The German P/C insurance sector is confronting challenging inflationary pressures that peaked in 2023 yet demonstrates resilience. Despite high claims inflation and rising reinsurance expenses and net retention, S&P Global Ratings believes profitability levels will improve in the next two years and will be sufficient to build up capital and reserving levels in line with the underlying market growth. Our ratings on German P/C insurers are resilient and likely to be broadly unchanged over 2024-2025. However, insurers will need to adjust their prices to reflect the inflation impact and market conditions.

Inflationary And Cost Pressures For Insurers Mounted In 2023

German P/C insurers experienced a difficult year in 2023 with high claims inflation, especially in motor insurance. They could push through comprehensive rate adjustments in property (commercial and retail), liability, accident, legal protection, credit, and transportation. However, rate adjustments were insufficient to offset pressure from claims inflation in the highly fragmented motor segment. The total gross combined ratio for the German P/C sector consequently deteriorated to 98% in 2023 from 95% in 2022, with motor insurance being the largest line of business--constituting about 37% of overall P/C premiums.

Despite declining to 6.1% from 8.7% in 2022, the consumer price inflation (CPI) index was high in 2023. Over 2024-2025, we project inflation to decline to 3.0% in 2024 and 2.1% in 2025 in Germany (see table 1). CPI can deviate from claims inflation, but we expect the effect of claims inflation to ease, mainly attributed to the annual renewal cycle prevalent in most German P/C business.

Table 1

In 2022 Germany's 10-year government bond yields exited negative territory, and in 2023 yields reached 2.5%. We forecast an average 10-year bond yield of 2.9% in 2024, and about 2.6% over 2025-2026. The German P/C insurance sector will benefit from this trend, and we anticipate an improvement in investment income as most low-yield bonds phase out from P/C insurers' asset portfolios over the next three years.

Overall, the German economy faced headwinds throughout 2023, with real GDP contracting by 0.2%. It is likely that easing inflationary pressures and a resilient labor market will support a moderate economic recovery in 2024 and 2025.

The German P/C Insurance Sector Is Resilient

German P/C insurers navigated high inflation in 2022 and 2023, record losses from natural catastrophes in 2021, and economic downturns in Germany in 2020 and 2023.

Ultra-low investment yields up to 2021 prompted German P/C insurers to focus on restoring and improving underwriting results sustainably. This has led to subsequent rate increases, particularly in cyclical business lines, such as motor and homeowners' insurance.

The sector achieved a 10-year average (2014-2023) net combined ratio of 95.6% (gross: 95.2%) demonstrating underwriting discipline (see chart 1). The underlying underwriting performance helped the market to strengthen its capital adequacy and claims reserves, and to establish a substantial equalization reserve.

Chart 1

The P/C insurance sector has had a strong track record since 2014, and its gross combined ratio only exceeded the 100% threshold in 2021 due to record high natural catastrophe claims.

Despite the economic downturn in 2023, insurance contracts increased by 2.8% and insurance gross written premiums by 6.7%--reaching €84.5 billion in 2023, up from €79.1 billion in 2022 (see chart 1). The substantial price increases, rather than the underlying growth in the volume of contracts, underpin much of the recent growth.

We project premium growth to range from 7%-9% in 2024, influenced by material rate adjustments in motor insurance. We forecast growth of approximately 4%-6% in 2025 based on our view that inflation will decrease in this period.

We assume that the overall German P/C net combined ratio will gradually improve to 96%-98% over 2024-2025, assuming average natural catastrophe losses of approximately €4.5 billion–€5.0 billion (10-year average).

The sector has a strong 10-year average (2014-2023) ROE of about 11%. After overall profitability dipped in 2023, we forecast a recovery because the effects of mitigated claims inflation and higher investment income will increasingly unfold over time. Therefore, the sector could reach a ROE of about 7%-10% over 2024-2025 (see chart 2).

