11 May 2010
Published in: Investment risk, Market risks
“UK life companies less troubled by Greek crisis”
UK life companies present investors with a relative safe haven from the immediate risk from Greek sovereign debt, according to Bernstein Research.
The risk of more widespread contagion is also less of a concern for the UK life companies compared with continental European names, because of the lower absolute exposure to all types of government bonds - including those perceived to be of greater risk.
Among the UK life names, Aviva - because of the scale of its European business - is the most exposed to European government debt. Aviva also has the highest leverage to government debt versus its UK life peers.
However, its exposure - both nominal and relative - is modest copared with continental insurance peers.
Aviva has disclosed a £500m exposure to Greek sovereign debt, down from £900m at the end of 2009, and a further £300m of exposure to Spain and Portugal.
Bernstein's observations were contained in a report entitled European banks and insurers: debt crisis over? which deals with the massive European debt package announced on Monday by the European Union, IMF and European Central Bank.
The research firm says three further issues need to be resolved to make the liquidity injection -- of up to €1.7trn in Bernstein's analysis --succeed:
- the mechanics of contagion need to be halted, i.e., the transfer of sovereign debt issues through the banks' balance sheets from one country to another have to be broken. The French and German banks are crucial, notes Bernstein. These carry the lions' share of the cross-border exposure of the key countries. It's encouraging that German banks and insurers have committed to support the Greek bail-out with €8.1bn of their own funds. However, Bernstein remains concerned about insurers and pension funds, where strict mandates and tight capital requirements could still force a sell-off.
- bringing the European countries back to fiscal health through tough austerity programmes is not the most promising solution to tackle indebtedness, observes Bernstein. These programmes could lead to a further significant contraction in GDP, which would bring down tax revenues, while at the same time increasing unemployment, which would weigh on the expense side.
- the coincidental sell-off in the US equity markets on 6 May highlighted the close arbitrage links across financial markets where "everything is correlated". Such close links across asset classes erode the diversification benefit which allows banks and insurers to maintain large and levered balance sheets and ultimately provide funding in riskier asset classes. Hence, says Bernstein, "it is necessary to break up these arbitrage links, one of which is the link between equities and naked credit default swaps."
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