Nobody would argue with Germany’s impressive show of strength through the financial crisis. But the fight isn’t over yet as interest rates drop, Solvency II steps up and Zurich emerges as a serious contender

The financial crisis provided the ultimate test to Germany’s major insurance and reinsurance companies. Yet most showed great resilience, emerging in good health from the downturn. And a snapshot of 2010 results reveals that they remain comfortably capitalised. But low interest rates, a softening market and the impending Solvency II regime will continue to test their superior business models for the foreseeable future.

For now, despite the drop in investment income and a competitive market, companies are in good shape.

“I think everybody had a good year in 2010 and the German underwriting result has slightly improved,” Hannover Re executive board member Michael Pickel says.

“The capital position seems to have much improved. I think what we’ll see in respect of the German insurers is they’re much better off than the international market because we haven’t had any major claims in the past year.”

Market leader Allianz’s 2010 year-end results – with a net income of €5.2bn ($7.35bn), a 12% increase from €4.7bn in 2009 – demonstrates resilience in a fragile economic environment, according to Moody’s.

But natural catastrophes and poor rate environments in some of its key markets depressed property casualty results. “Shareholders’ equity of €44.5bn and a solvency ratio of 173% demonstrate the strong capital position of Allianz, and it remains resilient to deteriorations in equity markets or the interest rate environment,” Moody’s vice-president and senior credit officer Paul Oates says.

A good year

The big professional reinsurers also posted solid profits for the year, with Munich Re leading the charge. Despite the high level of global catastrophes in 2010 – including the Chilean and New Zealand earthquakes – the German giant turned a profit of €2.43bn.

But it revealed a catastrophe loss of €495m for the final quarter of 2010 (including €267m from the Queensland floods), which pushed its combined ratio above 100%.

The reinsurer’s primary insurance group, ERGO – Germany’s second largest direct insurer – also had a good year, almost doubling its profit to €355m. Gross premiums in the primary insurance segment grew by around 5% to €17.5bn, with growth strongest in international business.

The high incidence of claims from natural catastrophes – such as the long winter and spring flooding in Germany and international cat events – led to a combined ratio of 100.4%.

It is thanks to resilient financial profiles that Standard & Poor’s outlook on the German insurance industry remains stable, although it does see hurdles ahead. Low interest rates are a growing challenge by virtue of an altered approach to investment, with a shift away from equities towards fixed income.

Long-tail lines of business such as liability and motor are particularly affected by low interest rates, while competition in motor and the high incidence of claims are making it tough to turn a profit in this dominant class of business – which accounts for 40% of the market.

“A prolonged period of subdued demand and low interest rates will likely reduce earnings in the sector even further,” writes S&P in its November German market analysis. “We expect that underwriting performance will therefore be one of the main factors influencing our ratings on property/casualty insurers in 2011.

“Nevertheless, we expect German insurance groups that benefit from strong property/casualty business to withstand the adverse operating conditions. This is, in particular, owing to what we see as their typically strong capital bases and diversification into more profitable non-motor lines.”

Also in the ring

Continuation of competitive market conditions is on the cards for 2011, with the primary market looking to hold firm on rates in spite of downward pressure.

“Germany still has a very high number of insurance companies and, year by year, attracts new market entrants, mostly from abroad,” Guy Carpenter Munich managing director Axel Flöring says. “Examples include the industrial business and the motor market. As a consequence, competition in almost all lines of business is fierce and this results in high pressure on rates.”

“In motor, which represents almost 40% of the non-life premium income, the market seems to have reached a turning point,” he continues. “Rates have been increasing market-wide by between 2.5% and 7%. This has been necessary as insurers on an accident-year basis make losses of up to 15%, which can only be mitigated by run-off profits from former business years.”

While Germany’s big international reinsurers – including Munich Re, Hannover Re and Berkshire Hathaway-owned General Reinsurance AG (formerly Cologne Re) – continue to maintain a strong market share in Germany, Europe and the rest of the world, competition is growing.

Despite the catastrophe losses in 2010 – with the Chilean earthquake costing the industry up to $8bn (€5.8bn) – the majority of claims emanate from events in non-peak regions and there were no costly US-landfalling hurricanes. As a result, capacity has remained stable and rates reduced by up to 5% on loss-free programmes at the 1 January renewals, according to Guy Carpenter.

The emergence of Zurich as a hub, and the likely impact of Solvency II, could see the once steadfast direct proportional market alter. Among the companies to set up a presence in Switzerland in recent months are Amlin, Allied World, Ariel, Aspen Re, Catlin, Novae, Partner Re and XL. Even within Switzerland, Munich Re has moved its headquarters for New Re from Geneva to Zurich to take advantage of the developing reinsurance infrastructure there.

Assuming Switzerland achieves third-country equivalence under Solvency II – as it is widely expected to – these companies will continue to have direct access to the Continental European market, including Germany. “I think competition is coming out of the Bermudan companies in Switzerland,” Hannover Re’s Pickel says.

Solvency II – weighing the impact

While reinsurers are expected to benefit from Solvency II, as demand for catastrophe reinsurance grows and insurers seek contingent capital, Pickel does not think the impending regulatory framework will result in a dramatic shift in buying behaviour. “It will be a beneficiary but I would not be so foolish to say we are the only solution. I think reinsurers are one capital provider.”

The fact that capital requirements may not be as burdensome as initially thought could limit Solvency II as a potential driver of consolidation in the market. “The preliminary feeling with QIS5 is that a major part of the market is adequately capitalised, even taking into account everything in QIS5,” Pickel says.

“I don’t mean that mergers and acquisitions won’t occur but that will be in the middle to high market segments, or for smaller companies where there’s too much volatile business on board.”

Nevertheless, Solvency II is expected to have some impact, with a shift towards non-proportional business becoming more evident as cedants look to offset some of the increased capital charges under the standard formula. The role of the reinsurance broker in the market is changing, with intermediaries no longer just used to place catastrophe business, a trend the new regulatory regime is likely to influence.

“Today, brokers are becoming a trusted adviser to their clients and the consultancy part has gained equal importance to the transactional part of the business,” Flöring says.

He thinks the impact of Solvency II will be felt most intensely in the life sector. “Due to the low interest rate environment, in conjunction with the expected sharpening of solvency requirements, the market is under pressure,” he explains. “Quite recently, six German life insurers have ceased writing new business and put their companies into run-off.”

Munich Re-owned insurer Ergo, for example, put its Victorian Leben subsidiary into run-off last year.

The pressures are largely a result of low interest rates, along with expected increases in capital requirements under Solvency II, notes S&P, given that most companies still rely on traditional products that are highly capital intensive.

“The market is expected to consolidate due to the complexity of the new regulations and the increased capital needs,” Flöring says. “It is also expected that there will be a greater focus on the active management of business that has been put into run-off with the aim of freeing up capital.” GR