish rapidly and cannot be used to finance additional reserving requirements for the coming years. The amount and financing pattern will depend on individual companies' portfolio structures, and can vary significantly.

Chart 8


Life insurers are adopting various measures to maintain their profitability and financial strength in a low yield environment. The weighted average return on assets (pre-tax gross surplus before bonus distribution divided by average total assets) for the 50 largest life insurers reduced to 1.1% in 2016 from 1.8% in 2013, but then remained stable until 2019. We also estimate it to have remained stable in 2021, demonstrating the tightened potential to build policyholder capital buffers.

Other strategies to offset low yields, such as strengthening risk results or changing the inforce book composition through new business shifts, will take years to achieve any meaningful impact. Consequently, we anticipate that life insurers will increase their efforts to improve their underwriting performance and cost efficiency (see chart 9).

Chart 9


Based on our projections of gross surplus trends for the life insurers we rate, we expect that German life insurers will at the very least be able to meet their policyholder guarantees over our projection period until 2025 under our base-case scenario. However, inflation and quickly rising yields will put stress on the build-up of additional reserving requirements and hence on industry participants' cash flows.

Health Insurers: Stable Performance Despite Medical Inflation And COVID-19-Related Claims

German health insurers' loss ratio increased by about two percentage points in 2021 from 2020 and stood at about 80%-82%. The cost ratio remained stable at around 8%-9% (see chart 10). This, together with an increase in premium income, resulted in a stable underwriting profitability ratio for 2021 of about 10%-12%. Since the sector's gross surplus is dominated by underwriting profits rather than interest income, in contrast to German life insurance, we do not see heightened risks for the investment results. The sector's ROE remained sound in 2021 at 9%-11%, confirming the sector's robustness.

Chart 10


German health insurers reported higher claims for 2021 (+2.0%) in absolute terms. This includes about €1.2 billion that the sector paid to doctors and dentists in additional costs for COVID-19 care. Moreover, medical treatments and operations that have been rescheduled from 2020 led to higher costs and affected the loss ratio, bringing it back to the levels before 2020.

Prospectively, we assume the German health market will continue to post strong underwriting results, with ROE between 9% and 11% and an underwriting profitability ratio between 10% and 12%, taking into account constraints in earnings prospects from demographic challenges, medical cost inflation, and only moderate premium growth. We believe these long-term challenges will be absorbed predominantly by the premium adjustment mechanism. For 2021, we expect premium adjustments to be around 4% across the market, with larger adjustments for 2022 of up to 9%.

In our view, the sector will continue to face challenges to attract new business for full comprehensive health coverage. Hence, we forecast only small increases in GPW of 1%-2% over 2022-2023 (see chart 2), mainly attributable to premium adjustments and growth in supplementary coverage rather than new business for full comprehensive health cover. We continue to see the sector's growth prospects depending significantly on decisions taken by policymakers in view of the persistence of full comprehensive cover. At the same time, the result of the federal election in 2021 in our view lowered the risk of a state comprehensive health insurance, at least for the current legislature.

Chart 11


Related Research

This report does not constitute a rating action.

Primary Credit Analysts:Johannes Bender, Frankfurt + 49 693 399 9196;
Manuel Adam, Frankfurt + 49 693 399 9199;
Viviane Ly, Frankfurt + 49 693 399 9120;
Silke Sacha, Frankfurt + 49 693 399 9195;
Secondary Contact:Volker Kudszus, Frankfurt + 49 693 399 9192;

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