Prices rose significantly in Germany in 2022 and 2023. This was evident not only to consumers, but also to insurers. Inflation is especially relevant for property and casualty insurers. However, they cannot simply rely on the consumer price index calculated by Germany’s Federal Statistical Office and the European Central Bank. Insurers also need to consider claims inflation, which encompasses the costs for materials and repairs as well as medical care.

While the consumer price index recently crept down compared to previous months, crucial indicators suggest that claims inflation remains high. For example, the repair cost index for motor vehicle insurance rose by almost eight percent in the third quarter of 2023 on an annual basis, an increase similar to the one seen in 2022. Costs for medical care are also increasing. Wages, too, are on the rise: they increased nominally by 6.3 percent in the third quarter of 2023 over the same quarter in 2022. In real terms, accounting for inflation, they rose by 0.6 percent.¹

For all these reasons, claims inflation must remain a top concern for insurers; the associated risks are not going away. As in the previous year, BaFin will be closely examining how undertakings account for claims inflation in their annual financial statements for 2023 – and intervening when necessary.

BaFin already made its expectations clear in 2022: undertakings need to take sufficient account of inflation. Inflation expectations factor into the technical provisions under Solvency II. If insurers expect prices to rise, this typically increases the required provisions if all other factors remain the same. Undertakings that draw up their balance sheets in accordance with the German Commercial Code (Handelsgesetzbuch – HGB) should avoid run-off losses (see also info box: “Run-off result”) when calculating their technical provisions – which means they should examine whether higher provision levels are necessary in light of higher claims inflation.

Have the undertakings fulfilled BaFin’s expectations? While the industry average for solvency ratios among property and casualty insurers has improved slightly since 2021, their technical provisions under Solvency II have decreased slightly. This is surprising given the high inflation rate.

Solvency II: undertakings’ assumptions are overly optimistic

Solvency II requires insurance undertakings to establish technical provisions for their expected claims incurred. If all other factors remain unchanged, rising inflation will require greater provisions. Rising interest rates and the resulting higher discounting of future claims incurred have counteracted this de-velopment. Provisions have decreased in particular for long tail segments such as motor vehicle liability insurance, where the complete settlement of claims can sometimes take several decades. These effects can vary strongly from undertaking to undertaking, though. In particular, they depend on the assump-tions used by undertakings to project future levels of inflation.

Contrary to the expectation announced by BaFin in 2022, many property and casualty insurers assumed a quick return to the original inflation level within two years when calculating their technical provisions at the end of 2022. To some extent, they also made optimistic assumptions regarding the level of future claims inflation. The assumptions for the year 2023 were partially even far below the relevant repre-sentative inflation indices. What’s more, many undertakings failed to make any estimate of historical inflation at all. BaFin takes a very critical view of all these findings.

Insurers need to make improvements

One thing is clear: many insurers need to adjust their calculations for the 2023 financial year. In accordance with section 75 (1) of the German Insurance Supervision Act (Versicherungsaufsichtsgesetz – VAG), they are required to calculate their technical provisions in a prudent, reliable and objective manner.

Undertakings should bear in mind that claims inflation for various segments remains significantly higher than general inflation. In addition, they should take better account of the high level of uncertainty regarding future claims incurred. Insurers should take an especially close look at their assumptions of future claims inflation in long tail segments with personal injuries.

These sectors could see substantially higher claims incurred in the future due to claims inflation, particularly as caused by increasing wages and the higher cost of medical care. BaFin therefore expects undertakings in this segment to apply prudent expert judgement that fulfils the regulatory requirements when making claims inflation assumptions from now on.

Above all, BaFin expects undertakings in long tail segments to generally anticipate a significantly higher level of cumulative excess inflation (see info box “Excess inflation and cumulative excess inflation”) than in shorter tail segments with shorter settlement periods, as well as more than two years of additional inflation.

In their actuarial methodology for considering claims inflation, undertakings should also avoid methods that tend to underestimate the necessary technical provisions.

In light of the inflation effect, BaFin expects the revised assumptions will lead a number of undertakings to increase their technical provisions under Solvency II.

HGB accounting: premiums need to increase

In reserving processes as described in the HGB, the technical provisions of property and casualty insurers are for the most part not discounted. The increase in interest rates therefore did not cause provisions to decrease for such undertakings. The 2022 financial year not only saw increases – some of them substantial – in the payments for insured events from the previous year, especially in partial and comprehensive motor vehicle insurance as well as fire, residential buildings and contents insurance. Insurers also reacted to this development by raising balance sheet provisions for outstanding claims. Gross provisions for outstanding claims relating to that financial year increased considerably for motor vehicle insurance in particular.

In 2023, however, high inflation caused only moderate increases in premiums for property and casualty insurers. The high competitive pressure even led to lower premiums in certain segments, such as motor vehicle insurance. Because these important segments risk suffering losses for the 2023 financial year, undertakings urgently need to increase premiums. BaFin had warned undertakings at an early stage: lines of business that constantly operate at a deficit are not acceptable.

For their annual financial statements for 2023, undertakings must also assess whether they need to set up a provision for impending losses, and document this assessment. In particular, a provision must be formed for losses that are likely to occur after the balance sheet date from policies concluded up to the end of the financial year (section 341e (2) no. 3 of the HGB). Such losses typically occur when premiums are too low. If undertakings do not adjust their premiums despite prior doubts of whether they are adequate – for example, because an undertaking has repeatedly incurred losses – BaFin expects them to form a provision for impending losses.

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