Property/casualty rates should start to turn in 2000 following a continuing deterioration in underwriting results in 1999, say Karlos van Endert and Andrew Goodwin.

In 1999, property/casualty insurance in Germany is expected to have reached the same poor levels of negative underwriting margins as in 1992/93 and we expect a turn of the cycle in 2000. We estimate overall non-life premiums will have stopped falling in 1999. There were further rate increases in motor in the last quarter, so we forecast no further deterioration in the underwriting margin for 2000 in spite of modestly higher claims. However, total insurance returns at the bottom of the cycle, i.e. 1999/2000, should be worse than during the bad underwriting years of 1992/93, because the interest rates in 1999/2000 are lower now than they were seven years ago.

After three years of negative growth since 1996, it should come as no surprise that 1999 will have seen total property/casualty premiums down again by an estimated 2.2%. We estimate the largest decline in 1999 premiums was in industrial lines which lost about 20% in 1998, followed by motor insurance, whose premiums went down by about 4% in 1998. The main reasons for the continuing decline in non-life premiums are the continuing price war in motor and parts of industrial lines insurance, stagnating real income of German households and a secular decline in demand for commercial insurance.

Although the liberalisation of the insurance market has progressed quite slowly in Germany, the insurance sector is now feeling the effects: higher underwriting losses, volume underwriting and no real cost savings because sales are still seen as the key issue and commission payments are the main cost element. The single factor that hit the German market most was the price war in motor rates allegedly started by Allianz around 1995. The market leader then tried to regain market share in motor insurance by lowering the rates for motor liability insurance.

Underwriting margins

As illustrated in the chart above, we believe that a modest recession in overall non-life premiums will be aggravated by a sharp fall in underwriting margins until 1999. Based on initial forecasts for the motor insurance sector that are detailed below, we expect an underwriting break-even for non-life insurance in 1998 after a 2.22% margin in 1997. On the assumption that non-motor property/casualty business will remain at 1997 levels, we estimate that the net underwriting margin for 1999 could fall to -2.5% mainly due to the projected DM 4 billion underwriting loss in motor insurance. The other non-life line, apart from motor, that we expect to have deteriorated substantially in 1999 is industrial fire. The Gesamtverband der Deutschen Versicherungswirtschaft (GDV) estimates that premium income in industrial fire with business interruption cover will fall 16.5% to DM 2.3 billion compared to a drop of 18.6% in 1998. Competition in prices and conditions persisted last year and the 1999 underwriting loss in industrial fire is expected to exceed DM 600 million.

Comparing net claims incurred for the current year with the claims figure including the run-off profits for the previous years reveals that since 1992 German non-life insurers have increasingly benefited from run-off profits.

Run-off profits
Non-life insurers have increasingly relied on run-off profits. We have plotted the net claims ratio including the run-off result from previous years' claims provisions against the claims ratio for the respective year in question, and the spread between the two ratios has widened from 5.3% in 1992 to an estimated 11.1% in 1999.

Since this widening of the spread illustrates the increasing importance of run-off profits, it is important to know if they are sustainable in future years. Maintaining a high reserve level is essential for the occurrence of run-off gains in future years. Since reserve ratios between 1991 and 1998 have risen moderately there does not seem to be any serious threat from under-reserving.

However, reserve levels may be reduced in future years. A new German law that effectively taxes these run-off gains before they occur is expected to change the reserving policy of German property/casualty insurers with immediate effect. Since there is much less of a tax incentive to continue the high reserving, we estimate that the spread between the two claims ratios will narrow in the future.

We, therefore, expect less benefit from run-off profits in the future and this could exacerbate the downturn in the short term. On the other hand setting up less conservative reserves on current year policies may to some extent offset the reduced benefit from run-off reserves.

