Briefing: Insurers should prepare for risk of another Eurozone crisis

By Saxon East

Fear is once again taking hold. The euro has fallen below parity with the dollar, plunging to its lowest level in 20 years.

As of today (14 September 2022), one euro equals exactly one US dollar, having recovered from a dip.

Having only just emerged from the costly pandemic, southern European countries now face the dual sledgehammers of rising inflation and an energy crisis.

Another eurozone crisis would have a major impact on insurance companies.

Before delving into that, some history on the eurozone – the monetary union of 19 member states of the European Union that have adopted the euro.

The last eurozone crisis was caused by a balance of payments crisis, when foreign capital into countries with substantial deficits diminished, even though they were dependent on foreign lending.

The crisis only ended when a European rescue package, backed by the solvency of Germany, was set aside for the troubled economies of Portugal, Greece, Spain, Italy and Ireland.

Also, in July 2012, the then European Central Bank (ECB) president Mario Draghi vowed to do ‘whatever it takes’ to ensure continued stability.

This implied the ECB would continue to buy the debt of troubled eurozone countries on the secondary markets and even make outright direct purchases of their bonds.

The markets settled eventually, but investors are now getting nervous once again.

Investors want 4% interest on Italian government bonds – a level at which concern kicks in as to whether Italy can meet its obligations at this higher rate.

The problem for insurers is that they hold the debt of these troubled countries. Under Solvency II rules, assets are valued on a mark-to-market basis.

A eurozone government debt crisis would lead to those bonds losing value and eroding capital buffers.

Furthermore, a eurozone recession leads of fewer products being bought by hard-pressed customers. Their share prices will take a hit.

At least insurers are better prepared this time around. Italian insurer Generali holds bonds of the Italian government.

A report from Reuters on August 2 2022 revealed that Generali had slashed its Italian state debt portfolio to €53bn by June, from €62bn last year.

Insurers will look to the European governments once again.

The eurozone coronavirus recovery fund still has funding for countries to tap.

Meanwhile, the ECB has firepower for more bond purchases.

Yet things can still go wrong. The ‘frugal four’ of Germany, Holland, Austria and Denmark will likely protest at any further funding.

Germany, an advocate of monetary discipline, will have concerns at the ECB hoovering up yet more distressed bonds during a time of high inflation.

If it comes about, a second eurozone crisis will have its tensions, arguments, market jitters and insurer share price volatility.

This is one risk that European insurers cannot ignore.