Fitch report analyses worst case scenario

Spain is on the brink of needing a eurozone bailout and Greece is on the verge of exiting the euro, events barely imagined possible just a couple of years ago.

The prospect of these worrying events taking place has led insurers to plan for a break-up of the eurozone. Lloyd’s chief executive Richard Ward admitted last week that contingency planning was being thrashed out. Despite making plans for a worst-case scenario, most insurer bosses believe the risk of a break-up is minimal and class it as a ‘tail-end’ risk.

But what would happen to insurers if the eurozone did break-up? A report from rating agency Fitch gives an insight into a potential outcome. The report suggests a return to local currencies would not be the death-knell for insurers, and in fact, well-managed insurers have good levels of resilience. Furthermore, insurers are not reliant on capital markets for funding. This is unlike many banks, which are still vulnerable to a credit crunch. Despite these positives, the report does warn about several risks insurers could face.

Currency re-denomination

Fitch says that Greece, Italy, Spain and Portugal would see their newly-issued currencies drop in value against the dollar and other major currencies.

Insurers match assets and liabilities locally, which would mitigate the impact of a re-denomination

However, Fitch warns: “Insurers strive to match their resident policyholder and other liabilities in local assets. It is unlikely, however, that the matching would be so precise as to eliminate all risk of loss. Further, possibly larger, losses could arise from the decline in value of local investments in excess of re-denomination.”

Relaxed capital adequacy rules

If insurers found their solvency under pressure, the regulators could relax rules on how insurers measure their capital. This would give insurers more time to strengthen their balance sheets. However, Fitch says that such a move would not deter it from carrying out rating downgrades. Fitch says: “Fitch takes seriously such breaches because they indicate that an insurance company has eroded much of its safety margin. If it had not already done so, the agency would downgrade the company to reflect its weakened financial position.”

Passing on losses to policyholders  

Insurers with life insurance divisions are able to pass on losses to policyholders. But Fitch says that it may not be possible to force all the losses on the policyholder in some situations. Allianz and Aviva have significant operations in Italy, one country where this issue could arise in a worst-case scenario.

Fitch says: “For unit-linked or participating (with profits) life assurance products, companies generally have the ability to pass certain investment losses to their policyholders. However, if losses were large, the ability to share losses with policyholders could be severely constrained, because the return on customer portfolios might be below the minimum guaranteed to policyholders. In addition, in Italy, profit sharing is not deferrable.”