Euro hazards not over yet

By all accounts, it’s been a pretty good 2012 in terms of a settling down of the eurozone crisis. Okay, Groupama’s been a victim of the crisis, but so far no others looks like getting sucked into the euro vortex. And with Fitch all but saying that insurers are dealing pretty well with the losses on their Greek bonds, things are definitely looking up – for now.

Greece is simply too small to have a considerable impact on the insurance industry. But it’s a completely different matter when you look at countries such as Italy, which is only behind the USA and Japan in terms of its debt burden at $2.2 trillion (£1.4 trillion). Composite life and general insurers such as Allianz, AXA and Aviva have played no small part in helping Italy build up this mountain. Italian debt stands at around 5% of life insurers’ investment portfolio’s, equivalent to a huge 44% of shareholders equity, according to French bank BNP Paribas.

There were creeping concerns last year that Italy might eventually have to force bondholders, including insurers, to take losses on their bonds. This was because the interest Italy was paying on its debts were almost certainly at unsustainable levels in the long term. Italy crept up to an eye-watering 8% interest at one point.

Since then, the European Central Bank has flooded the financial system with cheap loans. Banks have used the cheap loans to hoover up peripheral government debt and the increase in demand has brought down yields to sustainable levels. This has also had the benefit of making insurers’ peripheral bond assets safer.

The big risk now is that the European economies fall back into recession or suffer from slow growth. Long-term structural problems in peripheral countries still remain – banks scrambling to deleverage and not lending to businesses, a currency still too strong, high unemployment and uncompetitiveness against the northern European countries.

Added to all of this, austerity is biting hard on growth. If investors fear slow growth will hamper these countries’ ability to pay their debts, then yields will rise once again to dangerous levels and eventually, the rating agencies will question the stability of composite insurers.

An upturn in the eurozone crisis would hit recovering equity markets. That could delay or hamper the flotations of companies such as Hyperion, Direct Group, Hastings and Esure. Insurers would suffer a fall in share price, potentially increasing the prospect of mergers or takeovers.

Then there’s Solvency II – would insurers really have to value their dodgy bonds at market value, in other words, the price on the screen? We’ve already seen with Groupama, which rests at one above junk with Standard & Poor’s, that brokers get very nervous when an insurer’s rating goes south. The actual chances of a default may be slim, but brokers are well aware of the grim facts: their clients could face decreased payouts in both general insurance and life insurance. This is a pretty pessimistic analysis.

More positively, insurers such as Allianz have continued to buy peripheral sovereign debt, especially in Italy, believing that defaults are high unlikely. Aviva, which also holds considerable Italian and Spanish government debt, believes the threat of a sovereign bond payment crisis is minimal. There’s certainly a lot of confidence out there in early 2012 and markets have rebounded strongly. Long may it continue.