An end to motor insurance decay
The GDV has estimated a 0.9% decline in motor premiums (40% of total non-life market) in 1999. We believe that most large German motor insurers are not going to back pedal from the 5% price increase for motor third party liability (TPL) introduced in 1999 for new policies. However, since motor TPL is often a key product upon which other insurance products can be sold, many brokers and agents may apply all rebates available for motor TPL to avoid upsetting their existing customers. Since according to leading motor insurers the price of an average motor TPL policy has come down by about 20% before rebates between 1995 and 1998, modest increases on new business will not suffice to bring motor rates back to more reasonable levels

According to GDV estimates, total motor premium income for 1999 may have decreased further to DM 38.7 billion from DM 39.0 billion in 1998, while the number of cars insured increased by 2.5% to over 50 million. Premiums for motor liability cover (motor TPL) which account for about 60% of total motor business may drop to DM 23.8 billion in 1999. Both for motor TPL as well as for motor insurance as a whole the premium decreases forecast for 1999 are not as sharp as the fall from 1997 to 1998. This slowdown in premium decay was, however, not enough for a turnaround in motor insurance.

If we estimate new business to be 20% of total motor premiums in any one year, the 5% increase in motor rates for new business would only lift premium income by 1% per year going forward. Insurers had to consider rate increases in the region of 5-9% on existing business in order to see any impact over the next two years. We believe that a majority of the German motor insurers will increase prices on existing policies, but the level to which this increase is diluted by rebates is difficult to assess.

According to our estimates, the fundamentals of motor TPL business excluding the price are not deteriorating dramatically. The number of cars insured goes up steadily while the number of claims has come down since 1993. However, claims paid have been going up modestly and we forecast a continuation of this trend. The main reason for the increase in claims costs, despite decreasing claims numbers is that the average motor liability claim has risen to an estimated DM 6467 in 1998 (DM 5200 in 1993). The good news, however, is that the rate of increase of an average motor TPL claim has come down steadily from 8% in 1993 to an estimated 1% in 1998.

Continuous rate decay and claims increases in motor TPL have produced significant underwriting losses, which overshadow profitable parts of motor insurance. In theory this should be avoidable in view of the underlying growth in demand for motor insurance and a decline claims frequency illustrated above.

Large underwriting losses in motor TPL anticipated for 1999 will bring rates back to more reasonable levels. According to a recent forecast of the GDV, German motor insurance business may write a loss of about DM 4.0 billion this year after an underwriting loss of DM 2.3 billion in 1998. Based on this, we believe that net underwriting margins for the whole motor business could fall to -12.3% in 1999, narrowing the spread between the margin for total motor and motor TPLThe narrowing of this spread is mainly due to the fact that the profitability of the other motor business (comprehensive and partial comprehensive motor insurance) is expected to deteriorate in 1999 and, therefore, will not mitigate the losses from motor TPL as in the previous year. The turnaround in the fall of underwriting margins is based on the premium increases we expect to see in 2000. Our forecasts for 2000 show underwriting margins of -12.1% for total motor and -20.4% for motor TPL, indicating that motor TPL has reached the bottom of the underwriting margin cycle in 1999.

The underwriting results of the motor insurance industry contain a known element of distortion. Insurers calculate their underwriting result on a calendar year basis instead of looking at the years in which the claims occur. In years with particularly high claims ratios as we expect for 1999, this practice results in a mitigating effect through the run-off results of previous years.

Furthermore, we believe that companies do not allocate costs to the motor business appropriately. Total costs as percentage of premiums average 16% for the total motor business while the very profitable personal accident line bears more than 37% of costs. We believe that companies internally allocate more costs to the profitable lines of business, particularly in times of claims deterioration.

The true underwriting result of the German motor business would be even worse if looked at on an accident year basis and if realistic cost allocation were adapted. It is difficult to gauge if the market has taken account of the significant losses now being recorded in motor and is moving on a more universal level to improve rates. In motor, we do expect the beginning of a turn in rates as insurers seem to be applying similar increases to existing business as they introduced to new business in the first half of 1999.

Karlos van Endert ( and Andrew Goodwin ( are insurance analysts with Commerzbank Global Equities.