Chart 2

Persistent higher inflation places the sector at significant risk, although this is not our base case. If claims inflation stays high, reserves for long tail lines may need to increase disproportionately, which could diminish profitability.

The Motor Insurance Segment Underperforms Due To High Claims Inflation

Between 2011-2019 German motor insurers raised prices that led to underwriting profits for insurers until 2021. German motor insurers reported strong underwriting results for 2020 and 2021, mainly due to reduced economic activity and lower traffic volumes caused by pandemic-related lockdowns. Motor insurers have missed out on pushing through sufficient rate adjustments since 2020 to counterbalance the post-COVID-19 reopening of the economy and rising average claim costs.

The average nominal claim costs per motor policy have increased by 12.4% from 2018-2023, with the steepest increase in 2023 (see the purple line in chart 3). Insurers have also steadily reduced the average nominal premium for motor policies by 1.5% (see the yellow line in chart 3) from 2018-2022, with only a moderate increase in 2023.

Chart 3

The gross combined ratio in the motor segment therefore deteriorated to 110% in 2023 from 101% in 2022 (94.8% in 2021 and 90.6% in 2020).

As a result, German motor insurers raised renewals by double digits in 2024. We anticipate underwriting results to slowly recover due to the persistent growth in repair costs and expenses for spare parts. Expensive to repair high-tech features in cars, like cameras and sensors, contribute to motor insurance claims inflation--which typically exceeds the CPI. We therefore project the gross combined ratio for motor insurance to only gradually recover, reaching approximately 102%-106% in 2024 and 100%-104% in 2025.

Natural Catastrophe Claims Are Gradually Increasing In Severity And Frequency

More frequent natural catastrophe claims made 2023 a costly year with natural catastrophe losses of €4.9 billion (compared with €4.3 billion in 2022 and €12.5 billion in 2021). This is below the five-year average (2019-2023) of about €5.6 billion, but slightly exceeds the 10-year average (2014-2023) of approximately €4.7 billion.

We expect the increased average insured natural catastrophe claims observed over the past 50 years, with the trend toward higher frequency and greater severity events, will continue (see chart 4).

Chart 4

Of the €4.9 billion in natural catastrophe losses in 2023, €1.3 billion were associated with motor insurance and €3.6 billion were attributed to property insurance. Within property insurance, hail and storms accounted for damages of €2.7 billion, with an additional €900 million attributed to other natural hazards--such as flooding.

Natural catastrophe losses accounted for about 5.8% of gross written premiums, compared with 16.0% in 2021--the record natural catastrophe year--and the 10-year average (2014-2023) of 5.4% (see chart 5).

Chart 5

In 2021, reinsurers assumed most gross losses for German P/C insurers from the severe Ahr Valley floods (see chart 1). Consequently, reinsurers substantially raised premium rates, implementing stricter terms and repricing of risks. The German P/C insurance sector faces increased challenges due to higher net retention and reinsurance costs. We believe this trend will continue throughout 2024 and primary insurers will need to adapt to higher reinsurance prices. The frequency of natural catastrophe claims losses will weigh more on primary insurers' profitability going forward.

Insurers are increasingly incorporating higher average natural catastrophe claims, arising from climate change, in their decision-making processes--particularly regarding exposure management, risk management, reinsurance structure, and repricing. Robust scenario calculations are important and companies that do not implement climate change considerations in their business steering may face higher capital and earnings volatility.

Ratings On P/C Insurers To Remain Largely Stable

Our ratings on German P/C insurers are resilient and likely to be broadly unchanged over 2024-2025. The sector is well-diversified with a broad and deep product portfolio across retail and corporate clients covering motor, property, liability, accident, legal protection, credit, and transport and aviation insurance lines. This helps the sector to balance profitability, capitalization levels, and growth (see chart 6).

Chart 6

Pressure on claims costs from inflation, especially in the motor segment, and the forecast lower-than-average technical performance appears manageable and is partly offset by sound profitability in other lines as well as rising reinvestment rates.

Table 2